Cray Annual Report 2005 | Quarterlytics

FY2005 Annual Report · Cray

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2005 Annual Report Notice of 2006 Annual Meeting and Proxy StatementCray Inc. 411 First Avenue S., Suite 600 Seattle, WA 98104-2860 USAFellow Shareholders:

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The year 2005 was marked by dramatic and important change at Cray. As reÖected in our stock
performance and, in particular, our Ñrst half operating results, change on behalf of our shareholders was clearly
required. Ultimately, our goal is to create shareholder value by innovating on behalf of our customers and
delivering to them value in the form of world-class supercomputers, service and support.

We took a number of steps towards achieving this goal: adding key management personnel to improve
leadership and execution capability, reÑning our product strategy to focus on leadership technology develop-
ment and initiating operational adjustments intended to reduce our cost structure and increase eÇciencies. I
Ñrmly believe that as a consequence of these actions, we have improved Cray's position in the marketplace and
have provided the framework to once again grow and achieve sustained proÑtability.

Our Progress

In 2005 we increased our revenue to $201 million, a 38% improvement over 2004. This growth came by
extending our reach internationally and increasing market share in key segments around the world. While we
continued to strengthen our customer base in the intelligence, defense and scientiÑc research communities, we
also expanded our presence in other high performance computing sectors, such as earth sciences and
computer-aided engineering. In Europe, we increased our customer base signiÑcantly, adding inÖuential
organizations like the Swiss National Supercomputing Centre and within the current year, the United
Kingdom's AWE plc. It was also a record year in revenue for Cray Japan where we added marquee customers,
including the Sony Corporation and Toyota Auto Body. We further solidiÑed our North American customer
base with the addition of leading scientiÑc organizations, such as the Maui High Performance Computing
Center and the Pittsburgh Supercomputing Center.

From an operating perspective, we are seeing positive results of our cost-cutting measures in the form of
reduced operating expenses, positive cash Öow in the second half of 2005, and a greatly improved balanced
sheet, ending the year with a $46 million cash position. We delayed Ñling our 2005 Form 10-K due to the
investigation and subsequent resolution of a non-cash revenue recognition error that we discovered relative to
our 2004 Ñnancial results and have restated our 2004 Ñnancial statements to correct this error. We have
addressed all of the material weaknesses identiÑed in our 2004 Sarbanes-Oxley compliance assessment and are
pleased to say that we and our external auditors agree that the necessary internal controls are operating
eÅectively as of year-end 2005.

Today we are experiencing strong customer support of our existing systems and expect increasing success
with our planned product introductions over the next few years. Just in the past year, our customers have
exploited the unmatched capabilities of Cray supercomputers, resulting in remarkable scientific and engineering
breakthroughs. A handful of such accomplishments achieved on Cray's current computing platforms include:

‚ Korea Meteorological Administration is using its Cray X1ETM supercomputer, the fastest operational
numerical weather prediction system in the world, to facilitate development and operational services
for weather prediction and climate study, resulting in more accurate and timely weather, seasonal
climate and ocean wave forecasts.

‚ Using a Cray XT3TM system at Oak Ridge National Laboratory, researchers looking at alternative fuel
sources like fusion have been able to run the largest ever simulation of plasma behavior in a tokamak
(a type of plasma containment system) at the core of the multinational collaborative project known as
the International Thermonuclear Experimental Reactor (ITER). Viable tokamaks are a critical
element in potentially harnessing this virtually unlimited source of environmentally safe electricity.

‚ Leading golf equipment designer and manufacturer, PING Inc., is using the Cray XD1TM system as a
critical part of its research and development program, reducing the time needed to conduct preliminary
structural tests of new club designs from weeks to hours.

‚ Researchers are using the Cray X1E supercomputer at the Army High Performance Computing
Research Center to develop application software to simulate Öuid Öow in and around dynamically
changing structures. This technology is likely to have a dramatic impact on expanding the use of
supercomputing to address more complex multi-physics problems in applied science and engineering.
They have successfully simulated a variety of complex mechanical designs, such as an artiÑcial heart,
micro-unmanned aerial vehicles, rotocrafts, engines and turbines, as well as natural phenomena like the
Öapping of a hummingbird's wings.

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‚ Researchers using ""Red Storm,'' the Cray XT3 supercomputer at Sandia National Laboratories, are
exploring our universe in new ways. The Golevka asteroid has been an object of special interest since
2003, when NASA scientists discovered its course had changed, renewing interest in predicting
asteroids' paths and learning how to deÖect any that might be headed for Earth. Although Golevka is
not currently on a collision course with our planet, the available data on this well-studied asteroid has
enabled scientists at Sandia to simulate the eÅects of a hypothetical, 10-megaton explosion at
Golevka's center, a calculation that ran for 12 hours on over 7,000 of Red Storm's processors.

Our Direction and Vision

Our focus is on regaining market leadership in capability-class supercomputing through innovation and
execution. It is through innovation that our customers hope to achieve their goals, and therefore what we strive
to deliver. Execution, from cost containment to revenue growth as well as timely, high-quality product
introductions, requires eÅective coordination across a strong management team and the commitment of a
talented employee base. I believe that we have built a Cray team that is focused on execution, innovation and
regaining market leadership.

Continuous innovation is an everyday theme at Cray as we push to provide capability computing for
scientists and engineers at the forefront of technology. Even as our customers break new, exciting barriers
using Cray systems, their need for even higher performance is unlimited. Increasingly, problems and
applications are becoming more complex with computing requirements that surpass the limits of today's
technologies. We see this as a tremendous opportunity to create a paradigm shift in the industry and
reestablish Cray's market leadership. We envision a new supercomputing platform that integrates not one but
multiple processing technologies into a single, highly-scalable system that can adapt to the unique needs of
each application, providing superior performance and enhanced user productivity. We call this vision Adaptive
Supercomputing.

We believe the Adaptive Supercomputing approach is ideally suited to address the limitations of today's
supercomputers. Ultimately, the concept of Adaptive Supercomputing will enable our customers to overcome
barriers and accomplish their mission-critical goals. Given the breadth of our core technologies, the proven
capability of our supercomputing products and the talents of our team, we believe that we are uniquely
positioned to deliver on this vision.

In closing, I would like to welcome our new Chairman, Steve Kiely. I feel privileged to work with Steve
and believe his appointment is serving the Company and our shareholders well. I would also like to recognize
and thank our original founders, Jim Rottsolk and Burton Smith, for their many years of devotion to our
company. Cray would not exist today if it were not for their dedication, leadership and innovative thinking Ì I
know that their passion for supercomputing and the Cray legacy will live on in our new management team.

With the changes we have made in management, strategy and operations, I believe we will look back on
2005 as the year we fundamentally repositioned Cray for a return to leadership in the supercomputing
market Ì and I am very excited to be part of it. Moreover, I believe the objectives we have established will
position Cray for achieving sustained proÑtability and creating shareholder value.

On behalf of our Board of Directors and management, I would like to thank all of our employees,
customers, partners and shareholders for your continued support and loyalty to the most innovative
supercomputing company in the world.

PETER J. UNGARO
Chief Executive OÇcer and President

NOTICE OF 2006 ANNUAL MEETING OF SHAREHOLDERS

Dear Cray Inc. Shareholder:

You are cordially invited to attend the Annual Meeting of Shareholders of Cray Inc. which will be held at
our corporate headquarter offices located at Merrill Place, 411 First Avenue South, Seattle, Washington
98104-2860, on June 6, 2006, at 10:00 a.m.

At the Annual Meeting, shareholders will have the opportunity to vote on the following matters:

1. To elect eight directors, each to serve a one-year term;

2. To approve an amendment to our Restated Articles of Incorporation to effect a one-for-four

reverse stock split of all outstanding and authorized shares of our common stock;

3. To approve an amendment to our Restated Articles of Incorporation to increase the number of
authorized shares of common stock from 150,000,000 shares to 300,000,000 shares (on a pre-
split basis);

4. To approve our 2006 Long-Term Equity Compensation Plan; and

5. To conduct any other business that may properly come before the meeting, and any adjourn-

ments of the meeting.

If you were a shareholder of record on April 17, 2006, the record date for the Annual Meeting, you are

entitled to vote on these matters.

At the Annual Meeting, we will review our performance during the past year and comment on our

outlook. You will have an opportunity to ask questions about Cray and our operations.

Regardless of the number of shares you own, your vote is important. You may vote using any of the

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following methods:

‚ by Internet;
‚ by telephone;
‚ by proxy card; or
‚ in person at the Annual Meeting.

Voting by the Internet or by telephone is fast, convenient and your vote is immediately confirmed and
tabulated. You also help us reduce postage and proxy tabulation costs. Or you may sign and return the proxy
card in the enclosed envelope. Even if you plan to attend the Annual Meeting, we urge you to vote at your
earliest convenience so we avoid further solicitation costs. Any shareholder attending the meeting may vote in
person even if he or she has voted previously.

Details of the business to be conducted at the Annual Meeting are more fully described in the

accompanying Proxy Statement.

We look forward to seeing you. Thank you for your ongoing support of and interest in Cray.

Sincerely,

PETER J. UNGARO
Chief Executive Officer and President

Seattle, Washington
April 28, 2006

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PROXY STATEMENT

TABLE OF CONTENTS

Information About the Annual Meeting and Voting ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Our Common Stock Ownership ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Section 16(a) Beneficial Ownership Reporting Compliance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Corporate Governance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
The Board of DirectorsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
The Committees of the Board ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Lead Director; Chairman of the BoardÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Shareholder Communications, Director Candidate Recommendations and Nominations and Other
Shareholder ProposalsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
How We Compensate Directors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Director Attendance at Annual MeetingsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
The Executive Officers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
How We Compensate Executive Officers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Management Agreements and Policies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Compensation Committee Interlocks and Insider ParticipationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Report on Executive Compensation for 2005 by the Compensation Committee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Legal Proceedings and Indemnification ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Independent Registered Public Accounting Firms ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Change in Independent Registered Public Accounting Firms ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Information Regarding Our Independent Registered Public Accounting Firms ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Services and Fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Audit Committee Pre-Approval PolicyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Report on the 2005 Financial Statements and Independent Registered Public Accounting Firms by

the Audit Committee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Stock Performance Graph ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Discussion of Proposals Recommended by the Board ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Proposal 1: To Elect Eight Directors For One-Year TermsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Proposal 2: To Approve an Amendment to Our Restated Articles of Incorporation to Effect a One-

for-Four Reverse Stock Split of all Outstanding and Authorized Shares of Our Common StockÏÏÏ

Proposal 3: To Approve an Amendment to Our Restated Articles of Incorporation to Increase the
Number of Authorized Shares of Common Stock from 150,000,000 to 300,000,000 Shares (on a
pre-split basis) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Proposal 4: To Approve Our 2006 Long-Term Equity Compensation Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other Business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Appendix A: RCW Chapter 23B.13 of the Washington Business Corporation Act Regarding

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Dissenters' Rights ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ A-1
Appendix B: 2006 Long-Term Equity Compensation Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1

IMPORTANT

Whether or not you expect to attend the Annual Meeting in person, we urge you to vote at your
earliest convenience. You may vote by Internet or by telephone, or sign, date and return the enclosed
proxy card. Promptly voting by Internet or by telephone or returning the proxy card will save us the
expense and extra work of additional solicitation. If you wish to return the proxy card by mail, an
addressed envelope for which no postage is required if mailed in the United States is enclosed for that
purpose. Voting by Internet or by telephone or sending in your proxy card will not prevent you from
voting your shares at the meeting if you desire to do so, as you may revoke your earlier vote.

CRAY INC.
411 First Avenue South, Suite 600
Seattle, Washington 98104-2860

PROXY STATEMENT FOR
ANNUAL MEETING OF SHAREHOLDERS
June 6, 2006

INFORMATION ABOUT THE ANNUAL MEETING AND VOTING

Q: Why did you send me this Proxy Statement?

A: We sent you this Proxy Statement and the enclosed proxy card because our Board of Directors is soliciting
your proxy to vote your shares of common stock at the 2006 Annual Meeting of Shareholders. This proxy
may also be used at any adjournment of that meeting.

This Proxy Statement summarizes the information regarding the matters to be voted upon at the Annual
Meeting. You do not need to attend the Annual Meeting to vote your shares. You may vote by Internet or
by telephone or complete, sign and return the enclosed proxy card.

We began sending this Proxy Statement out on or about April 28, 2006, to all shareholders entitled to vote.
If you owned shares of our common stock at the close of business on April 17, 2006, the record date for the
Annual Meeting, you are entitled to vote those shares. On the record date, there were 91,750,299 shares of
our common stock outstanding, our only class of stock having general voting rights.

Q: How many votes do I have?

A: You have one vote for each share of our common stock that you owned on the record date. The proxy card

indicates the number of shares you owned on the record date.

Q: How can I vote?

A: You may vote by using the Internet, by telephone, by returning the enclosed proxy card or by voting in

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person at the Annual Meeting.

Q: How do I vote by Internet or by telephone?

A: For Shares Registered Directly in Your Name:

If your shares are registered directly in your name, you may vote on the Internet or by telephone through
services offered by our transfer agent, Mellon Investors Services LLC. Internet voting is available at the
following address: http://proxyvoting.com/cray. You should read this Proxy Statement and be prepared to
vote, and have available your 11-digit control number located on the right side at the bottom of your proxy
card.

To vote by telephone, please use a touch-tone phone and call 1-866-540-5760 (toll-free). You will be
asked to enter your 11-digit control number located on your proxy card.

You may vote by Internet or by telephone 24 hours a day, 7 days a week until 11:59 p.m. Eastern Daylight
Time/8:59 p.m. Pacific Daylight Time on June 5, 2006, the day before the Annual Meeting.

For Shares Registered in the Name of a Brokerage Firm or Bank:

A number of brokerage firms and banks participate in a program for shares held in ""street name'' that
offers Internet and telephone voting options. This program is different from the program provided by
Mellon Investor Services LLC, for shares registered directly in the name of the shareholder. If your shares
are held in an account at a brokerage firm or bank participating in this program, you may vote those shares
by using the web site or calling the telephone number referenced on your voting form and following the
instructions provided by your broker or banker.

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Q: How do I vote by proxy?

A: If you properly fill in your proxy card and send it to us in time to vote, your ""proxy'' (one of the individuals
named on your proxy card) will vote your shares as you have directed. If you sign the proxy card but do not
make specific choices, your proxy will vote your shares as recommended by the Board as follows:

""for'' electing the eight nominees for director, each to serve one-year terms;

""for'' approval of an amendment to our Restated Articles of Incorporation to effect a one-for-four
reverse stock split of all outstanding and authorized shares of our common stock;

""for'' approval of an amendment to our Restated Articles of Incorporation increasing the number of
authorized shares of common stock from 150,000,000 to 300,000,000 shares (on a pre-split basis); and

""for'' approval of our 2006 Long-Term Equity Compensation Plan.

If any other matter is presented, your proxy will vote in accordance with his best judgment. At the time we
printed this Proxy Statement, we knew of no matters that needed to be acted on at the Annual Meeting
other than those discussed in this Proxy Statement.

Q: May I change my vote or revoke my proxy?

A: Yes. If you change your mind after you have voted by Internet or telephone or sent in your proxy card and

wish to revote, you may do so by following these procedures:

1. Vote again by Internet or by telephone;

2. Send in another signed proxy with a later date;

3. Send a letter revoking your vote or proxy to our Corporate Secretary at our offices in Seattle,

Washington; or

4. Attend the Annual Meeting and vote in person.

We will tabulate the latest valid vote or instruction that we receive from you.

Q: How do I vote if I hold shares in my Cray 401(k) account?

A: Shares of Cray stock held in the Cray 401(k) Savings Plan and Trust (the ""401(k) Plan'') are registered
in the name of the Trustee of the 401(k) Plan, Fidelity Management Trust Company. Nevertheless, under
the 401(k) Plan participants may instruct the Trustee how to vote the shares of Cray common stock
allocated to their accounts.

The shares allocated under the 401(k) Plan can be voted by submitting voting instructions by Internet, by
telephone or by mailing in a special proxy card with respect to the shares held in the participant's account;
this card has a blue stripe at the top. Voting of shares held in the 401(k) Plan must be completed by the
close of business on Thursday, June 1, 2006. These shares cannot be voted at the Annual Meeting and
prior voting instructions cannot be revoked at the Annual Meeting. Otherwise, participants can vote these
shares in the same manner as described above for shares held directly in the name of the shareholder.

The Trustee will cast votes for shares in the 401(k) Plan according to each participant's instructions. If the
Trustee does not receive instructions from a participant in time for the Annual Meeting, the Trustee will
vote the participant's allocated shares in the same manner and proportion as the shares with respect to
which voting instructions were received.

Q: How do I vote in person?

A: If you plan to attend the Annual Meeting and vote in person, we will give you a ballot when you arrive. If
your shares are held in the ""street name'' of your bank or brokerage firm, you must obtain a ""legal proxy''
from the bank or brokerage firm that holds your shares. You should contact your bank or brokerage
account executive to learn how to obtain a legal proxy.

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Q: What is the quorum requirement for the meeting?

A: The quorum requirement for holding the meeting and transacting business is a majority of the outstanding
shares entitled to be voted. The shares may be present in person or represented by proxy at the meeting.
Both abstentions and broker non-votes are counted as present for the purpose of determining the presence
of a quorum.

Q: What vote is required to approve each proposal?

A: Proposal 1: To Elect Eight Directors For One-Year Terms.

The eight nominees for Director who receive the most votes will be elected. Accordingly, if you do not vote
for a nominee, or you indicate ""withhold authority to vote'' for a nominee on your proxy card, your vote
will not count either ""for'' or ""against'' the nominee.

Proposal 2: To Approve an Amendment to Our Restated Articles of Incorporation to Effect a One-for-
Four Reverse Stock Split of All Outstanding and Authorized Shares of Our Common Stock.

The affirmative vote of a majority of the outstanding shares of our common stock entitled to vote is
required to approve the amendment to our Restated Articles of Incorporation to effect a one-for-four
reverse stock split of all outstanding and authorized shares of our common stock. If you do not vote, or if
you abstain from voting on any proposal, it has the same effect as if you voted against such proposal.

Proposal 3: To Approve an Amendment to Our Restated Articles of Incorporation To Increase the
Number of Authorized Shares of Common Stock from 150,000,000 to 300,000,000 Shares (on a pre-split
basis).

The affirmative vote of a majority of the outstanding shares of our common stock entitled to vote is
required to approve the amendment to our Restated Articles of Incorporation to increase the number of
authorized shares of common stock from 150,000,000 to 300,000,000 shares (on a pre-split basis). If you
do not vote, or if you abstain from voting, it has the same effect as if you voted against this proposal.

Proposal 4: To Approve Our 2006 Long-Term Equity Compensation Plan.

To approve our 2006 Long-Term Equity Compensation Plan, the number of shares voted in favor of the
proposal must exceed the number of shares voted against. If you do not vote, or if you abstain from voting,
it has no effect on this proposal.

Q: What is the effect of broker non-votes?

A: If your broker holds your shares in its ""street name'' and does not receive voting instructions from you,

your broker nevertheless may vote your shares on Proposals 1, 2 and 3 but not on Proposal 4.

If a broker does not vote for a particular proposal, that is considered a broker non-vote. Broker non-votes
will be counted for the purpose of determining the presence of a quorum.

A broker non-vote on Proposals 2 and 3 would have the same effect as a vote against these proposals,
because passage requires the affirmative vote by holders of a majority of the outstanding shares of common
stock.

A broker non-vote would have no effect on the outcome of Proposal 1 or Proposal 4 as only a plurality of
votes cast is required to elect a Director and a majority of the votes cast is required to approve our 2006
Long-Term Equity Compensation Plan.

Q: Who will count the vote?

A: Representatives of Mellon Investor Services LLC, our transfer agent, will serve as the Inspector of

Elections and count the votes.

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Q: Is voting confidential?

A: We keep all the proxies, ballots and voting tabulations private as a matter of practice. We let only our
Inspector of Elections (Mellon Investor Services LLC) examine these documents. We will not disclose
your vote to our management unless it is necessary to meet legal requirements. We will forward to
management, however, any written comments that you make on the proxy card or elsewhere.

Q: Who pays the costs of soliciting proxies for the Annual Meeting?

A: We will pay all the costs of soliciting these proxies. Although we are mailing these proxy materials, our
officers and employees may also solicit proxies by telephone, by fax, via the Internet or other electronic
means of communication, or in person. No additional compensation will be paid to officers or employees
for their assistance in soliciting proxies. We will reimburse banks, brokers, nominees and other fiduciaries
for the expenses they incur in forwarding the proxy materials to you. W. F. Doring & Co., Inc. may help
solicit proxies for an approximate cost of $5,000 plus reasonable expenses.

Q: I receive multiple copies of the Proxy Statement and Annual Report on Form 10-K, and other documents

from Cray. Can I reduce the number of copies that I receive?

A: Yes, if you own shares through a brokerage firm, bank or other nominee.

Householding, a process that reduces the number of copies of the annual meeting materials and other
correspondence you receive through us, has been implemented for shareholders who share the same last
name and address and hold shares in ""street name,'' where the shares are held through the same brokerage
firm, bank or other nominee. This has saved us sending over 7,500 additional copies this year. If you hold
your shares in street name and would like to start, or stop, householding, please call 1-800-542-1061 and
provide the name of your broker, bank or other nominee and your account number(s).

We will deliver promptly upon written or oral request a separate copy of the annual meeting materials to a
shareholder at a shared address to which a single copy of such materials had been delivered.

Q: As a registered shareholder, can I view future proxy statements, annual reports and other documents over

the Internet, and not receive any hard copies through the mail?

A: Yes. If you wish to elect to view future proxy statements, annual reports and other documents only over the
Internet, please visit the Mellon Investor Service Direct web page, www.melloninvestor.com/isd/, and
follow the instructions for establishing a personal identification number and obtaining your documents
electronically. Your election to view these documents over the Internet will remain in effect until you
revoke it. Please be aware that if you choose to access these materials over the Internet, you may incur
costs such as telephone and Internet access charges for which you will be responsible.

Q: Whom should I call if I have any questions?

A: If you have any questions about the Annual Meeting or voting, or your ownership of our common stock,
please contact Kenneth W. Johnson, our Corporate Secretary, at (206) 701-2000. Mr. Johnson's email
address is ken@cray.com.

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OUR COMMON STOCK OWNERSHIP

The following table shows, as of April 17, 2006, the number of shares of our common stock beneficially
owned by the following persons: (a) all persons we know to be beneficial owners of at least 5% of our common
stock, (b) our directors, (c) the executive officers named in the Summary Compensation Table and (d) all
directors and executive officers as a group. As of April 17, 2006, there were 91,750,299 shares of our common
stock outstanding.

Name and Address*(1)

5% Shareholders
Terren S. Peizer(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

11111 Santa Monica Blvd., #650
Los Angeles, CA 90025

Common
Shares
Owned

Options or
Warrants
Exercisable
Within
60 Days

Total Beneficial
Ownership

Percentage

5,157,198

5.32%

Wells Fargo & Company(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

10,319,173

200,000

10,519,173

11.44%

420 Montgomery Street
San Francisco, CA 94104

Independent Directors
John B. Jones, Jr. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Kenneth W. Kennedy, Jr. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Stephen C. KielyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Frank L. LedermanÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Sally G. Narodick ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Daniel C. RegisÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Stephen C. RichardsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Named Executives
Peter J. Ungaro(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
James E. Rottsolk(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Brian C. Henry(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Margaret A. Williams(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Steven L. Scott ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Kenneth W. Johnson(4)(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Burton J. SmithÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

All directors and executive officers as a group

7,800
1,292
30,000
0
5,000
10,000
25,000

642,436
161,127
350,000
358,734
2,179
193,775
205,275

48,333
117,500
129,000
60,000
50,000
50,001
50,000

1,600,000
860,000
500,000
300,000
525,773
530,200
0

56,133
118,792
159,000
60,000
55,000
60,001
75,000

2,242,436
1,021,127
850,000
658,734
527,952
723,925
205,275

**
**
**
**
**
**
**

2.40%
1.10%
**
**
**
**
**

(16 persons)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

2,177,768

5,098,728

7,276,496

7.51%

* Unless otherwise indicated, all addresses are c/o Cray Inc., 411 First Avenue South, Suite 600, Seattle,

WA 98104-2860.

** Less than 1%

(1) This table is based upon information supplied by the named executive officers, directors and 5%
shareholders, including filings with the Securities and Exchange Commission (the ""SEC''). Unless
otherwise indicated in these notes and subject to community property laws where applicable, each of the
listed shareholders has sole voting and investment power with respect to the shares shown as beneficially
owned by such shareholder. The number of shares and percentage of beneficial ownership includes shares
of common stock issuable pursuant to stock options and warrants held by the person or group in question,
which may be exercised or converted on April 17, 2006, or within 60 days thereafter.

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(2) Mr. Peizer has sole voting and dispositive powers regarding the shares of common stock underlying
certain warrants, which are held of record by Laphroig LLC (warrants for 4,882,438 shares) and Chinaco
LLC (warrants for 256,970 shares).

(3) The information under the column ""Common Shares Owned'' is based on a Schedule 13G filed with the
SEC on February 15, 2006, regarding ownership as of December 31, 2005. In that Schedule 13G, Wells
Fargo & Company, as parent company, reported sole voting power over 10,078,142 shares and sole
dispositive power over 10,319,173 shares, with one subsidiary, Wells Capital Management Incorporated,
reporting sole voting power over 2,650,002 shares and sole dispositive power over 9,896,478 shares and
another subsidiary, Wells Fargo Funds Management, LLC, reporting sole voting power over
7,428,140 shares and sole dispositive power over 422,695 shares. We have issued a common stock
purchase warrant to Wells Fargo Foothill, Inc., which we believe is affiliated with the foregoing entities,
covering 200,000 shares, which is not reflected on the Schedule 13G.

(4) The number of common shares shown for the indicated executive officers includes restricted shares which
vest on June 30, 2007, and are forfeitable in certain circumstances, as follows: Mr. Ungaro Ì
600,000 shares, Mr. Henry Ì 350,000 shares, Ms. Williams Ì 350,000 shares, Mr. Johnson Ì
100,000 shares, and other executive officers Ì 150,000 shares.

(5) Mr. Rottsolk disclaims beneficial ownership of 5,871 shares for which he has voting and dispositive

powers as custodian for his son under the Washington Uniform Gifts to Minors Act.

(6) Mr. Johnson disclaims beneficial ownership of 2,600 shares for which he has voting and dispositive
powers as a trustee of trusts for the benefit of his children, 100 shares owned by his wife and 500 shares
owned by a child.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 (the ""Exchange Act'') requires that our directors,
executive officers and greater-than-10% shareholders file reports with the SEC on their initial beneficial
ownership of our common stock and any subsequent changes. They must also provide us with copies of the
reports.

We are required to tell you in this Proxy Statement if we know about any failure to report as required. We
reviewed copies of all reports furnished to us and obtained written representations that no other reports were
required. Based on this, we believe that all of these reporting persons complied with their filing requirements
for 2005.

CORPORATE GOVERNANCE

The goals of our Board of Directors are to build long-term value for our shareholders and to assure our
vitality for our customers, employees and others that depend on us. Our Board has adopted and follows
corporate governance practices that our Board and our senior management believe promote these purposes,
are sound and represent best practices. To this end we have adopted charters for each of our Board
committees, guidelines for our corporate governance and a Code of Business Conduct that applies to all of our
directors, officers and employees. We periodically review these governance practices against requirements of
the SEC, the listing standards of the Nasdaq National Market System (""Nasdaq''), the laws of the State of
Washington and practices suggested by recognized corporate governance authorities.

The Board of Directors

The Board of Directors oversees our business and affairs and monitors the performance of management.
In accordance with corporate governance principles, the Board does not involve itself in day-to-day operations.
The directors keep themselves informed through discussions with the Chief Executive Officer, other key
executives and our principal external advisers (legal counsel and outside auditors), by reading the reports and
other materials that we send them regularly and by participating in Board and committee meetings.

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Currently our Board has eight members. The Board has determined that seven directors, identified on the
Common Stock Ownership table above, meet the Nasdaq National Market System standards for indepen-
dence. Only independent directors serve on our Audit, Compensation and Corporate Governance Committees.

The Board met ten times and the Board standing committees held a total of 35 meetings during 2005.
Each director attended at least 95% of the meetings of the Board and relevant standing committees on which
such director served. The average attendance for all directors at Board and standing committee meetings was
over 98%.

The Committees of the Board

The Board has established an Audit Committee, a Compensation Committee and a Corporate Govern-
ance Committee as standing committees of the Board. None of the Directors who serve as members of these
committees is, or has ever been, one of our employees.

Audit Committee. The current members of the Audit Committee are: Daniel C. Regis (Chair), Sally
G. Narodick and Stephen C. Richards. The Audit Committee and the Board have determined that each
member of the Audit Committee is ""independent,'' as that term is defined in SEC and Nasdaq National
Market rules and regulations, and that Mr. Regis is an ""audit committee financial expert,'' as that term is
defined in SEC regulations. The Audit Committee had 25 meetings during 2005. The Audit Committee
assists the Board of Directors in fulfilling its responsibility for oversight of:

‚ the quality and integrity of our accounting and financial reporting processes and the audits of our

financial statements,

‚ the qualifications and independence of the public auditing firm engaged to issue an audit report on our

financial statements,

‚ the performance of our systems of internal controls, disclosure controls and internal audit

functions, and

‚ our procedures for legal and regulatory compliance, risk assessment and business conduct standards.

The Audit Committee is directly and solely responsible for appointing, determining the compensation
payable to, overseeing, terminating and replacing any independent auditor engaged by us for the purpose of
preparing or issuing an audit report or performing other audit, review or attest services for us.

The Audit Committee charter and the Code of Business Conduct are available on our web site:
www.cray.com under ""Investors Ì Corporate Governance Ì Committee Charters'' and ""Ì Governance Doc-
uments,'' respectively. The report of the Audit Committee regarding its review of the financial statements and
other matters is set forth below on page 29.

Compensation Committee. The current members of the Compensation Committee are: Frank L.
Lederman (Chair), John B. Jones, Jr., Kenneth W. Kennedy, Jr., Stephen C. Kiely and Stephen C. Richards
(who joined the Committee in October 2005). The Compensation Committee and the Board have determined
that each member of the Compensation Committee is ""independent,'' as that term is defined in Nasdaq rules
and regulations. The Compensation Committee held seven meetings in 2005. The Compensation Committee
assists the Board of Directors in fulfilling its responsibilities for the oversight of:

‚ our compensation policies, plans and benefit programs,

‚ the compensation of the chief executive officer and other executive officers, and

‚ the administration of our equity compensation plans.

Our compensation policies, plans and programs are designed to attract and retain the best personnel to
allow us to achieve our goals and maintain our competitive posture. We seek to foster an environment that
rewards superior performance and aligns the interests of our employees to the long-term interests of our
shareholders through equity incentives. The Compensation Committee has the authority to determine the
compensation of our executive officers other than the Chief Executive Officer. The Board (acting in executive

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session without the presence of the Chief Executive Officer) determines the compensation of the Chief
Executive Officer based on the recommendation of the Committee.

The Compensation Committee adopted a charter that has been approved by the Board of Directors. The
Compensation Committee charter is available on our web site: www.cray.com under ""Investors Ì Corporate
Governance Ì Committee Charters.'' Each year, the Compensation Committee reports to you on executive
compensation. The Compensation Committee's Report on Executive Compensation for 2005 is set forth below
beginning on page 18.

Corporate Governance Committee. The current members of the Corporate Governance Committee are:
Stephen C. Kiely (Chair), Frank L. Lederman and Daniel C. Regis. The Corporate Governance Committee
and the Board have determined that each member of the Corporate Governance Committee is ""independent,''
as that term is defined in Nasdaq National Market rules and regulations. The Corporate Governance
Committee held three meetings in 2005. The Corporate Governance Committee has the responsibility to:

‚ develop and recommend to the Board a set of corporate governance principles,

‚ recommend qualified individuals to the Board for nomination as directors,

‚ lead the Board in its annual review of the Board's performance, and

‚ recommend directors to the Board for appointment to Board committees.

The Corporate Governance Committee has adopted a charter and Corporate Governance Guidelines,
both of which have been approved by the Board of Directors. The Corporate Governance Committee charter
and the Corporate Governance Guidelines are available on our web site: www.cray.com under ""Investors-
Corporate Governance Ì Committee Charters'' and ""Ì Governance Documents,'' respectively.

From time to time, the Board establishes other committees on an ad-hoc basis to assist in its oversight

responsibilities.

Lead Director; Chairman of the Board

In January 2005 the Board appointed Stephen C. Kiely as Lead Director; in August 2005 Mr. Kiely was
appointed as Chairman of the Board, a non-executive position. As Lead Director and as Chairman, Mr. Kiely
consults with Mr. Ungaro, as Chief Executive Officer, regarding agenda items for Board meetings; chairs
executive sessions of the Board's independent directors; communicates concerns of the independent directors
to the Chief Executive Officer; and performs such other duties as the Board deems appropriate.

Shareholder Communications, Director Candidate Recommendations and Nominations and Other
Shareholder Proposals

Communications. The Corporate Governance Committee has established a procedure for our share-
holders to communicate with the Board. Communications should be in writing, addressed to: Corporate
Secretary, Cray Inc., 411 First Avenue South, Suite 600, Seattle, WA 98104-2860, and marked to the
attention of the Board or any of its individual committees or the Chairman of the Board. Copies of all
communications so addressed will be promptly forwarded to the chairman of the committee involved, in the
case of the communications addressed to the Board as a whole, to the Corporate Governance Committee or, if
addressed to the Chairman, to the Chairman of the Board.

Director Candidates. The criteria for Board membership as adopted by the Board include a person's
integrity, knowledge, judgment, skills, expertise, collegiality, diversity of experience and other time commit-
ments (including positions on other company boards) in the context of the then-current composition of the
Board. The Corporate Governance Committee is responsible for assessing the appropriate balance of skills
brought to the Board by its members, and ensuring that an appropriate mix of specialized knowledge (e.g.,
financial, industry or technology) is represented on the Board.

Once the Corporate Governance Committee has identified a potential director nominee, the Committee
in consultation with the Chief Executive Officer evaluates the prospective nominee against the specific criteria
that the Board has established and as set forth in our Corporate Governance Guidelines. If the Corporate

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Governance Committee determines to proceed with further consideration, then members of the Corporate
Governance Committee, the Chief Executive Officer and other members of the Board, as appropriate,
interview the prospective nominee. After completing this evaluation and interview, the Corporate Governance
Committee makes a recommendation to the full Board, which makes the final determination whether to elect
the new director.

The Corporate Governance Committee will consider candidates for director recommended by sharehold-
ers and will evaluate those candidates using the criteria set forth above. Shareholders should accompany their
recommendations by a sufficiently detailed description of the candidate's background and qualifications to
allow the Corporate Governance Committee to evaluate the candidate in light of the criteria described above,
a document signed by the candidate indicating his or her willingness to serve if elected and evidence of the
nominating shareholder's ownership of our common stock. Such recommendation and documents should be
submitted in writing to: Corporate Secretary, Cray Inc., 411 First Avenue South, Suite 600, Seattle,
WA 98104-2860, marked to the attention of the Corporate Governance Committee.

In addition, our Bylaws permit shareholders to nominate directors at a shareholders' meeting. In order to
nominate a director at a shareholders' meeting, you must notify us not fewer than 60 nor more than 90 days in
advance of the meeting or, if later, by the 10th business day following the first public announcement of the
meeting. In addition, the proposal must contain the information required in our Bylaws for director
nominations, including:

‚ your name and address,

‚ the number of shares of our common stock which you own and when you acquired them,

‚ a representation that you intend to appear at the meeting, in person or by proxy,

‚ each nominee's name, age, address and principal occupation or employment,

‚ all information concerning the nominee that must be disclosed about nominees in proxy solicitations

under the SEC proxy rules, and

‚ each nominee's executed consent to serve as a director if so elected.

The Chairman of the Board, in his discretion, may determine that a proposed nomination was not made

in accordance with the required procedures and, if so, disregard the nomination.

Shareholder Proposals.

In order for a shareholder proposal to be considered for inclusion in our proxy
statement for the 2007 Annual Meeting, we must receive the written proposal no later than December 31,
2006. Such proposals also must comply with SEC regulations regarding the inclusion of shareholder proposals
in company-sponsored proxy materials.

In order for a shareholder proposal to be raised from the floor during the 2006 Annual Meeting, written
notice of the proposal must be received by us not less than 60 nor more than 90 days prior to the meeting or, if
later, by the 10th business day following the first public announcement of the meeting. The proposal must also
contain the information required in our Bylaws for shareholder proposals, including:

‚ a brief description of the business you wish to bring before the meeting, the reasons for conducting such

business and the language of the proposal,

‚ your name and address,

‚ the number of shares of our common stock which you own and when you acquired them,

‚ a representation that you intend to appear at the meeting, in person or by proxy, and

‚ any material interest you have in the business to be brought before the meeting.

The Chairman of the Board, if the facts so warrant, may direct that any business was not properly brought

before the meeting in accordance with our Bylaws.

If you wish to obtain a free copy of our Bylaws, please contact Kenneth W. Johnson, Corporate Secretary,
Cray Inc., 411 First Avenue South, Suite 600, Seattle, WA 98104-2860. The Bylaws are available on our web
site: www.cray.com under ""Investors Ì Corporate Governance Ì Governance Documents.''

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How We Compensate Directors

Cash. Each non-employee Director receives an annual retainer of $10,000, paid quarterly, and a fee of
$2,500 for each meeting of the Board attended in person or $1,000 ($1,500 beginning April 1, 2006) if
attended telephonically. The Chairman of the Board receives an annual fee of $4,000, paid quarterly. The
Audit Committee chair receives an annual fee of $6,000, paid quarterly. The chairs of the Compensation
Committee and the Corporate Governance Committee each receive an annual fee of $2,000, paid quarterly,
and each director receives a fee of $1,000 ($2,000 beginning April 1, 2006) for each committee meeting
attended, whether in person or telephonically. When the Board creates committees other than the standing
committees identified above, the Board determines whether to extend the same committee fee structure to the
members of such committees. We reimburse all expenses related to participation in meetings of the
shareholders, Board and committees.

Equity Awards. Each non-employee director, upon his or her first election to the Board, is granted an
option for 20,000 shares, vesting immediately, and with an exercise price equal to the fair market value of our
common stock on the date of such first election. Prior to 2005, each non-employee director, on the date of the
Annual Meeting, was granted a non-qualified option for 20,000 shares of our common stock, vesting monthly
over the next twelve months and with an exercise price equal to the fair market value of our common stock on
the date of the Annual Meeting. If a non-employee director joined the Board during a term, he or she received
a pro-rata portion of the options for 20,000 shares. In 2005, non-employee directors received options for
20,000 shares that were laddered in installments of 5,000 shares each with per share exercise prices of $2.00,
$2.50, $3.00 and $3.50 each when the per share fair market value of our common stock was $1.47; these
options vested in full on December 31, 2005.

Commencing with the Annual Meeting in 2006, we plan to grant to each continuing non-employee
director elected by the shareholders restricted shares of common stock with a value equal to that director's
fees earned in the previous fiscal year, including annual retainer, fees for chairing the Board and Board
committees and for Board and committee attendance. The per share value of shares granted will be
determined by using the fair market value of our common stock on the date of such election. One-half of the
shares will be restricted against sale or transfer for a period of one year from date of grant; the balance will be
restricted against sale or transfer for a period of two years from the date of grant. The non-employee directors
may vote and receive dividends on the restricted shares while the restrictions remain in place. If a non-
employee director resigns from the Board without the prior approval of the Corporate Governance Committee
while the restrictions are in place, the non-employee director forfeits the shares so restricted. Implementation
of this policy is subject to shareholder approval of the 2006 Long-Term Equity Compensation Plan. If the
shareholders do not approve that Plan, then we will grant stock options to non-employee directors pursuant to
our current practice.

The Board has established stock ownership guidelines pursuant to which, no later than two years after
receiving restricted shares under the new plan, non-employee directors should hold shares of common stock
with at least a value, based on acquisition cost, equal to one-year's Board retainer and Board attendance fees.

We do not compensate employee directors for their service on the Board.

Under the arrangements described above, our directors earned the following amounts for 2005: Daniel J.
Evans (prior to his retirement from the Board) Ì $5,000; John B. Jones, Jr. Ì $40,500; Kenneth W.
Kennedy, Jr. Ì $38,500; Stephen C. Kiely Ì $45,500; Frank L. Lederman Ì $44,000; Sally G. Narodick Ì
$53,000; Daniel C. Regis Ì $65,500 and Stephen C. Richards Ì $53,000. Each director, other than
Mr. Evans, received stock options for 20,000 shares, that were laddered in installments of 5,000 shares each
with per share exercise prices of $2.00, $2.50, $3.00 and $3.50, respectively; these options vested in full on
December 31, 2005.

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Director Attendance at Annual Meetings

We encourage but do not require our directors to attend the Annual Meeting of Shareholders. Although
we usually schedule a regular Board meeting on the morning before the Annual Meeting, we were not able to
schedule a Board meeting on the date of the rescheduled 2006 Annual Meeting. All of our directors attended
the 2005 Annual Meeting.

The Executive Officers

How We Compensate Executive Officers

The tables and text on this and the following pages describe the salaries, bonuses and other compensation
paid during the last three years, options granted in 2005, option values as of year-end 2005 and option
repricings, as applicable, for both individuals who served as our President and Chief Executive Officer in 2005,
our next four most highly compensated executive officers who were serving as executive officers at the end of
2005 and one individual who would have been one of our four most highly compensated executive officers but
for the fact he was not serving as an executive officer at the end of 2005.

Summary Compensation Table

Name and Principal Position

Peter J. Ungaro(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Chief Executive Officer and
President

James E. Rottsolk(5)ÏÏÏÏÏÏÏÏÏÏÏÏ

Chief Executive Officer and
President

Brian C. Henry(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Executive Vice President
and Chief Financial Officer

Fiscal
Year

2005
2004
2003
2005
2004
2003
2005

Annual Compensation

Salary

Bonus(1)

Other Annual
Compensation

$264,262
$283,333
$100,480
$339,333
$350,000
$337,500
$168,641

$413,754

$319,680

$263,813
$281,250

Long-Term
Compensation

Restricted
Stock
Awards(2)

$846,000

$180,000

$131,245
$493,500

Securities
Underlying
Options

700,000
400,000
500,000
200,000
200,000

500,000

All Other
Compen-
sation(3)

$
2,543
$ 3,759
315
$
$662,530
$ 7,658
$ 8,106
2,292
$

Margaret A. Williams(7) ÏÏÏÏÏÏÏÏ

2005

$182,231

$125,000

$493,500

100,000

$ 1,465

Senior Vice President

Steven L. Scott(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Senior Vice President and
Chief Technology Officer

Kenneth W. Johnson(9) ÏÏÏÏÏÏÏÏÏ

Senior Vice President and
General Counsel

Burton J. Smith(10) ÏÏÏÏÏÏÏÏÏÏÏÏ

Chief Scientist

2005
2004
2003
2005
2004
2003
2005
2004
2003

$258,215
$214,400
$211,667
$219,076
$220,000
$217,500
$256,115
$250,000
$246,500

$125,000

$ 64,200
$ 25,000
$ 30,000
$ 88,440
750
$

$100,500

400,000
75,000

316,700
50,000

100,000
100,000

2,662
$
$ 3,756
3,625
$
5,907
$
$
7,713
$ 8,327
5,527
$
$
6,338
$ 8,169

$141,000

$ 43,995

$ 49,996

(1) Bonuses are shown for the year earned. If the bonuses were not paid during the year, they were paid in

the following calendar year.

(2) In 2005 we granted shares of restricted stock to the named executive officers as follows: Mr. Ungaro Ì
600,000 shares; Mr. Henry Ì 350,000 shares; Ms. Williams Ì 350,000 shares; and Mr. Johnson Ì
100,000 shares. All such shares vest on June 30, 2007, and are forfeitable if before such date the officer
is discharged with cause or resigns without good reason, as such terms are defined in the restrictive stock
agreements. If we were to pay dividends on our common stock, the holders of the restricted shares would
be eligible to receive such dividends. The values shown in the above table are based on the closing price
of $1.41 per share for our common stock on the date of grant, December 20, 2005, as reported by
Nasdaq. The restricted shares granted in 2005 are the only restricted shares currently owned by the
named executive officers. As of December 31, 2005, these shares had the following values, based on the

closing price of our common stock of $1.33 per share on December 30, 2005, the last trading day of the
year, as reported by Nasdaq: Mr. Ungaro Ì $798,000; Mr. Henry Ì $465,500; Ms. Williams Ì
$465,000, and Mr. Johnson Ì $133,000.

(3) ""All Other Compensation'' for 2005 includes premiums for group term life insurance policies
(Mr. Ungaro Ì $486, Mr. Rottsolk Ì $3,564, Mr. Henry Ì $542, Ms. Williams Ì $540, Mr. Scott Ì
$477, Mr. Johnson Ì $3,434, and Mr. Smith Ì $3,416) and our matching contributions under our
401(k) Plan (Mr. Ungaro Ì $2,057, Mr. Rottsolk Ì $2,716, Mr. Henry Ì $1,750, Ms. Williams Ì
$925, Mr. Scott Ì $2,185, Mr. Johnson Ì $2,473, and Mr. Smith Ì $2,111).

(4) Mr. Ungaro joined us in August 2003. The amount shown as ""Bonus'' for 2003 includes a one-time
hiring bonus of $250,000. On March 7, 2005, Mr. Ungaro was appointed President. In connection with
his appointment as President, he received a one-time appointment bonus of $300,000 that in part was in
lieu of a payment under a 2004 special incentive plan based on product revenue and gross margin. We
had accrued $88,647 for payment of such 2004 bonus. On August 8, 2005, Mr. Ungaro was named Chief
Executive Officer. The amount shown under ""Bonus'' for 2005 includes an override bonus based on
gross margin pursuant to our March 2005 agreement with Mr. Ungaro.

(5) Mr. Rottsolk was President until March 7, 2005, and Chief Executive Officer until August 8, 2005. He
remained an employee until January 1, 2006. The amount shown under ""All Other Compensation''
includes the amount of $656,250 which is payable to Mr. Rottsolk under our Executive Severance
Policy. This amount is being paid in bi-weekly payments from January 2006 through December 31,
2007.

(6) Mr. Henry joined us as Chief Financial Officer in May 2005. Mr. Henry earned a bonus for 2005 for the
accomplishment of certain goals specified in his offer letter. The amount shown as ""Bonus'' for 2005
also includes a one-time hiring bonus of $200,000, which vests monthly and will vest in full in May 2006;
Mr. Henry agreed to repay the unvested portion of this bonus if he leaves before May 2006.

(7) Ms. Williams joined us as a Senior Vice President in April 2005. The amount shown as ""Bonus'' for
2005 was a one-time hiring bonus which she has agreed to repay to us if she leaves before April 2006.

(8) Mr. Scott was appointed as Senior Vice President in October 2005. He previously served as an employee
from 1992 through mid-July 2005, and rejoined us in September 2005. The amount shown as ""Bonus''
for 2005 was a one-time hiring bonus, of which $63,000 was paid in September 2005 and $62,000 was
paid in March 2006, which Mr. Scott has agreed to repay to us if he leaves before September 2007.

(9) From November 2004 to May 2005, Mr. Johnson also served as our Chief Financial Officer, and the
amounts shown under ""Bonus'' for 2004 and 2005 were for his contributions for accepting this position
on an interim basis in addition to his other responsibilities. Of the options shown as granted to
Mr. Johnson in 2005, 216,700 were outstanding options that were repriced. See the tables below titled
""Option Grants in 2005'' and ""Ten-Year Option Repricings.''

(10) Mr. Smith resigned as an officer and employee effective December 7, 2005. The amount shown under
""Bonus'' includes payments to Mr. Smith for issued patents under a policy available to all employees.

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The following table provides information on option grants in 2005 to each of the executive officers named
in the Summary Compensation Table. All options were granted at or above the fair market value of our
common stock on the date of grant.

Option Grants in 2005

Name

Peter J. Ungaro ÏÏÏÏÏÏÏÏÏ

James E. Rottsolk(7) ÏÏÏÏ

Brian C. Henry ÏÏÏÏÏÏÏÏÏ
Margaret A. Williams ÏÏÏÏ

Steven L. Scott ÏÏÏÏÏÏÏÏÏ

Kenneth W. JohnsonÏÏÏÏÏ

Burton J. Smith(8)ÏÏÏÏÏÏ

Number of
Securities
Underlying
Options
Granted(1)

% of Total
Options
Granted to
Employees in
Fiscal Year(2)

Exercise Price
Per Share

Expiration
Date

Potential Realizable Value
at Assumed Annual Rates
of Stock Price Appreciation
for Option Term

5% (6)

10% (6)

175,000(3)
175,000(3)
175,000(3)
175,000(3)
50,000(3)
50,000(3)
50,000(3)
50,000(3)
500,000

50,000(4)
50,000(4)
50,000(4)
50,000(4)
25,000(3)
25,000(3)
25,000(3)
25,000(3)
25,000(3)
25,000(3)
25,000(3)
25,000(3)
300,000

25,000(3)
25,000(3)
25,000(3)
25,000(3)
29,200(5)
70,000(5)
117,500(5)
25,000(3)
25,000(3)
25,000(3)
25,000(3)

2.74%
2.74%
2.74%
2.74%
0.78%
0.78%
0.78%
0.78%
7.83%
0.78%
0.78%
0.78%
0.78%
0.39%
0.39%
0.39%
0.39%
0.39%
0.39%
0.39%
0.39%
4.70%
0.39%
0.39%
0.39%
0.39%
0.46%
1.10%
1.84%
0.39%
0.39%
0.39%
0.39%

$2.00
$2.50
$3.00
$3.50
$2.00
$2.50
$3.00
$3.50
$1.48
$2.08
$2.50
$2.91
$3.33
$2.00
$2.50
$3.00
$3.50
$2.00
$2.50
$3.00
$3.50
$0.95
$2.00
$2.50
$3.00
$3.50
$1.49
$1.49
$1.49
$2.00
$2.50
$3.00
$3.50

5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/23/15
4/27/15
4/27/15
4/27/15
4/27/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
5/11/15
9/26/15
5/11/15
5/11/15
5/11/15
5/11/15
2/03/09
2/01/10
8/26/12
5/11/15
5/11/15
5/11/15
5/11/15

$ 69,032

$ 19,723

$465,379
$ 65,405
$ 44,405
$ 23,905
2,905
$
9,862
$

9,862

$179,422
9,862
$

$
9,376
$ 28,816
$ 71,273
9,862
$

$ 317,240
$ 229,740
$ 142,240
54,740
$
90,640
$
65,640
$
40,640
$
$
15,640
$1,179,368
$ 165,749
$ 144,749
$ 124,249
$ 103,249
45,320
$
32,820
$
20,320
$
7,820
$
45,320
$
32,820
$
20,320
$
7,820
$
$ 454,694
45,320
$
32,820
$
20,320
$
7,820
$
19,409
$
63,676
$
$ 166,097
45,320
$
32,820
$
20,320
$
7,820
$

(1) The options listed above became vested in full on or before December 31, 2005. All of the executive
officers' options will expire ten years from the date of grant or, if earlier, upon a specified time after
employment terminates.

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(2) We granted options, including repriced options, for an aggregate of 6,388,530 shares to employees in

2005.

(3) On the date these options were granted, the fair market value of our common stock was $1.47 per share.

(4) On the date these options were granted, the fair market value of our common stock was $2.08 per share.

(5) These options, covering an aggregate of 216,700 shares, shown as granted to Mr. Johnson with a per share
exercise price of $1.49, were outstanding options that were repriced to the current fair value of our
common stock on December 20, 2005, the date of repricing. The terms of these options, other than the
exercise price, were not changed.

(6) The amounts reported in the last two columns represent hypothetical values that the executive officers
could realize upon exercise of the options immediately before the expiration of their terms, assuming the
specified compounded rates of appreciation of the price of our common stock over the term of the
options. We have calculated these numbers based on the rules of the SEC and they do not represent our
estimate of future price growth of our common stock. Our common stock may not achieve the rates of
appreciation assumed in this table, and the executive officers may not receive the amounts reflected in
this table. This table does not take into account any appreciation in the price of our common stock from
the date of grant to the current date. Values shown are net of the option exercise price but do not include
deductions for taxes or other expenses associated with the exercise.

(7) Mr. Rottsolk was President until March 7, 2005, and Chief Executive Officer until August 8, 2005. He
remained an employee until January 1, 2006. Mr. Rottsolk's options, if not exercised, expire on
December 31, 2007.

(8) Mr. Smith resigned as an officer and employee effective December 7, 2005, and these options terminated

as of that date.

Aggregated Option Values as of Year-End 2005

The following table provides information, with respect to each of the executive officers named in the
Summary Compensation Table, regarding the value of unexercised options held by them at December 31,
2005, less the applicable option exercise price but without any deduction for applicable taxes. Actual gains, if
any, will depend on the value of our common stock on the date of any sale of the underlying common stock.
No named executive officer exercised any stock options in 2005. All options held by the named executive
officers vested in full on or before December 31, 2005.

Name

Shares Underlying
Unexercised Options at
December 31, 2005

Value of Unexercised
In-the-Money Options at
December 31, 2005(1)

Exercisable

Unexercisable

Exercisable

Unexercisable

Peter J. Ungaro ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
James E. Rottsolk(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Brian C. HenryÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Margaret A. Williams ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Steven L. Scott ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Kenneth W. Johnson ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Burton J. Smith(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

1,600,000
1,754,000
500,000
300,000
525,773
530,200
1,076,000

0
0
0
0
0
0
0

0
$
0
$
0
$
0
$
$113,700
0
$
0
$

$0
$0
$0
$0
$0
$0
$0

(1) ""In-the-money'' stock options are options for which the exercise price is less than the market price of the
underlying stock on a particular date. On December 30, 2005, the last trading date of the year, the closing
per share price of our common stock on the Nasdaq National Market System was $1.33.

(2) Of Mr. Rottsolk's options, a total of 894,000 expired on January 10, 2006, following his termination of

employment. His remaining options, if not exercised, expire on December 31, 2007.

(3) Mr. Smith's options expired on March 7, 2006.

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Ten-Year Option Repricings

In connection with a broad grant of stock options and restricted stock to employees, including executive
officers, on December 20, 2005, we repriced an aggregate of 1,274,260 outstanding stock options previously
granted under plans that permitted repricings, including the options described below to individuals who are, or
who received these stock options when they were, executive officers. Other than lowering the exercise price,
we made no other change to any of the option terms. This is the only time we have repriced outstanding stock
options.

Name

Date

Securities
Underlying Market Price of
Common Stock
Number of
at Time of
Options
Repricing
Repriced

Exercise
Price at
Time of
Repricing

New Exercise
Price

Length of
Original Option
Term Remaining
at Date of
Repricing

Kenneth W. Johnson ÏÏÏÏ
Senior Vice President
and General Counsel
Christopher JehnÏÏÏÏÏÏÏÏ

12/20/05
12/20/05
12/20/05
12/20/05

70,000
29,200
117,500
32,293

Vice President

David R. KieferÏÏÏÏÏÏÏÏÏ
Senior Vice President

12/20/05
12/20/05

75,000
100,000

$1.49
$1.49
$1.49
$1.49

$1.49
$1.49

$7.84
$6.13
$3.95
$3.95

$5.00
$3.95

$1.49
$1.49
$1.49
$1.49

$1.49
$1.49

4.1 years
3.1 years
6.7 years
6.7 years

5.5 years
6.7 years

The report of our Compensation Committee on the repricing of stock options is contained in its Report on

Executive Compensation for 2005 set forth below beginning on page 18.

Equity Compensation Plan Information

The following table provides information as of December 31, 2005, with respect to compensation plans
under which shares of our common stock are authorized for issuance, including plans previously approved by
our shareholders and plans not previously approved by our shareholders.

Plan Category

Number of Shares of
Common Stock to be
Issued Upon Exercise of
Outstanding Options,
Warrants and Rights

Weighted-Average Exercise
Price of Outstanding
Options, Warrants and
Rights

Number of Shares of
Common Stock Available
for Future Issuance Under
Equity Compensation
Plans (excluding shares
reflected in 1st column)

Equity compensation plans

approved by shareholders(1)ÏÏÏ

13,485,363

Equity compensation plans not

approved by shareholders(2)ÏÏÏ

4,515,217

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

18,000,580

$4.72

$2.41

$4.14

2,263,468

100,070

2,363,538

(1) The shareholders approved our 1988, 1995 Independent Director, 1995, 1999 and 2003 stock option
plans, our 2004 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 4 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. On March 21, 2005, the vesting of all employee stock options with per
share exercise prices of $2.36 or higher was accelerated, and on May 11, 2005, the vesting of all employee
stock options with per share exercise prices of $1.47 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 long-term equity compensation plan,

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the Board may grant restricted and performance stock grants in addition to incentive and nonqualified
stock options. Under these option and equity compensation plans approved by shareholders under which
we may grant stock options, an aggregate of 113,599 shares remained available for grant as of
December 31, 2005; we may grant restricted stock and stock bonuses only under the 2004 long-term
equity compensation plan; as of December 31, 2005, only 9,023 shares remained available for grant under
the 2004 long-term equity compensation plan.

Under the 2001 employee stock purchase plan, all employees are eligible to participate and through
December 15, 2005, had the right to purchase shares in three-month offering periods at the lesser of
(a) 85% of the fair market value of the common stock at the beginning of each offering period or
(b) 100% of the fair market value of the common stock at the end of each offering period. Effective
December 16, 2005, the pricing formula was changed to 95% of the fair market value of our common
stock at the end of each offering period. The 2001 employee stock purchase plan covers a total of
4,000,000 shares; at December 31, 2005, we had issued a total of 1,850,131 shares under the 2001 plan
and had a total of 2,149,869 shares available for future issuance. The first two columns do not include the
shares available under the 2001 employee stock purchase plan for the offering period that spans
December 31, 2005, as neither the number of shares to be issued in that offering period nor the offering
price were then 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 6,000,000 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, 2005, under the
2000 non-executive employee stock plan we had options for 3,658,030 shares outstanding and 100,070
options available for grant.

On April 1, 2004, in connection with the acquisition of OctigaBay Systems Corporation, 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. Under the Cray Canada key employee stock option plan, we had 857,187 options
outstanding as of December 31, 2005. On March 8, 2006, the Cray Canada plan was terminated.
Although on December 31, 2005, we had 519,750 options available for grant to individuals eligible under
that plan, we issued no options under the Cray Canada plan between that date and termination of the
Cray Canada plan, and those shares are not included in third column above.

From time to time we have issued warrants as compensation to consultants and others for services
without shareholder approval. As of December 31, 2005, we had no such warrants outstanding.

Management Agreements and Policies

Management Continuation Agreements. We have entered into Management Continuation Agreements
with certain of our employees, including our current executive officers named in the Summary Compensation
Table above. Pursuant to these agreements, each such officer or employee is eligible to receive, in the event
that his or her employment is terminated within three years following a change of control, other than for just
cause, death, disability, retirement or resignation other than for good reason, as such terms are defined in the
agreement, an amount equal to two times his or her annual compensation, continuation of health benefits and
group term life insurance for twenty-four months thereafter and the acceleration of vesting for all options held.
If these severance payments were to constitute ""excess parachute payments'' for federal income tax purposes,
we have agreed to pay any excise taxes due with respect to those ""excess parachute payments,'' and any
further excise taxes and federal and state income taxes due with respect to these additional payments, so that
the employee receives the same after-tax compensation the employee would have received if no excise tax
were imposed.

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Under the Management Continuation Agreements, ""annual compensation'' means one year of base
salary, at the highest base salary rate that was paid to the employee in the 12-month period prior to the date of
his or her termination of employment, plus 100% of the annual bonus which the employee was eligible to
receive in that 12-month period. A ""change of control'' includes a 50% or greater change in voting power
immediately following a merger or an acquisition and certain changes in the composition of the Board of
Directors during a thirty-six month period not initiated by our Board of Directors.

Executive Severance Policy.

In October 2002 the Board adopted an Executive Severance Policy that
covers our officers, including the executive officers named in the Summary Compensation Table. This policy
primarily applies to terminations of employment without cause or resignations for good reason (as such terms
are defined in the policy); this policy does not apply if the Management Continuation Agreements described
above are applicable and does not apply to terminations due to death, disability or retirement. If applicable,
this policy provides for continuation of base salary, exclusive of bonus, for varying periods except as discussed
below. For the Chief Executive Officer, until March 7, 2005, the period was twelve months plus one month for
each year of service as an officer up to a maximum of fifteen months; for senior vice presidents, the period is
nine months plus one month for each year of service as an officer up to a maximum of twelve months; and for
other vice presidents, the period is six months plus one month for each year of service as an officer up to a
maximum of nine months. On March 7, 2005, the Board amended the Executive Severance Plan with respect
to the salary portion of the severance payment to be paid to the Chief Executive Officer and the President.
The Chief Executive Officer receives 100% of the total of the annual base salary and the executive bonus
based on the target established by the Board for each year. The payment to the President is based on his total
annual base salary, the executive bonus based on the target established by the Board for each year and an
override bonus based on gross margin and the Board-approved plan for each year, with the President receiving
200% of such compensation if his employment was terminated before the end of March 2008 and 100% of
such compensation thereafter. On August 8, 2005, in connection with Mr. Ungaro being appointed the Chief
Executive Officer in addition to being the President, the Executive Severance Policy was amended to
eliminate the separate severance payment to the Chief Executive Officer and to provide that the payment
previously payable to the President was for the President and the Chief Executive Officer. This policy also
provides for continued payment of our portion of medical, dental, vision and life insurance benefits, extension
of a period to exercise stock options if permitted by the applicable option agreement and executive
outplacement services. To receive these benefits the officer must provide us with a general release and
continue to comply with his or her confidentiality and other agreements with us. Our obligations under this
policy are unfunded and the Board has the express right to modify or terminate this policy at any time. The
arrangements with Mr. Rottsolk in connection with his resignation effective January 1, 2006, were pursuant to
the Executive Severance Policy as then in effect.

Compensation Agreements with Mr. Ungaro. On March 7, 2005, we entered into a letter agreement
with Mr. Ungaro regarding his appointment as President. Under that agreement, Mr. Ungaro's annual base
salary was increased to $350,000 effective March 1, 2005, he received a one-time appointment bonus of
$300,000 that in part was in lieu of a payment under a 2004 special incentive plan based on product revenue
and gross margin under which we had accrued $88,647 for payment of such 2004 bonus, he is eligible for an
award of 75% of base salary under our executive bonus plan, and he is eligible to receive an override bonus
based on our total gross margin, as the gross margin is reported in our public financial statements. The bonus
is .0035 of the gross margin up to the gross margin target in the plan approved by the Board for such year, and
.006 of gross margin in excess of such approved gross margin. The override bonus is to be paid quarterly, after
filing of the applicable Reports on Forms 10-Q or 10-K with the SEC, with any true-up necessary in the
payment for the fourth quarter of each fiscal year.

Retention Agreements. On December 20, 2005, our Board of Directors approved retention agreements
with each of three executive officers: Peter J. Ungaro, President and Chief Executive Officer; Brian C. Henry,
Executive Vice President and Chief Financial Officer; and Margaret A. Williams, Senior Vice President. The
agreements provide that if the officer remains employed by us on December 31, 2006, and December 31, 2007,
he or she will receive a retention bonus. The amount of the bonus is equal to, for 2006, 100% of the sum of the
officer's base pay in 2006 plus target bonus assuming 100% of target is reached, and, for 2007, 50% of the sum

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of the officer's base pay in 2007 plus target bonus assuming 100% of target is reached. In the event the officer
is terminated without cause or terminates with good reason, as such terms are defined in the agreement,
Mr. Henry and Ms. Williams would receive payment under the retention agreement and, if applicable, a
payment under our Executive Severance Policy, as then in effect; in such event Mr. Ungaro would receive the
higher of the payment under the retention agreement or the Executive Severance Policy, but not payments
under both. An officer would not receive a payment under the retention agreement if he or she were
terminated for cause, died, retired, terminated employment for other than for good reason or because of
disability, as such terms are defined in the retention agreement. If there were a change of control, the Board
then would decide whether the retention agreements would be applicable in addition to the Management
Continuation Agreements described above.

Compensation Committee Interlocks and Insider Participation

The current members of the Compensation Committee are Frank L. Lederman (chair), John B.
Jones, Jr., Kenneth W. Kennedy, Jr. Stephen C. Kiely and Stephen C. Richards. No member of the
Compensation Committee was an officer or employee of Cray Inc. or any of our subsidiaries in 2005 or
formerly. In addition, none of our executive officers served on the board of directors or compensation
committee of any entity whose executive officers included one of our directors.

Report on Executive Compensation for 2005 by the Compensation Committee

The Compensation Committee of the Board of Directors is responsible for reviewing and approving the
compensation philosophy of Cray Inc. and its subsidiaries (together, the ""Company'') and for reviewing on a
periodic basis the competitiveness of the Company's compensation plans and benefits programs to ensure that
these plans and programs serve to attract and retain highly qualified employees, including executive officers, to
motivate all employees to achieve the Company's business objectives and to align the interests of all
employees with the long-term interests of the shareholders.

The Compensation Committee's membership and duties are described above under ""Corporate Govern-

ance Ì The Board of Directors Ì The Committees of the Board Ì Compensation Committee.''

Philosophy

The Company's compensation philosophy is to provide policies, plans and programs designed to attract
and retain the best personnel at all levels to allow it to achieve its goals and maintain its competitive posture.
The Company's executive officer compensation policies are founded on these same principles. Pursuant to this
overall approach:

‚ Compensation is based on the level of job responsibility, individual performance and Company
performance. As employees assume greater levels of responsibility, an increasing proportion of their
pay is linked to Company performance and shareholder return.

‚ To attract and retain a highly skilled work force, the Company must remain competitive with the pay
of other employers that compete with it for talent. In all markets the Company faces competition for its
employees from many sources, often including technology companies with far greater resources. This
competitive pressure has increased the need to improve overall compensation, even in the light of
disappointing Company performance in the last two years. To provide stability, the Company has
provided retention incentives where appropriate.

‚ The Company seeks to align the interests of its employees to the long-term interests of the shareholders
through equity incentives, principally with stock options and on a more limited basis through restricted
stock grants.

General Compensation Program

In furtherance of this philosophy, the Company's compensation program for employees generally has the

following elements:

Salaries

The Company's approach is to have base salaries at approximately the 50% median for the job title and
responsibility, with additional compensation coming from cash bonus and long-term equity incentives. Base
salaries are reviewed annually based on Company and individual performance for the previous year, taking into
account any adjustments in job responsibility during the year. In this process, both internal and external
relative parity among employees are considered as is published compensation information, particularly the
Radford Surveys, and competitive information obtained in connection with new employee hires and, when
possible, from departing employees.

Cash Bonuses

Employees not on a commission plan participate in the Company's variable pay program. Variable pay
cash bonus goals are expressed as a percentage of base salary and are established each year, with levels of
bonuses increasing based on job responsibilities. The variable pay bonuses have been based both on Company
performance and on achievement of individual goals established each year, and generally are paid after the
year has been completed. In 2005, as in previous years, a prerequisite for payment of any variable pay cash
bonus was annual net operating income, and thus no variable pay bonuses were paid for 2005 to any employee.
The Committee is reviewing the continuation of this requirement in 2006 for employees, especially those who
do not have direct responsibility for overall Company financial performance.

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Equity Incentives

Stock Options. Long-term equity incentives generally have taken the form of ten-year stock options
with exercise prices set at 100% of fair market value of the Company's common stock on the date of grant,
thus providing value to the optionee only if the value of the Company's common stock appreciates. Through
2005, our general approach was to grant stock options to new employees as of their first date of employment.
The Company also has had a broad annual grant of options to nearly all employees, with the number of options
in individual cases based on the employee's performance and job responsibility, generally measured by salary
range. While previous option grants had four-year vesting periods, with 25% of the options vesting after one
year and the balance vesting over the next 36 months, stock options granted in 2005 generally vested on or
before December 31, 2005. In addition, in 2005 the Board approved immediate vesting of all outstanding
options held by employees with an exercise price of $1.47 per share or higher. In taking this action the Board
balanced the retentive value of longer-term vesting programs against employee morale and the perception of
option values, particularly in light of the decline in market value of the Company's common stock and new
accounting rules requiring the deemed value of vesting options to be recorded as a compensation expense on
the Company's financial statements.

December Option Grant and Repricing.

In 2005, the general grant of stock options to employees
occurred in December. Given the performance of the Company, and as no variable pay cash bonuses had been
paid for 2004 or would be payable for 2005, and in recognition that the market price for the Company's
common stock was at levels substantially below the exercise price for many of the outstanding options held by
employees, which substantially negated the incentive value of those options, the Compensation Committee
concurred with management's recommendation that a larger equity grant than in recent years was appropriate
to increase morale and to further align employees' interests with shareholders' interests. The Company,
however, did not have sufficient options available for grant under its existing stock option plans to accomplish
these goals fully. The Company's 2003 stock option plan and 2004 long-term equity compensation plan did not
permit repricing of options granted under those plans, although earlier option plans permitted option repricing.
The Board of Directors, including the Compensation Committee, while generally not favoring repricing of
outstanding stock options, concluded that repricing of certain outstanding options where permitted was the

only way of fully achieving the goals of the broad equity grant. As a result, the Board of Directors, upon the
recommendation of the Compensation Committee, approved a grant of 1,237,060 new options with ten-year
terms, immediate vesting and an exercise price of $1.49 per share, the fair market value of the Company's
common stock, and it lowered the exercise price of 1,274,260 outstanding options with exercise prices above
$3.50 per share to $1.49 per share without changing other terms of these existing options. The Company used
option valuation methodology to equalize as much as possible the value of a repriced option with a shorter life
to a new grant of a ten-year option. This is the only time that the Company has repriced outstanding options.
For 2006, the Compensation Committee is reviewing with the Company the general grant of options to new
employees, the parameters of annual grants and the appropriate vesting period of new options.

Restricted Stock.

In the December 2005 grant, the Board approved the grant of 1,815,000 shares of
restricted stock, vesting on June 30, 2007. This grant was limited to certain key managers and executive
officers, as described more fully below under ""Executive Officer Compensation.'' The grant of restricted stock
was to provide both equity and retention incentives.

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Employee Stock Purchase Plan. The Company also provides all employees with the opportunity to
purchase shares of its common stock under an Employee Stock Purchase Plan (""ESPP'') qualified under
Section 423 of the U.S. Internal Revenue Code. Participants may contribute from $50 per month up to 15% of
their gross pay and purchase shares in three-month offering periods. Through December 15, 2005, the ESPP
permitted participants to purchase shares at the lower of 85% of the market value of the Company's common
stock at the beginning of each offering period or 100% of the market value at the end of each offering period,
thus rewarding participants if the market price generally increased during the period. Because of the change in
the accounting rules for equity compensation, the Company's shareholders approved amendments to the
ESPP changing the purchase price formula for purchases in 2006 to 95% of the market value of the common
stock at the end of each offering period.

Retirement Plan

The Company's only retirement plan for all U.S. employees, including executive officers, is a qualified
401(k) plan under which employees may contribute a portion of their salary on a pre-tax basis. Contributions
in 2005 were limited to $14,000 annually, with a limit of up to $18,000 for employees age 50 or over.
Employees may invest in a limited number of mutual funds, and may not use voluntary contributions to
purchase shares of the Company's common stock. Until 2004, the Company matched employee contributions
at a 25% rate, with half of the match paid in cash on a quarterly basis during the year and the balance payable
after the end of the year in cash and/or Company common stock. The remaining match usually has been paid
in shares of the Company's common stock. There are no restrictions, other than those imposed by the
securities laws regarding insider trading, on employees transferring the value of the Company's common stock
in their accounts to other permitted investments. In 2005, the Company ceased its matching contribution for
the second half of the year. The Company intends to reinstate a form of matching contribution when overall
Company performance improves.

Benefits

The Company believes its benefits plans provide an important element to overall employee compensation.
The Company has several benefit plans available on a non-discriminatory basis to all employees in the United
States, including group medical, dental and vision plans, life insurance, long-term care, short and long-term
disability, supplemental income protection, a retiree medical plan, flexible spending accounts for health care
and dependent care, an employee assistance plan and travel assistance.

The foregoing describes generally the Company's compensation program for its employees in the United
States. Subject to local laws and practices, the Company attempts to provide the same or substantially
equivalent programs and benefits for its employees located in other countries.

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Executive Officer Compensation

The elements of executive officer compensation follow the general compensation elements described
above. Executive officers participate in the ESPP, 401(k) plan and benefits plans on the same basis as all
U.S. employees. Except as described below with respect to an executive severance policy, management
continuation agreements and certain retention agreements, the Company provides no deferred or special
compensation or retirement plans and no perquisites (other than five reserved parking places at the
Company's Seattle, Washington, headquarters) for executive officers.

For compensation purposes, the Company considers as executive officers the Chief Executive Officer and
those officers who are responsible for a principal business unit or who perform a policy-making function and
who report to the Chief Executive Officer. The Company currently has identified, in addition to the Chief
Executive Officer, six officers as executive officers. The Compensation Committee determines an annual
compensation plan for the executive officers, other than for the Chief Executive Officer, after soliciting the
recommendations of the Chief Executive Officer, and recommends the compensation of the Chief Executive
Officer to the full Board. The ""Summary Compensation Table'' above sets forth the compensation for the last
three fiscal years for the two individuals who served as Chief Executive Officer in 2005, for the next four most
highly compensated executive officers who were serving as executive officers at the end of 2005 and for one
individual who would have been one of the four most highly compensated executive officers but for the fact he
was not serving as an executive officer at the end of 2005.

Base Salary

In making individual base salary decisions for executive officers, the Committee considers each officer's
duties, the quality of the officer's performance, the officer's potential, market compensation practices, the
contribution the officer has made to our overall performance, the Company's financial status and salary levels
in comparable high technology companies. The Committee also compares the salary of each officer with other
officers' salaries, taking into account the number of years employed by the Company, the possibility of future
promotions and the extent and frequency of prior salary adjustments. As with our employees generally, base
salaries are generally established at median levels with a higher percentage of total compensation being at risk
through the management cash bonus program and equity incentives.

In 2005, the Company's senior management team was significantly restructured, including promoting
Peter J. Ungaro first to President and later to Chief Executive Officer, and adding Margaret A. Williams,
Brian C. Henry, Steven L. Scott and Jan C. Silverman to key executive officer positions. While each hire was
negotiated separately, principal consideration was given to providing competitive compensation in order to
attract them to come and to stay with the Company while attempting to stay within the Company's general
compensation structure, including overall compensation and the role of base salary, cash bonuses and long-
term equity incentives.

Cash Bonuses

Our executive bonus plan is a material element of the annual compensation program for our executive
officers. The Company also includes other officers in this plan, except for those with sales functions who are
on a sales commission plan. The 2005 executive bonus plan provided for bonuses as a percentage of salary
based on our achieving certain specified goals regarding net operating income (as adjusted for unplanned
significant costs and adjustments) and, with respect to each participant, meeting certain individual perform-
ance goals. Target bonuses for executive officers, other than the Chief Executive Officer, range from 40% to
50% of base salary. Depending on Company performance, an individual could earn up to 200% of target, with
the Chief Executive Officer, subject to Committee concurrence, authorized to recommend final bonuses
ranging from 0% to 125% based on individual performance. Although Company performance and individual
goals each counted for 50% of the total possible bonus in 2005, the Company had to reach a certain level of net
operating income for any bonus to be paid. For 2005, given the Company's financial results for the year, the
Compensation Committee granted no bonuses to executive officers or other participants under this plan. The
bonus to Mr. Johnson for 2005 was for his contributions in accepting the position of Chief Financial Officer on

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an interim basis in the fall of 2004 and service as such during the first five months in 2005 in addition to his
other responsibilities. In attracting Mr. Henry to become our Chief Financial Officer, and as specified in his
offer letter, the Company agreed that half his 2005 bonus would be based on achieving specific key goals
without being dependent on the Company reaching a level of operating income.

As noted earlier, the Company significantly revamped its senior management team in 2005. In order to attract
these new executives to new positions with the Company, and to keep within the Company's general salary
structure, the Company provided appointment or hiring bonuses that, except for Mr. Ungaro, vested over
negotiated periods and were repayable if the executive left the Company before vesting. The appointment and
hiring bonuses granted to the named executive officers are reflected on the ""Summary Compensation Table''
above.

Equity

In determining the amount of equity compensation to be awarded to executive officers in a fiscal year, the
Compensation Committee considers the current stock ownership of the officer, relevant industry experience,
the impact of the officer's contribution, the number of years each officer has been employed by us, the
possibility of future promotions, the extent and frequency of prior option grants, the officer's unvested stock
option position and the range of outstanding options with exercise prices below or near the current market
price for the Company's common stock. In prior years, as with options granted to all employees described
above, options were granted to executive officers at fair market value upon grant and with four-year vesting
periods. In May 2005, stock options were granted to executive officers upon consideration of these factors. In
providing the May 2005 grants, the Committee also was concerned about the relatively low level of the
Company's common stock market price. It also was considering the impact of the new accounting rule
requiring the expensing of vesting stock options on the financial statements as compensation expense. To
accommodate these concerns, and to provide both retention and financial incentives, the stock options granted
in May 2005 vested on December 31, 2005, but with exercise prices set above the market price for the
Company's common stock on the date of grant, which was $1.47 per share, with 25% of each option granted
having exercise prices of $2.00, $2.50, $3.00 and $3.50 per share, respectively. Separately, all executive officers
also had the vesting of existing options accelerated in 2005 on the same basis as all employees, as described
above under ""General Compensation Program Ì Equity Incentives Ì Stock Options.''

In the fall of 2005, the Compensation Committee worked with the senior management team for a broad
grant of stock options to all employees, which occurred in December 2005. The background of the December
2005 grant of stock options and repricing of certain outstanding options is described above under ""General
Compensation Program Ì Equity Incentives Ì December Option Grant and Repricing.'' The Compensation
Committee decided to include executive officers in this grant in addition to the May 2005 grant for several
reasons, including recognition of improvements in the Company's financial performance in the second half,
particularly reduction of operating expenses; increasing their equity participation in the Company, further
aligning their interests with the shareholders for long-term growth; and retaining parity among the executive
officers in light of equity grants to new officers hired during the year where grants were given in consideration
of competitive offers. Of the 1,237,060 options granted in December 2005, none were issued to executive
officers. Of the 1,274,260 options that were repriced, an aggregate of 423,993 repriced options were held by
individuals who are, or who received the options when they were, executive officers, as set forth on the ""Ten-
Year Option Repricing Table'' above.

As part of the December 2005 grant, the Compensation Committee also approved the grant of restricted
stock to certain executive officers and key managers, with 1,410,000 of the total of 1,815,000 restricted shares
issued to executive officers; both these figures exclude 150,000 restricted shares previously granted to
Mr. Silverman in connection with his joining the Company. The restrictions on transfer lapse on June 30,
2007; if prior to that date a recipient is terminated for cause or terminates without good reason, as those terms
are defined in the restricted stock grant agreement, the officer forfeits those restricted shares. These grants of
restricted stock were to increase each recipient's ownership of the Company's common stock, thereby aligning
their interests with shareholder interests, and with the vesting schedule to provide a retention incentive. The

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restricted stock grants to named executive officers are reflected on the ""Summary Compensation Table''
above and are described in footnote 2 to that table.

Executive Severance Policy. The Board of Directors has had an executive severance policy in effect
since October 2002 that covers specified officers, including the Company's executive officers, in order to
provide an incentive for individuals to assume key leadership positions. The policy sets forth certain payments
and benefits to be provided when applicable, but does not restrict the Company's ability to terminate the
employment of any covered officer. This policy applies if the officer's employment is terminated other than for
cause, death, disability, retirement or resignation other than for good reason (as such terms are defined in the
policy); this policy does not apply if the management continuation agreements described below are applicable.
The terms of the executive severance policy are described more fully under ""Management Agreements and
Policies'' above. Changes in the policy in 2005 with respect to Mr. Rottsolk and Mr. Ungaro, as Chief
Executive Officers, are described under ""Chief Executive Officers'' below. Obligations under this policy are
funded out of the Company's general assets. The Company has the authority to amend or discontinue the
executive severance policy, and the Chief Executive Officer has the authority to change the officers to whom
the policy applies at any time; prior to termination of employment, no officer has any vested rights under this
policy. Mr. Rottsolk is receiving payments and benefits pursuant to this policy, as described in footnote 5 to
the ""Summary Compensation Table'' above.

Management Continuation Agreements. We have entered into management continuation agreements
with certain of our officers, including our current executive officers named in the ""Summary Compensation
Table'' above. Pursuant to these agreements, each such officer is eligible to receive, in the event that his or her
employment is terminated within three years following a change of control, other than for just cause, death,
disability, retirement or resignation other than for good reason, as such terms are defined in the agreement, an
amount equal to two times his or her annual cash compensation, continuation of health benefits and group
term life insurance for twenty-four months thereafter and the acceleration of vesting for all options held. The
purpose of these agreements is to ensure the continuity of management and to foster objectivity in the face of
potentially distracting circumstances arising from the possibility of a change of control of the Company. We
are not aware of any such change of control now being contemplated. The terms of the Management
Continuation Agreements are described more fully under ""Management Agreements and Policies'' above.

Chief Executive Officers

Base Salary and Cash Bonus

The Committee recommends to the Board the compensation of the Chief Executive Officer, including
base salary, bonus plan and equity incentives. In March 2005, the Board restructured the Company's senior
management, with Mr. Ungaro becoming President and responsible for all of the Company's functions except
finance, legal and government relations, and Mr. Rottsolk continuing as Chairman and Chief Executive
Officer. In connection with this change, Mr. Ungaro's base salary was increased from $300,000 to $350,000,
he received a one-time appointment bonus of $300,000, and his target percentage in the executive bonus plan
was increased from 50% to 75% of base salary. The $300,000 appointment bonus in part was in lieu of a
payment under a 2004 special incentive plan based on product revenue and gross margin under which the
Company had accrued $88,647 for payment. Mr. Ungaro was also provided a special override bonus for 2005
based on total gross margin as reported in our public financial statements in recognition that the Company's
gross margin had been deteriorating in recent years. In recognition of the uncertainty that such a restructure
creates, the Compensation Committee also recommended, and the Board approved, amending the executive
severance plan for Mr. Rottsolk and Mr. Ungaro to provide for a payment based on total cash compensation
rather than on base salary only. For Mr. Rottsolk, the severance plan payment was set at 100% of the total of
base salary and target bonus under the management bonus plan; for Mr. Ungaro, the severance plan payment
was set at 200% of the total of base salary, target bonus under the management plan and target bonus under
the override bonus through March 2008 and 100% of the total of such elements thereafter. At the same time,
Mr. Rottsolk's annual base salary was increased from $350,000 to $375,000. The Compensation Committee
and Board believed these increases and changes were necessary and appropriate in order to attract Mr. Ungaro
to assume these expanded responsibilities and to reflect that Mr. Ungaro reported to Mr. Rottsolk.

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In August 2005, Mr. Ungaro assumed the responsibilities of Chief Executive Officer while continuing to

serve as President. There were no changes to his compensation in connection with that change.

Equity

In May 2005, as recommended by the Committee and approved by the Board, Mr. Rottsolk received an
option grant for 200,000 shares, and Mr. Ungaro received an option grant for 700,000 shares, each with per
share exercise prices above the then current market price for the Company's common stock at the time and on
the same other terms for all executive officers, as described above. The size of the grants reflected the
Compensation Committee's judgment as to future contributions to the Company and was to provide a
substantial level of equity incentive in alignment with shareholders' interests. As with all other employees and
executive officers, Mr. Rottsolk and Mr. Ungaro had the vesting of outstanding options accelerated, also as
described earlier. As part of the December equity grant, Mr. Ungaro received a grant of 600,000 shares of
restricted stock vesting on June 30, 2007, and on the same terms as restricted stock grants to other executives
and key managers described above. The size of the grant reflected recognition of Mr. Ungaro's leadership role
in assembling a restructured senior management team and reducing operating expenses and that Mr. Ungaro's
stock options have exercise prices above the current market prices for the Company's common stock,
including the options described above and options granted in 2003 for 500,000 shares at $9.00 per share. The
grant was also designed to provide a strong retention incentive.

Retention Agreements

In addition to the salary and equity compensation described above, the Board of Directors wanted to
provide a significant retention incentive for Mr. Ungaro and two other new executive officers with important
roles, Mr. Henry as Executive Vice President and Chief Financial Officer and Ms. Williams as Senior Vice
President responsible for all research and development activities. In December 2005, the Board approved and
the Company entered into separate retention agreements with each of these three executive officers providing
financial incentives if the officer remained employed by the Company at December 31, 2006, and at
December 31, 2007. These agreements reflected the awareness that each of these individuals are well known
and highly sought, that they each have contributed significantly to the Company in their new roles in the
relatively brief period they have been with the Company and that the loss of any of these individuals at this
time particularly would materially adversely affect the Company. The terms of the retention agreements are
described under ""Management Agreement and Policies'' above.

Section 162(m)

Section 162(m) of the Internal Revenue Code limits to $1 million per person the amount that the
Company may deduct for compensation paid to any of its most highly compensated officers in any year. This
limitation does not apply, however, to ""performance-based'' compensation, as defined under the Federal tax
laws. Stock options and annual incentive awards generally qualify as ""performance-based'' compensation, and
are, therefore, fully deductible.

The Committee considers the anticipated tax treatment to the Company and its executive officers when
reviewing executive compensation programs. The deductibility of some types of compensation payments can
depend upon the timing of an executive's vesting or exercise of previously granted rights. Interpretations of
and changes in applicable tax laws and regulations, as well as other factors beyond the Committee's control,
also can affect deductibility of compensation.

The Committee will continue to assess alternatives for preserving the deductibility of compensation
payments and benefits. However, the Committee will not necessarily seek to limit executive compensation to
amounts deductible under Section 162(m), since the Committee wishes to maintain the flexibility to structure
the Company's compensation programs in ways that best promote the best interests of the Company and its
shareholders.

Conclusion

The Committee and the Board believe that the caliber and motivation of all our employees, and especially
our executive leadership, are essential to the Company's performance. We believe our management
compensation programs contribute to the Company's ability to differentiate our performance from others in
the marketplace. We will continue to evolve and administer our compensation program in a manner that we
believe will be in shareholders' interests and worthy of shareholder support.

The Compensation Committee

Frank L. Lederman, Chairman
John B. Jones, Jr.
Kenneth W. Kennedy, Jr.
Stephen C. Kiely
Stephen C. Richards

Legal Proceedings and Indemnification

We and several of our current and former officers and directors have been named as defendants in a
securities class action lawsuit filed in the U.S. District Court for the Western District of Washington.
Plaintiffs seek to represent a class of purchasers of our securities from October 23, 2002, through May 9, 2005.
The consolidated complaint alleges federal securities law violations in connection with the issuance of various
public statements. In addition, shareholder derivative lawsuits which purport to be brought on our behalf and
assert allegations substantially similar to those asserted in the class action complaint, as well as allegations of
breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust
enrichment, have been filed in the U.S. District Court for the Western District of Washington and in the
Superior Court of the State of Washington for King County against members of our Board of Directors,
including all nominees for the Directors identified below under ""Discussion Of Proposals Recommended By
The Board Ì Proposal 1: To Elect Eight Directors For One-Year Terms,'' and certain current and former
officers and former directors. Under the indemnification provisions contained in our Bylaws, we are required to
pay for our current and former directors, and the Board has determined that we will pay for our current and
former officers, all the expenses, including attorneys' fees, incurred by these current and former officers and
directors, in defending against these actions. Each of these individuals has provided an undertaking to repay all
amounts advanced if it is ultimately determined that he or she is not entitled to be so indemnified.

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INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS

Change in Independent Registered Public Accounting Firms

On April 11, 2005, Deloitte & Touche LLP (""D&T'') informed the Chairman of our Audit Committee
that D&T would not stand for re-election as our independent registered public accounting firm for the fiscal
year ending December 31, 2005. D&T had been our independent auditors since 1987. D&T continued to be
engaged to provide its attestation report on management's assessment of our internal control over financial
reporting required by Item 308(b) of Regulation S-K for filing in an amendment to our Annual Report on
Form 10-K for the year ended December 31, 2004, and to review our interim financial information to be
included in our Quarterly Report on Form 10-Q for our first quarter ended March 31, 2005.

D&T completed its services for us with the filing on May 10, 2005, of our Quarterly Report on

Form 10-Q for our first quarter ended March 31, 2005.

We have been informed by D&T that its decision not to stand for re-election was not the result of any
disagreements between us and D&T on matters of accounting principles or practices, financial statement
disclosure or audit scope or procedures.

The audit reports of D&T on our financial statements for fiscal years ended December 31, 2004, and
2003, contained no adverse opinion or disclaimer of opinion, and were not qualified or modified as to
uncertainty, audit scope or accounting principles. As set forth under Item 9A of our Form 10-K/A filed with
the SEC on May 3, 2005, D&T's report on internal control over financial reporting disclaimed an opinion on
management's assessment of the effectiveness of our internal control over financial reporting because of a
scope limitation and expressed an adverse opinion on the effectiveness of our internal control over financial
reporting because of material weaknesses and the effects of the scope limitation. We received an unqualified
audit report from D&T on the consolidated financial statements contained in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2004.

During the period from January 1, 2003, through May 10, 2005, when D&T completed its services, there
were no disagreements between us and D&T on any matter of accounting principles or practices, financial
statement disclosure or audit scope or procedure which, if not resolved to D&T's satisfaction, would have
caused it to make a reference to the subject matter of the disagreement in connection with its reports.

During the period from January 1, 2003, through May 10, 2005, there were no reportable events as

defined in Item 304(a)(1)(v) of Regulation S-K, except as follows:

‚ In connection with the performance of its audit of our financial statements for the year ended
December 31, 2003, D&T reported to our Audit Committee that a reportable condition existed with
respect to the lack of policies and procedures relating to accounting for non-revenue related contracts
with third parties, specifically contracts entered into without the knowledge of and/or review by our
accounting department to properly assess and account for the related contract;

‚ With respect to the material weaknesses in internal control over financial reporting described under

Item 9A of our Form 10-K filed with the SEC on April 1, 2005; and

‚ With respect to the material weaknesses in internal control over financial reporting described under

Item 9A of our Form 10-K/A filed with the SEC on May 3, 2005.

On June 30, 2005, our Audit Committee engaged the firm of Peterson Sullivan PLLC of Seattle,

Washington, to act as our independent registered public accounting firm.

During the fiscal years ended December 31, 2003, and 2004 and the interim period to June 30, 2005, we
did not consult with Peterson Sullivan PLLC for any services, including either: (i) the application of
accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that
might be rendered on our financial statements; or (ii) any matter that was either the subject of a disagreement
or a reportable event.

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Information Regarding our Independent Registered Public Accounting Firms

Peterson Sullivan PLLC commenced serving as our independent auditors on June 30, 2005 and audited
our 2005 financial statements. Our Audit Committee has selected Peterson Sullivan PLLC to serve as our
independent auditors for 2006. As stated above, Deloitte & Touche LLP served as our independent auditors
through May 10, 2005, and audited our 2004 financial statements. Representatives of Peterson Sullivan PLLC
are expected to be present at the Annual Meeting, and will have the opportunity to make a statement and to
respond to appropriate questions.

Services and Fees

The following table lists the fees for services rendered by Deloitte & Touche LLP for 2004 and through

May 10, 2005 (except for performance of statutory audits of certain foreign subsidiaries past this date):

Services

Audit Fees(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Audit-Related Fees(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Tax Fees(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
All Other Fees(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

2005

2004

$173,000

45,000

$1,419,000
29,000
228,000

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$218,000

$1,649,000

The following table lists the fees for services rendered by Peterson Sullivan PLLC from June 30, 2005,

through December 31, 2005:

Services

Audit Fees(1) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Audit-Related Fees(2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Tax Fees(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
All Other Fees(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

2005

$789,000

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$789,000

(1) Audit services billed for 2005 and 2004 consisted of: audit of our annual financial statements, audits of
our assessment of our internal control over financial reporting and the effectiveness of our internal control
over financial reporting under Section 404 of the Sarbanes-Oxley Act, reviews of our quarterly financial
statements, statutory and regulatory audits, consents, comfort letters and other services related to filings
with the SEC and capital raising offerings.

(2) No audit-related services were billed in 2005. Audit-related services billed in 2004 consisted of employee

benefit audits.

(3) Tax services billed in 2005 and 2004 consisted of tax compliance and tax planning and advice:

‚ Fees for tax compliance services totaled $30,000 in 2005 and $70,000 in 2004. Tax compliance services
are services rendered, based upon facts already in existence or completed transactions, to document,
compute and obtain government approval for amounts to be included in tax filings. Such services
consisted of federal, state and local income tax return assistance, sales and use, property and other tax
return assistance, assistance with tax return filings in certain foreign jurisdictions and transfer pricing
documentation.

‚ Fees for tax planning and advice services totaled $15,000 in 2005 and $158,000 in 2004. Tax planning
and advice are services rendered with respect to proposed transactions or that structure a transaction to
obtain a particular tax result. Such services consisted of tax advice related to research and development
tax credits and tax advice related to intra-group restructuring.

(4) There were no fees billed for other services in 2005 or 2004 by either Deloitte & Touche LLP or Peterson

Sullivan PLLC.

The Audit Committee has determined that the provision of non-audit services for us by Deloitte &
Touche LLP for us in 2004 and 2005, were compatible with such firm maintaining its independence. Peterson
Sullivan PLLC to date has not performed any non-audit services for us.

The Audit Committee approved the following non-audit services performed by by Deloitte & Touche

LLP in 2004 and 2005:

‚ Consultations and consents related to SEC filings and registrations statements,

‚ Audits of employee benefit plans,

‚ Statutory audits required by our foreign subsidiaries and consultation on accounting matters,

‚ Tax planning and tax compliance for the U.S. and foreign income and other taxes, and

‚ Assistance related to implementation of Section 404 of the Sarbanes-Oxley Act of 2002.

Audit Committee Pre-Approval Policy

All audit, tax and other services to be performed for us by Peterson Sullivan PLLC from June 30, 2005,
and, prior to May 10, 2005, by Deloitte & Touche LLP, must be pre-approved by the Audit Committee. The
Audit Committee reviews the description of the services and an estimate of the anticipated costs of performing
those services. Services not previously approved cannot commence until such approval has been granted. Pre-
approval usually is granted at regularly scheduled meetings. If unanticipated items arise between meetings of
the Audit Committee, the Audit Committee has delegated approval authority to the Chairman of the Audit
Committee, in which case the Chairman communicates such pre-approvals to the full Committee at its next
meeting. During 2005, all services performed by Peterson Sullivan PLLC and Deloitte & Touche LLP were
pre-approved by the Audit Committee in accordance with this policy.

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Report on the 2005 Financial Statements and Independent Registered Public Accounting Firms by the
Audit Committee

The Audit Committee of the Board of Directors has furnished the following report:

The management of Cray Inc. (the ""Company'') has the responsibility for the financial statements and
for their integrity and objectivity. To help fulfill this responsibility, management maintains a system of internal
controls designed to provide reasonable assurance that assets are safeguarded against loss or unauthorized use
and that transactions are executed in accordance with management's authorizations and are reflected
accurately in our records. The Audit Committee oversees the fulfillment by management of its responsibilities
over financial controls and the preparation of the financial statements. The Audit Committee has reviewed the
Company's audited financial statements for the fiscal year ended December 31, 2005, and discussed such
statements with management and the Company's independent registered public accounting firm, Peterson
Sullivan PLLC, including discussions concerning the quality of accounting principles, reasonableness of
significant judgments and disclosures in the financial statements.

The Audit Committee also has discussed with the Company's independent auditors such matters relating
to the performance of the audit as are required to be discussed by Statement of Auditing Standards No. 61
(Communications with Audit and Finance Committees, as amended). Additionally, the Audit Committee has
discussed with the independent auditors their independence with respect to the Company and considered
whether their potential provision of non-audit services is compatible with maintaining that independence. In
this consideration, the Audit Committee reviewed the fees billed by the independent auditors as disclosed
above. The Company has received the written disclosures and the letter from the independent auditors
required by the Independence Standards Board Standard No. 1.

In reliance on the reviews and discussions referred to above, the Audit Committee has recommended to
the Board of Directors that the audited financial statements be included in the Annual Report on Form 10-K
for the year ended December 31, 2005, for filing with the Securities and Exchange Commission.

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The Audit Committee

Daniel C. Regis, Chairman
Sally G. Narodick
Stephen C. Richards

STOCK PERFORMANCE GRAPH

The graph below compares the cumulative total return to shareholders for our common stock with the
comparable return of the Nasdaq Stock Market (U.S. companies) Index and the Nasdaq Computer
Manufacturer Stocks Index.

The graph assumes that a shareholder invested $100 in our common stock on December 29, 2000, and
that all dividends were reinvested. We have never paid cash dividends on our common stock. All return
information is historical and is not necessarily indicative of future performance.

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, 2005

Cray Inc.
Nasdaq Stock Market (U.S.)
Nasdaq Computer Manufacturer Stocks

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1000

900

800

700

600

500

400

300

200

100

12/29/00

12/31/01

12/31/02

12/31/03

12/31/04

12/30/05

12/29/00 12/31/01 12/31/02 12/31/03 12/31/04 12/30/05

Cray Inc.

100.0

124.7

511.3

662.0

310.7

Nasdaq Stock Market (U.S.)

100.0

Nasdaq Computer Manufacturer Stocks

100.0

79.3

68.9

54.8

45.7

82.0

63.5

89.2

83.0

88.7

91.1

85.0

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DISCUSSION OF PROPOSALS RECOMMENDED BY THE BOARD

Proposal 1: To Elect Eight Directors For One-Year Terms

Our Bylaws fix the number of members of our Board at eight. Eight directors presently serve on our
Board of Directors for terms ending at the 2006 Annual Meeting. The Board has nominated Ms. Narodick and
Messrs. Jones, Kennedy, Kiely, Lederman, Regis, Richards and Ungaro for reelection to the Board, each to
hold office until the Annual Meeting in 2007.

We know of no reason why any nominee may be unable to serve as a director. If any nominee becomes
unable to serve, your proxy may vote for another nominee proposed by the Board, or the Board may reduce the
number of directors to be elected. If any director resigns, dies or is otherwise unable to serve out his or her
term, or the Board increases the number of directors, the Board may fill the vacancy.

Each nominee is a defendant in certain derivative lawsuits recently filed in federal and state courts
located in Seattle, Washington, purportedly on our behalf. See ""Corporate Governance Ì Litigation and
Indemnification'' above.

Board Recommendation: The Board of Directors recommends that you vote ""for'' the election of all

nominees for director.

Information about each nominee for director is set forth below.

John B. Jones, Jr.

Mr. Jones, 61, joined our Board in December 2004. He was a leading high technology equity research
analyst for nearly twenty years. Until his retirement in the fall of 2004, Mr. Jones was a Senior Managing
Director at Schwab SoundView Capital Markets. He joined SoundView in 2002 as a Senior Equity Research
Analyst. From 1992 to 2002, Mr. Jones was a Managing Director and Senior Analyst at Salomon Brothers,
Salomon Smith Barney and Citibank, where he covered the Server and Enterprise Hardware, Printer and
Test & Measurement industries. From 1985 to 1992, he was a partner and senior analyst at Montgomery
Securities. Prior to his career as an equity research analyst, Mr. Jones held various positions in the computer
industry at Stratus Computer, Wang Laboratories and IBM. He is a director of Stratus Technologies Inc., a
provider of fault tolerant computer servers, technologies and services. He received his B.S. degree from the
University of Oregon.

Kenneth W. Kennedy, Jr.

Professor Kennedy, 60, joined our Board in 1989. He is the John and Ann Doerr University Professor of
Computational Engineering at Rice University and also is Director of the Center for High Performance
Software Research at Rice University, a position he has held since 1989. He directed the National Science
Foundation Center for Research on Parallel Computation from 1989 to January 2000. From 1997 to 1999,
Professor Kennedy served as Co-Chair of the President's Information Technology Advisory Committee and
remained a member of that committee until 2001. He is a Fellow of the Institute of Electrical and Electronics
Engineers, the Association for Computing Machinery, and the American Association for the Advancement of
Science and has been a member of the National Academy of Engineering since 1990. In 1999, he was named
recipient of the ACM SIGPLAN Programming Languages Achievement Award, the third time this award
was given. He received his M.S. and Ph.D. degrees from New York University.

Stephen C. Kiely

Mr. Kiely, 60, joined our Board in 1999, was appointed Lead Director in January 2005 and Chairman of
the Board in August 2005. He is Chairman of Stratus Technologies Inc., a provider of fault tolerant computer
servers, technologies and services, headquartered in Maynard, Massachusetts. Mr. Kiely has served in his
present position at Stratus Technologies since 1999 when Stratus was purchased from Ascend Communica-
tions and he served as Chief Executive Officer of Stratus Technologies from 1999 through June 2003.
Mr. Kiely joined Stratus in 1994 and held various executive positions with Stratus, becoming President of the
Stratus Enterprise Computer division in 1998. Prior to joining Stratus, Mr. Kiely held a number of executive

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positions with several information technology companies, including EON Corporation, Bull Information
Systems, Prisma, Inc., Prime Computer and IBM. Mr. Kiely is a past member of the Advisory Council for the
School of Engineering at Rice University, has served as a board member of the Massachusetts Technology
Park Corporation and was a member of an advisory board to the President of the State University of New
York at New Paltz. Mr. Kiely received his B.A. in Mathematics at Fairfield University and his M.S. in
Management at the Stanford University Graduate School of Business.

Frank L. Lederman

Dr. Lederman, 56, joined our Board in May 2004. He served as a Vice President and Chief Technical
Officer of Alcoa, Inc., from 1995 to his retirement in 2002. From 1988 to 1995, Dr. Lederman was with
Toronto-based Noranda Inc., where he served as Senior Vice President, Technology. His responsibilities
included directing the Noranda Technology Center in Montreal. Before joining Noranda, he was with General
Electric Company from 1976 to 1988 serving in a number of positions in management and as a physicist,
including as manager of electronics research programs and resources in the Corporate Research and
Development Center in Schenectady, N.Y. Dr. Lederman received an M.S. and Ph.D. in Physics at the
University of Illinois and a B.S. and M.S. at Carnegie-Mellon University, and was a Post-Doctoral Fellow in
Electrical Engineering at the University of Pennsylvania.

Sally G. Narodick

Ms. Narodick, 60, joined our Board in October 2004. She is a retired educational technology and
e-learning consultant. From 2000 to 2004 she was President of Narodick Consulting, an e-learning consulting
firm. From 1998 to 2000, she served as Chief Executive Officer of Apex Online Learning, an Internet
educational software company. Previously, Ms. Narodick served as an education technology consultant, both
independently and for the Consumer Division of IBM from 1996 to 1998. From 1989 to 1996, Ms. Narodick
served as Chairman and Chief Executive Officer of Edmark Corporation, an educational software company
sold to IBM in 1996. From 1973 to 1987, she served in a variety of financial management capacities at Seafirst
Corporation and Seafirst Bank, and was a securities analyst at Paine Webber from 1970 to 1973. She also
serves as a Board member of Penford Corporation, Puget Energy, Inc., Solutia Inc. and SumTotal Systems. A
graduate of Boston University, Ms. Narodick earned an M.A. in Teaching from Columbia University and an
M.B.A. from New York University.

Daniel C. Regis

Mr. Regis, 66, joined our Board in 2003. He currently is Managing Director of Digital Partners, a venture
capital fund specializing in Northwest emerging technology companies, which he co-founded in 2000. From
1996 to 1999, he was President of Kirlan Venture Capital, Inc., where he managed similarly focused
technology funds. Prior to that, Mr. Regis spent thirty-two years with Price Waterhouse LLP, including
serving as managing partner of the Seattle office and previously of the Northwest and Portland, Oregon
offices. He is a director of Columbia Banking System, Inc., and Art Technology Group, Inc. He received his
B.S. from Seattle University.

Stephen C. Richards

Mr. Richards, 52, joined our Board in October 2004 and is currently a private investor. Previously he
served as Chief Operating Officer and Chief Financial Officer of McAfee, Inc., the leading provider of
intrusion prevention and risk management solutions, a position he held for four years until his retirement in
December 2004. He served as Chief Online Trading Officer of E*TRADE Group, Inc., a position he held
from March 1999 to June 2000. From 1998 to February 1999, he served as Senior Vice President, Corporate
Development and New Ventures at E*TRADE, following two years as E*TRADE's Senior Vice President of
Finance, Chief Financial Officer and Treasurer. Prior to joining E*TRADE in April 1996, he was Managing
Director and Chief Financial Officer of Correspondent Clearing at Bear Stearns & Companies, Inc., Vice
President/Deputy Controller of Becker Paribas and First Vice President/Controller of Jefferies and Company,
Inc. Mr. Richards is a member of the Board of Directors of Tradestation Group Inc., Guidance Software, Inc.,
HealthBenefit Corporation and Zantaz, Inc., and is a member of the Board of Governors of the Pacific Stock
Exchange and a trustee for the UC Davis Foundation. Mr. Richards is a Certified Public Accountant. He

received a B.A. from the University of California at Davis and an M.B.A. in Finance from the University of
California at Los Angeles.

Peter J. Ungaro

Mr. Ungaro, 37, has served on our Board and as our Chief Executive Officer since August 2005 and as
President since March 2005; he previously served as Senior Vice President responsible for sales, marketing
and services since September 2004 and before then served as Vice President responsible for sales and
marketing from when he joined us in August 2003. Prior to joining us, he served as Vice President, Worldwide
Deep Computing Sales for IBM from April 2003. Prior to that assignment, he was IBM's vice president,
worldwide high performance computing sales, a position he held since February 1999. He also held a variety of
other sales leadership positions since joining IBM in 1991. Mr. Ungaro received a B.A. in business
administration from Washington State University.

Proposal 2: To Approve an Amendment to Our Restated Articles of Incorporation to Effect a One-for-
Four Reverse Stock Split of all Outstanding and Authorized Shares of Our Common Stock

Introduction

We propose to amend our Restated Articles of Incorporation to effect a one-for-four reverse stock split of
all outstanding and authorized shares of our common stock. The Board of Directors reserves the right,
notwithstanding shareholder approval, and without further action by the shareholders, to abandon or to delay
the reverse stock split, if at any time prior to the filing of the amendment it determines, in its sole discretion,
that the reverse stock split would not be in the best interests of our shareholders.

The text that will be included in the Articles of Amendment to effect the one-for-four reverse stock split

is as follows:

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""As of the beginning of the first business day (the ""Effective Date'') after the filing of these Articles
of Amendment every four issued and outstanding and authorized shares of the Corporation's Common
Stock automatically shall be combined and reconstituted into one share of Common Stock, par value
$0.01 per share, of the Corporation, thereby giving effect to a one-for-four reverse stock split without
further action of any kind (the ""Reverse Stock Split''). Each holder of a certificate or certificates that
immediately prior to the Effective Date represented outstanding shares of Common Stock shall be
entitled to receive, upon surrender of such certificates to the Corporation for cancellation, a certificate or
certificates representing the number of whole shares (rounded down to the nearest whole shares) of
Common Stock held by such holder on the Effective Date after giving effect to the Reverse Stock Split.
No fractional shares of Common Stock shall be issued in the Reverse Stock Split; instead, shareholders
who would otherwise be entitled to fractional shares will receive a cash payment in lieu of such fraction
based upon the reported closing price of the Corporation's Common Stock on the trading date
immediately before the Effective Date. No other exchange, reclassification or cancellation of issued
shares shall be effected by this Amendment.''

Upon this amendment becoming effective, and if Proposal 3 regarding an increase in the number of
authorized shares of common stock is not approved by the shareholders, the number of authorized shares of
common stock would decrease from the current 150,000,000 shares to 37,500,000 shares of common stock. If
both this amendment and Proposal 3 become effective, the number of authorized shares of common stock
would be 75,000,000 shares of common stock. If this amendment does not become effective and if Proposal 3
does, then we would have 300,000,000 shares of authorized common stock. See the discussion under
""Proposal 3: To Approve an Amendment to our Restated Articles of Incorporation to Increase the Number of
Authorized Shares from 150,000,000 to 300,000,000 shares, on a pre-split basis'' below.

Examples. As of the effective date of the reverse stock split, all shareholders will own a proportionally
reduced number of shares of common stock, excluding any fractional shares cancelled in exchange for cash.
For example, if a shareholder owned 1,000 shares of common stock immediately prior to the effective date,
then the shareholder would own 250 shares of common stock as of the effective date, which reflects the same
proportional ownership interest in our shares of common stock because all shareholders would have the same

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reduction. As a further example, if a person held a stock option or warrant for 1,000 shares with an exercise
price of $2.50 per share immediately prior to the effective date, the person would hold an option or warrant for
250 shares with an exercise price of $10.00 per share as of the effective date; in each case, however, the holder
of the option or warrant must spend $2,500 to exercise the option or warrant in full. See ""Principal Effects of a
Reverse Stock Split Ì Common Stock'' below. As discussed below under ""Reasons For a Reverse Stock
Split,'' we expect the per share market price for our common stock to increase in approximate proportion to
the reverse split, although there can be assurance that it would do so.

Reasons For A Reverse Stock Split

As of April 17, 2006, our total market value was approximately $139.46 million and we had
91,750,299 shares of common stock issued and outstanding. On such date, the closing price for our common
stock on Nasdaq was $1.52 per share. We believe that a reverse stock split may be desirable because the
increased market price of our common stock expected as a result of implementing a reverse stock split will
encourage investor interest and trading in our common stock and improve the marketability and liquidity of
our common stock. Because of the trading volatility often associated with low-priced stocks, many brokerage
houses and institutional investors have internal policies and practices that either prohibit them from investing
in low-priced stocks or tend to discourage individual brokers from recommending low-priced stocks to their
customers. Some of those policies and practices may function to make the processing of trades in low-priced
stocks economically unattractive to brokers. Additionally, because brokers' commissions on low-priced stocks
generally represent a higher percentage of the stock price than commissions on higher-priced stocks, the
current average price per share of our common stock can result in individual shareholders paying transaction
costs representing a higher percentage of their total share value than would be the case if the share price were
substantially higher. We recognize that the liquidity of our common stock may be adversely affected by a
reverse stock split given the reduced number of shares that would be outstanding after the reverse stock split.
However, from January 1, 2005, through March 1, 2006, our daily trading volume, as reported by Nasdaq, has
averaged over 1,200,000 shares, and we believe that there will be sufficient post-split shares to provide
adequate liquidity for our shareholders. The Board of Directors believes that the anticipated higher market
price may reduce, to some extent, the negative effects on the liquidity and marketability of the common stock
inherent in some of the policies and practices of institutional investors and brokerage houses described above.

Our common stock has been listed on Nasdaq since January 20, 1998. Nasdaq's rules require that we
comply with certain maintenance standards to continue to be listed on Nasdaq, including a minimum closing
bid price of $1.00 per share. Because our current stock price is above $1.00 per share, we do not believe that
we currently are at substantial risk of non-compliance with this maintenance requirement. Our common stock,
however, closed below $1.00 per share for 19 consecutive days in September and October 2005, and it is
possible that the market price for our common stock could decline again to such levels. An increased stock
price resulting from a reverse stock split would reduce the potential risk that our common stock could fall
below the Nasdaq minimum closing bid requirement.

We cannot predict, however, whether a reverse stock split would achieve the desired results. The price per
share of our common stock is also a function of our financial performance and other factors, some of which
may be unrelated to the number of shares outstanding. Accordingly, there can be no assurance that the closing
bid price of our common stock after a reverse stock split would increase in an amount proportionate to the
decrease in the number of issued and outstanding shares, or would increase at all, or that any increase can be
sustained for a prolonged period of time.

Principal Effects of a Reverse Stock Split

Common Stock

Our common stock is currently registered under Section 12(g) of the Exchange Act, and we are subject
to the periodic reporting and other requirements of the Exchange Act. The proposed reverse stock split will not
affect the registration of the common stock under the Exchange Act. If any proposed reverse stock split is
implemented, our common stock will continue to be reported on the Nasdaq National Market under the

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symbol ""CRAY,'' although Nasdaq would add the letter ""D'' to the end of our trading symbol for a period of
at least 20 trading days to indicate that the reverse stock split has occurred.

After the effective date of a reverse stock split, each shareholder will own a proportionally reduced
number of shares of our common stock, as set forth in the examples above. The reverse stock split will affect
all of our shareholders uniformly and will not affect any shareholder's percentage ownership interests in us,
except to the extent that a reverse stock split results in any of our shareholders owning a fractional share as
described below. Proportionate voting rights and other rights and preferences of the holders of our common
stock will not be affected by a reverse stock split other than as a result of the payment of cash in lieu of
fractional shares. For example, shareholders are not currently entitled to cumulative voting rights and will not
be entitled to such rights following the reverse stock split. Further, the number of shareholders of record will
not be affected by a reverse stock split except to the extent that any shareholder holds only a fractional share
interest and receives cash for such interest after a reverse stock split, as discussed below.

A reverse stock split will result in some shareholders Ì those currently owning less than 400 shares Ì
owning ""odd-lots'' of less than 100 shares of our common stock. Brokerage commissions and other costs of
transactions in odd-lots are generally somewhat higher than the costs of transactions on ""round-lots'' of even
multiples of 100 shares.

The proposed reverse stock split would change the number of authorized shares of common stock, as
designated by our Restated Articles of Incorporation, from 150,000,000 shares to 37,500,000 shares. However,
if Proposal 3 also is approved, then after giving effect to the reverse stock split the number of authorized shares
of common stock would be 75,000,000 shares.

The proposed reverse stock split is not a first step in a ""going-private'' transaction.

For illustrative purposes, the following table, which is based on 91,750,299 shares of common stock
outstanding and 48,227,849 shares of common stock reserved for issuance as of April 17, 2006, approximates
the effect on our common stock of the proposed one-for-four reverse stock split, assuming Proposal 4 to
approve the 2006 Long-Term Equity Compensation Plan is approved by the shareholders, and whether
Proposal 3 to increase the authorized number of shares of common stock is or is not approved by the
shareholders.

Prior to Reverse Stock Split

After Reverse Stock Split

Current

If Proposal 4
is approved

If Proposals 3 and
4 are approved

If Proposal 3 is
not approved(1)

If Proposal 3
is approved(1)

Authorized Common

Stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Issued and OutstandingÏÏÏ
Issued, Outstanding and

Reserved for Issuance ÏÏ
Percentage Reduction ÏÏÏÏ

150,000,000
91,750,299

300,000,000
91,750,299

37,500,000
22,937,574

75,000,000
22,937,574

139,978,148

149,978,148

37,494,537
75%

(1) Assumes approval of Proposal 4; does not reflect the cancellation of fractional shares and payment in cash

in lieu thereof.

Options, Warrants, Convertible Notes And Other Securities

In addition, all outstanding options, warrants, convertible notes and other securities entitling their holders
to purchase shares of our common stock would be adjusted as a result of any reverse stock split, as required by
the terms of these securities. In particular, the exchange ratio for each instrument would be reduced, and the
exercise price per share, if applicable, would be increased, in accordance with the terms of each instrument
and based on the one-for-four ratio of the reverse stock split, as set forth in the above example. Also, the
number of shares reserved for issuance under the existing employee stock option plans, warrant and
convertible notes would be reduced proportionally based on the one-for-four ratio of the reverse stock split.

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Fractional Shares

No fractional shares of common stock will be issued as a result of the proposed reverse stock split.
Instead, shareholders who otherwise would be entitled to receive fractional shares because they hold a number
of shares not evenly divisible by the one-for-four ratio, upon surrender to the exchange agent of such
certificates representing such fractional shares, will be entitled to receive cash in an amount equal to the
product obtained by multiplying (i) the closing sales price of our common stock on the trading date
immediately preceding the effective date of the reverse stock split as reported on Nasdaq by (ii) the number
of shares of our common stock held by such shareholder that would otherwise have been exchanged for such
fractional share interest.

Implementation And Exchange Of Stock Certificates

If our shareholders approve the proposal and our Board of Directors decides to effectuate a reverse stock
split, we will file an amendment to our Restated Articles of Incorporation with the Secretary of State of
Washington. The reverse stock split will become effective at the time specified in the amendment Ì the next
business day after the filing of the amendment Ì which we refer to as the effective date.

As of the effective date of the reverse stock split, each certificate representing shares of our common
stock before the reverse stock split would be deemed, for all corporate purposes, to evidence ownership of the
reduced number of shares of our common stock resulting from the reverse stock split, except that holders of
unexchanged shares would not be entitled to receive any dividends or other distributions payable by us after
the effective date until they surrender their old stock certificates for exchange. All shares underlying options,
warrants, convertible notes and other securities would also be automatically adjusted on the effective date.

Our transfer agent, Mellon Investor Services LLC, would act as the exchange agent for purposes of
implementing the exchange of stock certificates. As soon as practicable after the effective date, shareholders
and holders of securities convertible into or exercisable for our common stock would be notified of the
effectiveness of the reverse stock split. Shareholders of record would receive a letter of transmittal requesting
them to surrender their old stock certificates for new stock certificates, which will bear a different CUSIP
number, reflecting the adjusted number of shares as a result of the reverse stock split. Persons who hold their
shares in brokerage accounts or ""street name'' would not be required to take any further action to effect the
exchange of their shares. No new certificates would be issued to a shareholder until such shareholder has
surrendered any outstanding certificates together with the properly completed and executed letter of
transmittal to the exchange agent. Until surrender, each certificate representing shares before the reverse
stock split would continue to be valid and would represent the adjusted number of shares based on the ratio of
the reverse stock split. Shareholders should not destroy any stock certificate and should not submit any
certificates until they receive a letter of transmittal.

Certain Federal Income Tax Consequences

The following is a summary of material United States federal income tax consequences of a reverse stock
split. It does not address any state, local or foreign income or other tax consequences. It applies to you only if
you held pre-reverse stock split common stock shares and post-reverse stock split common stock shares as
capital assets for tax purposes. This section does not apply to you if you are a member of a class of holders
subject to special rules, such as (i) a dealer in securities or currencies, (ii) a trader in securities that elects to
use a mark-to-market method of accounting for your securities holdings, (iii) a bank, (iv) a life insurance
company, (v) a tax-exempt organization, (vi) a person that owns common stock shares that are a hedge or
that are hedged against interest rate risks, (vii) a person that owns common stock shares as part of a straddle
or conversion transaction for tax purposes, (viii) a foreign person, or (ix) a person whose functional currency
for tax purposes is not the U.S. dollar. This section is based on the Internal Revenue Code of 1986, as
amended, its legislative history, existing and proposed regulations under the Internal Revenue Code, published
rulings and court decisions, all as currently in effect, all of which are subject to change, possibly on a
retroactive basis.

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PLEASE CONSULT YOUR OWN TAX ADVISOR CONCERNING THE CONSEQUENCES OF
A REVERSE STOCK SPLIT IN YOUR PARTICULAR CIRCUMSTANCES UNDER THE INTER-
NAL REVENUE CODE AND THE LAWS OF ANY OTHER TAXING JURISDICTION.

Tax Consequences To Common Shareholders

This discussion applies only to United States holders. A United States holder, as used herein, is a
shareholder that is: (i) a citizen or resident of the United States, (ii) a domestic corporation, (iii) an estate
whose income is subject to United States federal income tax regardless of its source, or (iv) a trust if a United
States court can exercise primary supervision over the trust's administration and one or more United States
persons are authorized to control all substantial decisions of the trust.

Other than with respect to any cash payments received in lieu of fractional shares discussed below, no
gain or loss should be recognized by a shareholder upon such shareholder's exchange of pre-reverse stock split
shares for post-reverse stock split shares pursuant to a reverse stock split. The aggregate tax basis of the post-
reverse stock split shares received in the reverse stock split (including any fraction of a new share deemed to
have been received) will be the same as the shareholder's aggregate tax basis in the pre-reverse stock split
shares exchanged therefor. In general, shareholders who receive cash in exchange for their fractional share
interests in the post-reverse stock split shares as a result of a reverse stock split will be deemed for federal
income tax purposes to have first received the fractional share interests and then to have had those fractional
share interests redeemed for cash. The shareholder's holding period for the post-reverse stock split shares will
include the period during which the shareholder held the pre-reverse stock split shares surrendered in the
reverse stock split.

The receipt of cash instead of a fractional share of our common stock by a United States holder of our
common stock will generally result in a taxable gain or loss equal to the difference between the amount of cash
received and the holder's adjusted federal income tax basis in the fractional share. Gain or loss generally will
be a capital gain or loss. Capital gain of a non-corporate United States holder, upon disposition of property
held for more than one year generally is taxed at a maximum rate of 15%. Deductibility of capital loss is
subject to limitations.

A non-corporate shareholder that receives cash in lieu of a fractional share may be subject to backup
withholding at 28% unless the shareholder provides its taxpayer identification number (""TIN'') and certifies
that the TIN is correct, or certifies that it is awaiting a TIN, unless an exemption applies. Backup withholding
is not an additional tax. The amount of backup withholding can be credited against the United States federal
income tax liability of the person subject to backup withholding, including for purposes of obtaining a refund,
provided that the required information is provided to the Internal Revenue Service.

Tax Consequences to the Company

We should not recognize any gain or loss as a result of the proposed reverse stock split.

Accounting Consequences

The par value per share of our common stock would remain unchanged at $0.01 per share after any
reverse stock split. As a result, on the effective date of a reverse stock split, the stated capital on the
Company's balance sheet attributable to the common stock will be reduced proportionally, based on the ratio
of the reverse stock split, from its present amount, and the additional paid-in capital account will be credited
with the amount by which the stated capital is reduced. The net income or loss per share of common stock and
net book value will be increased because there will be fewer shares of the common stock outstanding. We do
not anticipate that any other accounting consequences would arise as a result of a reverse stock split.

Dissenters' Rights

Chapter 23B.13 of the Washington Business Corporation Act provides for dissenters' rights for any
amendment to the articles of incorporation that reduces the total number of shares owned by the shareholder

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to a fraction of a share, if the fractional share created by the amendment is to be acquired by us for cash. In
our case, these provisions only apply to holders of three or fewer shares of our common stock.

Any such shareholder who otherwise would have been entitled to receive only a fractional share in the
reverse stock split may be entitled to a judicial appraisal of the fair value of his or her fractional share. Merely
voting against the reverse stock split is not sufficient to preserve a shareholder's dissenters' rights. In order to
be entitled to appraisal rights under Chapter 23B.13, a shareholder must:

‚ be within the class of shareholders who may be entitled to appraisal rights (i.e., those shareholders who
would have been entitled to receive only a fractional share as they own three or fewer shares of our
common stock);

‚ deliver to us, before the vote on the reverse stock split is taken, notice of the shareholder's intention to

demand appraisal of his or her fractional share if the reverse stock split is effected; and

‚ not vote in favor of the reverse stock split (a shareholder does not have to vote against the reverse stock

split to preserve dissenters' rights).

A shareholder's failure to vote in favor of the proposed reverse stock split will not be sufficient to satisfy
the notice requirements of the statute; the shareholder must also deliver the required notice before the vote
occurs.

The foregoing summary of Chapter 23B.13 of the Washington Business Corporation Act does not purport
to be complete and is qualified in its entirety by reference to the full text of Chapter 23B.13, which is set forth
as Appendix A attached to this proxy statement. Shareholders who wish to exercise their statutory right of
appraisal are urged to consult legal counsel for assistance in exercising their rights. Any shareholder entitled to
appraisal rights who fails to comply completely and on a timely basis with all requirements of Chapter 23B.13
for perfecting appraisal rights will lose those rights.

Board Recommendation: The Board of Directors recommends a vote for approval of Proposal 2 to
amend our Restated Articles of Incorporation to effect a one-for-four reverse stock split of all outstanding and
authorized shares of our common stock.

Proposal 3: To Approve an Amendment to Our Restated Articles of Incorporation to Increase the
Number of Authorized Shares of Common Stock from 150,000,000 to 300,000,000 Shares (on a pre-split
basis)

We propose to amend Article II(A) of our Restated Articles of Incorporation to increase the number of
authorized shares of common stock from 150,000,000 to 300,000,000 shares, on a pre-split basis. As amended,
Article II(A) of our Restated Articles of Incorporation would read as set forth below:

""A. Authorized Capital. The Corporation is authorized to issue a total of three hundred five million
(305,000,000) shares, consisting of three hundred million (300,000,000) shares of $.01 par value to
be designated ""Common Stock'' and five million (5,000,000) shares of $.01 par value to be
designated ""Preferred Stock.'' Subject to any rights expressly granted to Preferred Stock issued
pursuant to Paragraph B of this Article, the Common Stock shall have all the rights ordinarily
associated with common shares, including but not limited to general voting rights, general rights to
dividends, and liquidation rights. The Preferred Stock shall have the rights and preferences described
in Paragraph B of this article or in a resolution of the Board of Directors adopted pursuant to
Paragraph B.''

If both Proposal 2 regarding the one-for-four reverse stock split and Proposal 3 become effective, then as

amended, Article II(A) of our Restated Articles of Incorporation would read as set forth below:

""A. Authorized Capital. The Corporation is authorized to issue a total of eighty million
(80,000,000) shares, consisting of seventy-five million (75,000,000) shares of $.01 par value to be
designated ""Common Stock'' and five million (5,000,000) shares of $.01 par value to be designated
""Preferred Stock.'' Subject to any rights expressly granted to Preferred Stock issued pursuant to

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Paragraph B of this Article, the Common Stock shall have all the rights ordinarily associated with
common shares, including but not limited to general voting rights, general rights to dividends, and
liquidation rights. The Preferred Stock shall have the rights and preferences described in Para-
graph B of this article or in a resolution of the Board of Directors adopted pursuant to Paragraph B.''

As of April 17, 2006, we had no shares of preferred stock issued and outstanding of an authorized
5,000,000 shares of preferred stock and approximately 91.75 million shares of common stock issued and
outstanding and had reserved approximately 48.23 million shares of common stock for issuance under existing
convertibles notes, warrants, stock options and other employee benefit plans. Assuming shareholder approval
of the 2006 Long-Term Equity Compensation Plan, we will have an aggregate of approximately 149.98 million
shares of common stock issued and reserved for issuance at the time of the Annual Meeting.

Our authorized preferred stock of 5,000,000 shares would not be changed by this proposed amendment.
Our preferred stock is undesignated. The Board of Directors, without shareholder approval, may issue the
preferred stock with voting and conversion rights that could materially and adversely affect the voting power of
the holders of common stock, and could also decrease the amount of earnings and assets available for
distribution to the holders of common stock.

The rights of additional authorized shares of common stock would be identical to shares now authorized.

The authorization of common stock will not, in itself, have any effect on your rights as a shareholder. If
the Board were to issue additional shares of common stock for other than a stock split or dividend, however, it
could have a dilutive effect on our earnings per share and on your voting power in the Company, perhaps
significantly.

We believe that the proposed increase in the number of authorized shares of common stock is in the best
interests of our shareholders. It is important for the Board to have the flexibility to act promptly to meet future
business needs as they arise. Sufficient shares should be readily available to maintain our financing and capital
raising flexibility, fund acquisitions and mergers, enable employee benefit plans such as the 2006 Long-Term
Equity Compensation Plan, provide for matching contributions under our 401(k) Plan, enable stock splits and
dividends and for other proper business purposes. Having a limited number of shares available severely limits
our flexibility and hinders our ability to raise capital, move quickly with respect to acquisition opportunities
and attract employees.

By having additional shares readily available for issuance, we will be able to act expeditiously without
spending the time and incurring the expense of soliciting proxies and holding special meetings of shareholders.
We have no present plans, agreements, commitments or understandings for the issuance or use of these
proposed additional shares of common stock, although such shares could be used as future matching
contributions under our 401(k) Plan for our U.S. employees and restricted stock grants to our non-employee
directors.

The Board may issue additional shares of common stock without action on your part only if the action is
permissible under Washington corporate law and the rules of Nasdaq, on which our common stock is listed.
For example, approval by the shareholders would be required by Nasdaq rules if the issuance of shares of
common stock, or securities convertible into common stock, such as the preferred stock, would result in a
change of control of the Company. Nasdaq also requires shareholder approval before the issuance of shares in
private transactions equal to 20% or more of the common stock or voting power outstanding before the
issuance for less than the greater of the book value or market value of the common stock and before the
issuance of shares in an acquisition equal to 20% or more of the common stock or voting power outstanding
before the acquisition. Exceptions to these rules may be made upon application to Nasdaq.

The future issuance of additional shares of common stock also could be used to block an unsolicited
acquisition through the issuance of large blocks of stock to persons or entities considered by our officers and
directors to be opposed to such acquisition, which might be deemed to have an anti-takeover effect (i.e., might
impede the completion of a merger, tender offer or other takeover attempt). Our management and Board
could use the additional shares to resist or frustrate a third-party transaction providing an above-market
premium that is favored by a majority of our independent shareholders. In fact, the mere existence of such a

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block of authorized but unissued shares, and the Board's ability to issue such shares without shareholder
approval, might deter a bidder from seeking to acquire our shares on an unfriendly basis. We have other
provisions in our restated articles of incorporation, restated bylaws and credit agreements that could make it
more difficult for a third party to acquire us. For example, our articles of incorporation and bylaws provide
limitations on removing a director, the ability of the Board to issue preferred stock with such voting, dividend,
liquidation and other terms as the Board determines, no cumulative voting for directors, special voting
requirements for certain mergers and other business combinations and special procedures for calling special
meetings of the shareholders, proposing matters for shareholder approval and nominating directors.

While the authorization of additional shares of common stock alone or together with the preceding
provisions may have an anti-takeover effect, the Board does not intend or view the proposed increase in
authorized common stock as an anti-takeover measure, nor are we aware of any proposed transactions of this
type. We have no present plans or proposals to adopt any other provisions or enter into any other arrangements
that may have material anti-takeover consequences.

Board Recommendation: The Board of Directors recommends that you vote ""for'' approval of
Proposal 3 to amend our Restated Articles of Incorporation to increase the number of authorized shares of
common stock to 300,000,000, on a pre-split basis.

Proposal 4: To Approve Our 2006 Long-Term Equity Compensation Plan

On March 8, 2006, the Board of Directors approved the adoption of the 2006 Long-Term Equity
Compensation Plan (the ""2006 Plan''), subject to shareholder approval. The 2006 Plan authorizes the
issuance of up to 10,000,000 shares (2,500,000 shares if the one-for-four reverse stock split is implemented) of
common stock pursuant to stock options, as stock bonus awards and grants of restricted stock.

The complete text of the 2006 Plan is set forth as Appendix B to this proxy statement. The following

summary description is qualified in its entirety to reference to the full text of the 2006 Plan.

We believe that the approval of the 2006 Plan is in the best interest of our shareholders. Stock options
remain a key factor in attracting, rewarding and retaining employees, including officers. Stock options serve to
align the interest of optionees with the long-term interests of our shareholders. Our options are granted at fair
market value on the day of grant and generally vest over four years, with no vesting for the first year. Thus an
optionee realizes an economic gain in connection with his or her stock options only if there is a long-term
appreciation in the market price for our common stock. Having insufficient options available for grant would
adversely affect our ability to attract and retain employees, officers, directors, agents and consultants.

In some circumstances the use of stock bonus grants and/or restricted stock grants, either alone or in
combination with stock options, may provide an appropriate compensation structure and employee benefit.
Given the desire to have flexibility in granting incentive awards in the future, the 2006 Plan permits the
granting of stock bonuses and restricted stock grants as well as stock options.

We currently have four stock option plans with options available for grant to our employees generally.
Under these four plans, an aggregate of options covering 213,669 shares of common stock remained available
for grant as of December 31, 2005, of which no more than 113,599 options may be granted to executive
officers and directors. We may grant restricted stock and stock bonuses only under the 2004 Long-Term
Equity Plan, under which we had only 9,023 shares available for grant as of December 31, 2005. We recently
terminated a stock option plan we assumed in connection with the 2004 acquisition of OctigaBay Systems
Corporation, now known as Cray Canada Inc.

Terms of the 2006 Plan

Purposes of the 2006 Plan. The purposes of the 2006 Plan are to provide a means for us to attract,
reward and retain the services and advice of our employees, officers, directors, agents and consultants, and to
provide them with added incentives by encouraging ownership of our common stock.

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Maximum Number of Shares. The 2006 Plan provides that up to 10,000,000 shares of common stock
(2,500,000 shares if the one-for-four reverse stock split is approved and implemented) may be issued pursuant
to the Plan pursuant to stock options, stock bonuses and restricted stock awards. These numbers would be
adjusted for changes in our capital structure, such as a stock split or reverse stock split. If any option or award
expires or is surrendered, cancelled or terminated for any reason without having been exercised or awarded in
full, the unpurchased or unearned shares subject to such option or award shall again be available for grant
under the 2006 Plan.

Types of Options. The options granted may be either incentive stock options (""ISOs'') or nonqualified
stock options, although ISOs may be granted only to employees. The Board determines the term of each
option and when options are exercisable. The Board's general practice has been to have options become
exercisable over a four-year period, with 25% becoming exercisable one year after grant and then ratably
monthly over the next 36 months, although most options granted in 2005 vested on December 31, 2005, or
immediately upon grant. Options granted to non-employee directors generally vest over a twelve-month
period, ratably per month; options granted in 2005 to non-employee directors vested on December 31, 2005.
Options expire no later than ten years from the date of grant, although the Board may grant options that expire
earlier.

Stock Awards. The Board may determine the number of shares to be awarded, the period of time for the
award, and the terms, conditions (including performance conditions) and restrictions applicable to each
award.

Eligible Participants. Eligible participants are current or future employees (including employees who
are directors), officers, independent directors, agents and consultants. The Board has the authority to select
the persons to whom awards are given. Our practice is to grant additional options to nearly all employees as
part of their annual reviews, and to grant options to key new employees upon hiring. We had approximately
770 employees as of March 1, 2006.

If the shareholders approve the 2006 Plan, we plan to grant restricted stock to our continuing non-
employee directors pursuant to the compensation plan described above under ""Corporate Governance Ì The
Board of Directors Ì How We Compensate Directors Ì Equity Awards.'' The number of shares granted to
each non-employee director will be determined by dividing the amounts shown corresponding to each non-
employee director by the fair market value of our common stock on the date of the 2006 Annual Meeting. If
the shareholders do not approve the 2006 Plan, we would grant stock options to each non-employee director
pursuant to our current policy. The value of the shares of restricted stock to be granted to each continuing non-
employee director is:

Name

John B. Jones, Jr. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Kenneth W. Kennedy, Jr. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Stephen C. KielyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Frank L. Lederman ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Sally G. Narodick ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Daniel C. RegisÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Stephen C. RichardsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Amount

$40,500
38,500
45,500
44,000
53,000
65,500
53,000

We have no commitments to grant any restricted stock or grant options under the 2006 Plan to any

executive officer or other employees.

Exercise Prices. The Board determines the exercise price of options. The exercise price for both
incentive stock options (""ISOs'') and nonqualified options may not be less than 100% of the fair market value
on the date of grant. For any grant of ISOs to employees who own more than 10% of our voting stock, the
exercise price must be not less than 110% of the fair market value on the date of grant and the term of the ISO
cannot exceed five years.

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Maximum Size of Grants. No one individual may receive options and awards aggregating more than
1,600,000 shares (400,000 shares if the one-for-four reverse stock split is approved and implemented) in any
one year.

Transferability. Recent changes to the Internal Revenue Code and SEC rules now permit nonqualified
options to be transferable. While generally such options remain nontransferable other than by will or the laws of
descent and distribution or pursuant to a qualified domestic relations order, the Board, in its discretion and
subject to such terms and conditions as it shall specify, may permit the transfer of a nonqualified option to an
optionee's family members or to one or more trusts or partnerships established for the benefit of such family
members. ISOs remain nontransferable other than by will or the laws of descent and distribution. The Board also
may impose restrictions on the transferability of shares of stock received pursuant to other types of awards.

Termination of Service. Unless otherwise determined by the Board or specified in a particular option
agreement, if an optionee's employment or service with us terminates, other than for cause, death or disability,
the optionee may exercise the portion of his or her option exercisable at the time of termination for a period of
three months after termination, or, if earlier, until the option expires. If the optionee is terminated for ""cause''
or ""resigns in lieu of dismissal'' (as such terms are defined in the Plan), the option is deemed to have
terminated at the time of the first act which led to such termination. If an optionee dies while employed by or
providing services to us, or an optionee's employment or other relationship with us terminates due to
permanent and total disability, the optionee or his or her successor has 12 months from such event to exercise
the option (including any unvested portion), or, if earlier, until the option expires. The Board has the authority
to extend those three-month and 12-month periods, but not beyond the expiration date of any option, and to
increase the portion of an option that is exercisable.

Foreign Qualified Grants. The Board may adopt such supplements to the 2006 Plan as may be
necessary to comply with the applicable laws of foreign jurisdictions and to afford participants favorable
treatment under such laws, provided that no award shall be granted under any such supplement with terms
that are more beneficial to the participants than the terms permitted under the 2006 Plan.

Change in Control Provisions.

In order to maintain the rights of participants in the event of a merger,
consolidation or plan of exchange, other than in which the holders of our voting securities hold at least 50% of
the voting securities of the surviving corporation or its parent corporation, or a sale of all or substantially all of
our assets, or our liquidation or dissolution, then, unless the existing options and restrictions on awards are
continued or assumed by the successor entity, with appropriate adjustments, then the 2006 Plan and existing
options and restrictions on awards shall terminate upon the effective date of the transaction. In such event,
each optionee would have the opportunity to exercise his or her options in full, including any portion not then
vested, and the restrictions and conditions to outstanding stock awards would lapse, all prior to the effective
date of the transaction.

Term of the Plan and Amendments. Unless sooner terminated by the Board, the 2006 Plan will
terminate ten years from the date of its adoption by the Board. The Board has the power to suspend or
terminate the 2006 Plan at any time. The Board is authorized to amend the 2006 Plan, except that shareholder
approval is required for any amendment that would:

‚ increase the number of shares available for issuance under the 2006 Plan,

‚ permit the granting of stock options or awards to a new class of persons not presently covered by the

2006 Plan, or

‚ require shareholder approval under applicable law or regulation.

The Board, in its discretion, may include further provisions and limitations in any option agreement as it
deems equitable and in our best interests. The Board, subject to the terms of the 2006 Plan and applicable law,
may also amend outstanding options and awards, except that no amendment may be made which impairs or
diminishes the rights of an option or award holder without such holder's consent. The Board, without prior
shareholder approval, may not reduce the exercise price of outstanding options issued under the 2006 Plan or
cancel or amend such options for the purpose of repricing, replacing or regranting such options with a lower
exercise price.

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U.S. Tax Consequences of the 2006 Plan

Stock Options. Under U.S. federal tax laws, the grant of a stock option will not result in taxable income
at the time of the grant for us or the optionee. The optionee will have no taxable income upon exercising an
ISO (except that the alternative minimum tax may apply), and we will receive no deduction when an ISO is
exercised. Upon exercising a nonqualified stock option, the optionee will recognize ordinary income in the
amount by which the fair market value of the common stock at the time of exercise exceeds the exercise price;
we will be entitled to a deduction for the same amount. Such income is subject to withholding tax as ""wages.''
Currently withholding and employment taxes do not apply to the exercise of an ISO or the disposition of
shares acquired upon the exercise of an ISO. The Treasury Department and the Internal Revenue Service are
considering whether to apply such taxes to such exercises and dispositions. Future changes in or clarifications
of the tax laws may cause us to conclude that such taxes are required.

The tax treatment of an optionee for a disposition of shares acquired through the exercise of an option is
dependent upon the length of time the shares have been held and on whether such shares were acquired by
exercising an ISO or a nonqualified stock option. Generally upon the sale of shares obtained by exercising a
nonqualified option, the optionee will treat the gain realized on the sale over the market value of our common
stock on the exercise as a capital gain. If an employee exercises an ISO and holds the shares for two years
from the date of grant and one year after exercise, then the optionee will recognize long-term capital gain or
loss equal to the difference between the sale price and the option exercise price. Shares obtained by an
exercise of an ISO that are sold without satisfying these holding periods will be treated as shares received from
the exercise of a nonqualified option.

Generally, there will be no tax consequence to us in connection with the disposition of shares acquired
under an option except that we may be entitled to a deduction in the case of a disposition of shares acquired
upon exercise of an ISO before the applicable ISO holding periods have been satisfied.

We generally will be entitled to a tax deduction equal to the amount includable as income by the
employee at the same time or times as the employee recognizes income with respect to the shares. Such
income is subject to withholding tax as ""wages.''

Stock Bonuses and Other Grants of Stock. An employee who receives a stock bonus or a grant of stock
in connection with the performance of services generally will realize taxable income at the time of receipt. An
employee will not recognize income at the time of receipt, however, if the shares are subject to a substantial
risk of forfeiture for purposes of Section 83 of the Internal Revenue Code, unless the employee elects under
Section 83(b) of the Internal Revenue Code within 30 days after the original transfer to recognize income at
the time of the original transfer. Restrictions on transferability, by themselves, do not constitute a substantial
risk of forfeiture for Section 83 purposes. If the shares are subject to a substantial risk of forfeiture at the time
of receipt and the employee has not made a Section 83(b) election within 30 days after the original transfer,
the employee will recognize taxable income in the year the substantial risk of forfeiture lapses. We generally
will be entitled to a tax deduction equal to the amount includable as income by the employee at the same time
or times as the employee recognizes income with respect to the shares. Such income is subject to withholding
tax as ""wages,'' and the 2006 Plan provides that awardees may pay such withholding tax by cash or return of
shares as is necessary.

Section 162(m) of the Internal Revenue Code limits to $1 million per person the amount we may deduct
for compensation paid to certain officers and certain of our most highly compensated employees. Compensa-
tion received through the exercise of stock options is not subject to this $1 million limit if the option and plan
meet certain requirements, including options granted with an exercise price at not less than fair market value.
Our policy is to grant options meeting the requirements of Section 162(m) and applicable regulations.

Stock Price Information. The last sales price of our common stock as reported on the Nasdaq National

Market System on April 17, 2006, was $1.52 per share.

Board Recommendation: The Board of Directors recommends that you vote ""for'' approval of Proposal 4 to
approve the 2006 Long-Term Equity Compensation Plan.

OTHER BUSINESS

The Board knows of no other matters to be brought before the Annual Meeting of Shareholders. If,
however, other matters are properly presented at the meeting, the individuals designated on the proxy card will
vote your shares according to their judgment on those matters.

Our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, including financial
statements and schedules, forms a part of our 2005 Annual Report that was mailed to shareholders with this
Proxy Statement. The Annual Report is available on our web site: www.cray.com under ""Investors Ì
Financials Ì SEC Filings.'' Additional copies of the 2005 Annual Report on Form 10-K may be obtained
without charge by writing to Kenneth W. Johnson, Corporate Secretary, Cray Inc., 411 First Avenue South,
Suite 600, Seattle, WA 98104-2860.

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Seattle, Washington
April 28, 2006

By order of the Board of Directors,

KENNETH W. JOHNSON
Corporate Secretary

Appendix A

RCW CHAPTER 23B.13
OF THE WASHINGTON BUSINESS CORPORATION ACT
DISSENTERS' RIGHTS

RCW 23B.13.010. Definitions

As used in this chapter:

(1) ""Corporation'' means the issuer of the shares held by a dissenter before the corporate action, or

the surviving or acquiring corporation by merger or share exchange of that issuer.

(2) ""Dissenter'' means a shareholder who is entitled to dissent from corporate action under
RCW 23B.13.020 and who exercises that right when and in the manner required by RCW 23B.13.200
through 23B.13.280.

(3) ""Fair value,'' with respect to a dissenter's shares, means the value of the shares immediately
before the effective date of the corporate action to which the dissenter objects, excluding any appreciation
or depreciation in anticipation of the corporate action unless exclusion would be inequitable.

(4) ""Interest'' means interest from the effective date of the corporate action until the date of
payment, at the average rate currently paid by the corporation on its principal bank loans or, if none, at a
rate that is fair and equitable under all the circumstances.

(5) ""Record shareholder'' means the person in whose name shares are registered in the records of a
corporation or the beneficial owner of shares to the extent of the rights granted by a nominee certificate
on file with a corporation.

(6) ""Beneficial shareholder'' means the person who is a beneficial owner of shares held in a voting

trust or by a nominee as the record shareholder.

(7) ""Shareholder'' means the record shareholder or the beneficial shareholder.

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RCW 23B.13.020. Right to Dissent

(1) A shareholder is entitled to dissent from, and obtain payment of the fair value of the shareholder's

shares in the event of, any of the following corporate actions:

(a) Consummation of a plan of merger to which the corporation is a party (i) if shareholder
approval is required for the merger by RCW 23B.11.030, 23B.11.080, or the articles of incorporation and
the shareholder is entitled to vote on the merger, or (ii) if the corporation is a subsidiary that is merged
with its parent under RCW 23B.11.040;

(b) Consummation of a plan of share exchange to which the corporation is a party as the

corporation whose shares will be acquired, if the shareholder is entitled to vote on the plan;

(c) Consummation of a sale or exchange of all, or substantially all, of the property of the
corporation other than in the usual and regular course of business, if the shareholder is entitled to vote on
the sale or exchange, including a sale in dissolution, but not including a sale pursuant to court order or a
sale for cash pursuant to a plan by which all or substantially all of the net proceeds of the sale will be
distributed to the shareholders within one year after the date of sale;

(d) An amendment of the articles of incorporation, whether or not the shareholder was entitled to
vote on the amendment, if the amendment effects a redemption or cancellation of all of the shareholder's
shares in exchange for cash or other consideration other than shares of the corporation; or

(e) Any corporate action taken pursuant to a shareholder vote to the extent the articles of
incorporation, bylaws, or a resolution of the board of directors provides that voting or nonvoting
shareholders are entitled to dissent and obtain payment for their shares.

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(2) A shareholder entitled to dissent and obtain payment for the shareholder's shares under this chapter
may not challenge the corporate action creating the shareholder's entitlement unless the action fails to comply
with the procedural requirements imposed by this title, RCW 25.10.900 through 25.10.955, the articles of
incorporation, or the bylaws, or is fraudulent with respect to the shareholder or the corporation.

(3) The right of a dissenting shareholder to obtain payment of the fair value of the shareholder's shares

shall terminate upon the occurrence of any one of the following events:

(a) The proposed corporate action is abandoned or rescinded;

(b) A court having jurisdiction permanently enjoins or sets aside the corporate action; or

corporation.

RCW 23B.13.030. Dissent by Nominees and Beneficial Owners

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(1) A record shareholder may assert dissenters' rights as to fewer than all the shares registered in the
shareholder's name only if the shareholder dissents with respect to all shares beneficially owned by any one
person and delivers to the corporation a notice of the name and address of each person on whose behalf the
shareholder asserts dissenters' rights. The rights of a partial dissenter under this subsection are determined as
if the shares as to which the dissenter dissents and the dissenter's other shares were registered in the names of
different shareholders.

(2) A beneficial shareholder may assert dissenters' rights as to shares held on the beneficial share-

holder's behalf only if:

(a) The beneficial shareholder submits to the corporation the record shareholder's consent to the
dissent not later than the time the beneficial shareholder asserts dissenters' rights, which consent shall be
set forth either (i) in a record or (ii) if the corporation has designated an address, location, or system to
which the consent may be electronically transmitted and the consent is electronically transmitted to the
designated address, location, or system, in an electronically transmitted record; and

(b) The beneficial shareholder does so with respect to all shares of which such shareholder is the

beneficial shareholder or over which such shareholder has power to direct the vote.

RCW 23B.13.200. Notice of Dissenters' Rights

(1) If proposed corporate action creating dissenters' rights under RCW 23B.13.020 is submitted to a
vote at a shareholders' meeting, the meeting notice must state that shareholders are or may be entitled to
assert dissenters' rights under this chapter and be accompanied by a copy of this chapter.

(2) If corporate action creating dissenters' rights under RCW 23B.13.020 is taken without a vote of
shareholders, the corporation, within ten days after the effective date of such corporate action, shall deliver a
notice to all shareholders entitled to assert dissenters' rights that the action was taken and send them the
notice described in RCW 23B.13.220.

RCW 23B.13.210. Notice of Intent to Demand Payment

(1) If proposed corporate action creating dissenters' rights under RCW 23B.13.020 is submitted to a
vote at a shareholders' meeting, a shareholder who wishes to assert dissenters' rights must (a) deliver to the
corporation before the vote is taken notice of the shareholder's intent to demand payment for the shareholder's
shares if the proposed action is effected, and (b) not vote such shares in favor of the proposed action.

(2) A shareholder who does not satisfy the requirements of subsection (1) of this section is not entitled

to payment for the shareholder's shares under this chapter.

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RCW 23B.13.220. Dissenters' Rights Ì Notice

(1) If proposed corporate action creating dissenters' rights under RCW 23B.13.020 is authorized at a
shareholders' meeting, the corporation shall deliver a notice to all shareholders who satisfied the requirements
of RCW 23B.13.210.

(2) The notice must be sent within ten days after the effective date of the corporate action, and must:

(a) State where the payment demand must be sent and where and when certificates for certificated

shares must be deposited;

(b) Inform holders of uncertificated shares to what extent transfer of the shares will be restricted

after the payment demand is received;

(c) Supply a form for demanding payment that includes the date of the first announcement to news
media or to shareholders of the terms of the proposed corporate action and requires that the person
asserting dissenters' rights certify whether or not the person acquired beneficial ownership of the shares
before that date;

(d) Set a date by which the corporation must receive the payment demand, which date may not be
fewer than thirty nor more than sixty days after the date the notice in subsection (1) of this section is
delivered; and

(e) Be accompanied by a copy of this chapter.

RCW 23B.13.230. Duty to Demand Payment

(1) A shareholder sent a notice described in RCW 23B.13.220 must demand payment, certify whether
the shareholder acquired beneficial ownership of the shares before the date required to be set forth in the
notice pursuant to RCW 23B.13.220(2)(c), and deposit the shareholder's certificates, all in accordance with
the terms of the notice.

(2) The shareholder who demands payment and deposits the shareholder's share certificates under
subsection (1) of this section retains all other rights of a shareholder until the proposed corporate action is
effected.

(3) A shareholder who does not demand payment or deposit the shareholder's share certificates where
required, each by the date set in the notice, is not entitled to payment for the shareholder's shares under this
chapter.

RCW 23B.13.240. Share Restrictions

(1) The corporation may restrict the transfer of uncertificated shares from the date the demand for their
payment is received until the proposed corporate action is effected or the restriction is released under
RCW 23B.13.260.

(2) The person for whom dissenters' rights are asserted as to uncertificated shares retains all other rights

of a shareholder until the effective date of the proposed corporate action.

RCW 23B.13.250. Payment

(1) Except as provided in RCW 23B.13.270, within thirty days of the later of the effective date of the
proposed corporate action, or the date the payment demand is received, the corporation shall pay each
dissenter who complied with RCW 23B.13.230 the amount the corporation estimates to be the fair value of
the shareholder's shares, plus accrued interest.

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(2) The payment must be accompanied by:

(a) The corporation's balance sheet as of the end of a fiscal year ending not more than sixteen
months before the date of payment, an income statement for that year, a statement of changes in
shareholders' equity for that year, and the latest available interim financial statements, if any;

(b) An explanation of how the corporation estimated the fair value of the shares;

(d) A statement of the dissenter's right to demand payment under RCW 23B.13.280; and

(e) A copy of this chapter.

RCW 23B.13.260. Failure to Take Action

(1) If the corporation does not effect the proposed action within sixty days after the date set for
demanding payment and depositing share certificates, the corporation shall return the deposited certificates
and release any transfer restrictions imposed on uncertificated shares.

(2) If after returning deposited certificates and releasing transfer restrictions, the corporation wishes to
undertake the proposed action, it must send a new dissenters' notice under RCW 23B.13.220 and repeat the
payment demand procedure.

RCW 23B.13.270. After-acquired Shares

(1) A corporation may elect to withhold payment required by RCW 23B.13.250 from a dissenter unless
the dissenter was the beneficial owner of the shares before the date set forth in the dissenters' notice as the
date of the first announcement to news media or to shareholders of the terms of the proposed corporate action.

(2) To the extent the corporation elects to withhold payment under subsection (1) of this section, after
taking the proposed corporate action, it shall estimate the fair value of the shares, plus accrued interest, and
shall pay this amount to each dissenter who agrees to accept it in full satisfaction of the dissenter's demand.
The corporation shall send with its offer an explanation of how it estimated the fair value of the shares, an
explanation of how the interest was calculated, and a statement of the dissenter's right to demand payment
under RCW 23B.13.280.

RCW 23B.13.280. Procedure if Shareholder Dissatisfied with Payment or Offer

(1) A dissenter may deliver a notice to the corporation informing the corporation of the dissenter's own
estimate of the fair value of the dissenter's shares and amount of interest due, and demand payment of the
dissenter's estimate, less any payment under RCW 23B.13.250, or reject the corporation's offer under
RCW 23B.13.270 and demand payment of the dissenter's estimate of the fair value of the dissenter's shares
and interest due, if:

(a) The dissenter believes that the amount paid under RCW 23B.13.250 or offered under
RCW 23B.13.270 is less than the fair value of the dissenter's shares or that the interest due is incorrectly
calculated;

(b) The corporation fails to make payment under RCW 23B.13.250 within sixty days after the date

set for demanding payment; or

(c) The corporation does not effect the proposed action and does not return the deposited
certificates or release the transfer restrictions imposed on uncertificated shares within sixty days after the
date set for demanding payment.

(2) A dissenter waives the right to demand payment under this section unless the dissenter notifies the
corporation of the dissenter's demand under subsection (1) of this section within thirty days after the
corporation made or offered payment for the dissenter's shares.

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RCW 23B.13.300. Court Action

(1) If a demand for payment under RCW 23B.13.280 remains unsettled, the corporation shall
commence a proceeding within sixty days after receiving the payment demand and petition the court to
determine the fair value of the shares and accrued interest. If the corporation does not commence the
proceeding within the sixty-day period, it shall pay each dissenter whose demand remains unsettled the
amount demanded.

(2) The corporation shall commence the proceeding in the superior court of the county where a
corporation's principal office, or, if none in this state, its registered office, is located. If the corporation is a
foreign corporation without a registered office in this state, it shall commence the proceeding in the county in
this state where the registered office of the domestic corporation merged with or whose shares were acquired
by the foreign corporation was located.

(3) The corporation shall make all dissenters, whether or not residents of this state, whose demands
remain unsettled, parties to the proceeding as in an action against their shares and all parties must be served
with a copy of the petition. Nonresidents may be served by registered or certified mail or by publication as
provided by law.

(4) The corporation may join as a party to the proceeding any shareholder who claims to be a dissenter
but who has not, in the opinion of the corporation, complied with the provisions of this chapter. If the court
determines that such shareholder has not complied with the provisions of this chapter, the shareholder shall be
dismissed as a party.

(5) The jurisdiction of the court in which the proceeding is commenced under subsection (2) of this
section is plenary and exclusive. The court may appoint one or more persons as appraisers to receive evidence
and recommend decision on the question of fair value. The appraisers have the powers described in the order
appointing them, or in any amendment to it. The dissenters are entitled to the same discovery rights as parties
in other civil proceedings.

(6) Each dissenter made a party to the proceeding is entitled to judgment (a) for the amount, if any, by
which the court finds the fair value of the dissenter's shares, plus interest, exceeds the amount paid by the
corporation, or (b) for the fair value, plus accrued interest, of the dissenter's after-acquired shares for which
the corporation elected to withhold payment under RCW 23B.13.270.

RCW 23B.13.310. Court Costs and Counsel Fees

(1) The court in a proceeding commenced under RCW 23B.13.300 shall determine all costs of the
proceeding, including the reasonable compensation and expenses of appraisers appointed by the court. The
court shall assess the costs against the corporation, except that the court may assess the costs against all or
some of the dissenters, in amounts the court finds equitable, to the extent the court finds the dissenters acted
arbitrarily, vexatiously, or not in good faith in demanding payment under RCW 23B.13.280.

(2) The court may also assess the fees and expenses of counsel and experts for the respective parties, in

amounts the court finds equitable:

(a) Against the corporation and in favor of any or all dissenters if the court finds the corporation did

not substantially comply with the requirements of RCW 23B.13.200 through 23B.13.280; or

(b) Against either the corporation or a dissenter, in favor of any other party, if the court finds that
the party against whom the fees and expenses are assessed acted arbitrarily, vexatiously, or not in good
faith with respect to the rights provided by chapter 23B.13 RCW.

(3) If the court finds that the services of counsel for any dissenter were of substantial benefit to other
dissenters similarly situated, and that the fees for those services should not be assessed against the corporation,
the court may award to these counsel reasonable fees to be paid out of the amounts awarded the dissenters
who were benefited.

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Appendix B

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CRAY INC.

2006 LONG-TERM EQUITY COMPENSATION PLAN

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TABLE OF CONTENTS

Page

1. Purpose ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
2. Stock Subject to This Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
3. AdministrationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
3.1 Powers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
3.2 Limited Liability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
3.3 Securities Exchange Act of 1934 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
3.4 Committee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
4. Awards ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-1
5. Option Grants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-2
5.1 Incentive Stock OptionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-2
5.2 Non-Qualified Stock Options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3
5.3 Vesting ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3
5.4 Nontransferability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3
5.5 Termination of Options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-3
5.6 Exercise ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-5
5.7 Foreign Qualified Grants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-5
5.8 Corporate Mergers, Acquisitions, Etc. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-5
5.9 Holding Period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-5
5.10 Option AgreementsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-5
6. Stock Bonuses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-6
7. Restricted Stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-6
8. Adjustments Upon Changes in Capitalization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-6
8.1 Stock Splits, Capital Stock Adjustments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-6
8.2 Effect of Merger, Sale of Assets, Liquidation or Dissolution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-6
8.3 Fractional Shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-7
8.4 Determination of Board to Be Final ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-7
9. Securities Regulations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-7
9.1 Compliance with Law ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-7
9.2 Investment Purpose ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-7
10. Amendment and Termination ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
10.1 Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
10.2 OptionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
10.3 Automatic Termination ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
11. Miscellaneous ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
11.1 Time of Granting Options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
11.2 No Status as Shareholder ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
11.3 Status as an Employee ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-8
11.4 Reservation of SharesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-9
12. Effectiveness of This Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ B-9

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CRAY INC.

2006 LONG-TERM EQUITY COMPENSATION PLAN

1. Purpose. The purpose of the 2006 Long-Term Equity Compensation Plan (the ""Plan'') is to enable
Cray Inc. (the ""Company'') to attract, reward and retain the services or advice of the current or future
employees, officers, directors, agents and consultants of the Company and its subsidiaries, and to provide
added incentives to them by encouraging stock ownership in the Company. For purposes of this Plan, a person
is considered to be employed by or in the service of the Company if the person is employed by or in the service
of any entity (the ""Employer'') that is either the Company or a subsidiary of the Company.

2. Stock Subject to This Plan. Subject to adjustment as provided below and in Section 8 hereof, the
stock subject to this Plan shall consist of shares of the Company's common stock (the ""Common Stock''),
and the total number of shares of Common Stock to be issued under this Plan shall not exceed
10,000,000 shares ®2,500,000 shares if the 2006 proposed one-for-four reverse stock split is implemented©, all
as such Common Stock was constituted on the effective date of this Plan. If an option or award granted under
this Plan expires, terminates or is canceled, the unissued shares subject to that option or award shall again be
available under this Plan. If shares awarded as a bonus pursuant to Section 6 or issued pursuant to Section 7
under this Plan are forfeited to or repurchased by the Company, the number of shares forfeited or repurchased
shall again be available under this Plan.

3. Administration. This Plan shall be administered by the Board of Directors of the Company (the

""Board''). The Board may suspend, amend or terminate this Plan as provided in Section 10.

3.1 Powers. The Plan shall be administered by the Board, which shall determine and designate the
individuals to whom options and awards shall be made, the amount of the options and awards and the other
terms and conditions of the options and awards. Subject to the provisions of the Plan, the Board may adopt
and amend rules and regulations relating to administration of the Plan, advance the lapse of any waiting
period, accelerate any exercise date, waive or modify any restriction applicable to shares (except those
restrictions imposed by law) and make all other determinations in the judgment of the Board necessary or
desirable for the administration of the Plan. The interpretation and construction of the provisions of the Plan
and any option or award issued under this Plan, and related agreements by the Board shall be final and
conclusive. The Board may correct any defect or supply any omission or reconcile any inconsistency in the
Plan or in any related agreement in the manner and to the extent it deems expedient to carry the Plan into
effect, or to be consistent with any rule or regulation promulgated in connection herewith. All actions taken by
the Board shall be conclusive and binding on all interested parties. The Board may delegate administrative
functions to individuals who are officers or employees of the Company.

3.2 Limited Liability. No member of the Board or officer of the Company shall be liable for any
action or inaction of the Board, any Board committee, the Company or any another person or, except in
circumstances involving bad faith, of himself or herself. Subject only to compliance with the explicit provisions
hereof, the Board may act in its absolute discretion in all matters related to this Plan.

3.3 Securities Exchange Act of 1934. At any time that the Company has a class of securities
registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the ""Exchange Act''),
this Plan shall be administered by the Board in accordance with Rule 16b-3 adopted under the Exchange Act,
as such rule may be amended from time to time.

3.4 Committee. The Board by resolution may delegate to a committee of the Board (the ""Commit-
tee'') any or all authority for administration of the Plan. If a Committee is appointed, all references to the
Board in the Plan shall mean and relate to such Committee, except that only the Board may amend, modify,
suspend or terminate the Plan as provided in Section 10.

4. Awards. The Board may grant options or awards to any current or future employee, officer, director,
agent or consultant of the Company or any of its subsidiaries. The Board may take the following actions from
time to time, separately or in combination, under this Plan: (a) grant Incentive Stock Options, as defined in
Section 422 of the Internal Revenue Code of 1986, as amended (the ""Code''), to any employee of the

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Company or its subsidiaries, as provided in Section 5.1 of this Plan; (b) grant options other than Incentive
Stock Options (""Non-Qualified Stock Options''), as provided in Section 5.2 of this Plan; (c) award stock
bonuses as provided in Section 6; and (d) issue shares subject to restrictions as provided in Section 7. The
Board shall select the individuals to whom awards shall be made and shall specify the action taken with
respect to each individual to whom an award is made. Shares issued upon exercise of options or awards
granted under this Plan may be subject to such restrictions on transfer, repurchase rights or other restrictions
as may be determined by the Board. No person may be granted options and awards to acquire more than a
total of 1,600,000 shares of Common Stock ®400,000 shares if the 2006 proposed one-for-four reverse stock
split is implemented© in any calendar year.

5. Option Grants.

5.1
conditions:

Incentive Stock Options.

Incentive Stock Options shall be subject to the following terms and

(a) Incentive Stock Options may be granted under this Plan only to employees of the Company or
its subsidiaries within the meaning of Section 422(a)(2) of the Code, including employees who are
directors.

(b) No employee may be granted Incentive Stock Options under this Plan to the extent that the
aggregate fair market value, on the date of grant, of the Common Stock with respect to which Incentive
Stock Options are exercisable for the first time by that employee during any calendar year, under this
Plan and under any other incentive stock option plan (within the meaning of Section 422 of the Code) of
the Company or any subsidiary, exceeds $100,000. To the extent that any option designated as an
Incentive Stock Option exceeds the $100,000 limit, such option shall be treated as a Non-Qualified Stock
Option. In making this determination, options shall be taken into account in the order in which they were
granted, and the fair market value of the shares of Common Stock shall be determined as of the time that
the option with respect to such shares was granted.

(c) An Incentive Stock Option may be granted under this Plan to an employee possessing more
than 10% of the total combined voting power of all classes of stock of the Company (as determined
pursuant to the attribution rules contained in Section 424(d) of the Code) only if the exercise price is at
least 110% of the fair market value of the Common Stock subject to the option on the date the option is
granted, as described in Section 5.1(f) of this Plan, and only if the option by its terms is not exercisable
after the expiration of five years from the date it is granted.

(d) Except as provided in Section 5.5 of this Plan, no Incentive Stock Option granted under this
Plan may be exercised unless at the time of such exercise the optionee is employed by the Company or
any subsidiary of the Company and the optionee has been so employed continuously since the date such
option was granted.

(e) Subject to Sections 5.1(c) and 5.1(d) of this Plan, Incentive Stock Options granted under this
Plan shall continue in effect for the period fixed by the Board, except that no Incentive Stock Option
shall be exercisable after the expiration of 10 years from the date it is granted.

(f) The exercise price shall not be less than 100% of the fair market value of the shares of Common
Stock covered by the Incentive Stock Option at the date the option is granted. The fair market value of
shares shall be the closing price per share of the Common Stock on the trading date immediately prior to
the date of grant as reported on a securities quotation system or stock exchange or other principal market
for the Common Stock. If such shares are not so reported or listed, the Board shall from time to time
determine the fair market value of the shares of Common Stock in its discretion.

(g) The provisions of clauses (b) and (c) of this Section shall not apply if either the applicable
sections of the Code or the regulations thereunder are amended so as to change or eliminate such
limitations or to permit appropriate modifications of those requirements by the Board.

(h) If within two years after an Incentive Stock Option is granted or within 12 months after an
Incentive Stock Option is exercised, the optionee sells or otherwise disposes of Common Stock acquired

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on exercise of the Option, the optionee shall within 30 days of the sale or disposition notify the Company
in writing of (i) the date of the sale or disposition, (ii) the amount realized on the sale or disposition and
(iii) the nature of the disposition (e.g., sale, gift, etc.).

5.2 Non-Qualified Stock Options. Non-Qualified Stock Options shall be subject to the following

terms and conditions:

(a) The exercise price shall not be less than 100% of the fair market value of the shares of Common
Stock covered by the Non-Qualified Stock Option on the date the option is granted. The fair market
value of shares of Common Stock covered by a Non-Qualified Stock Option shall be determined by the
Board, as described in Section 5.1(f).

(b) Non-Qualified Stock Options granted under this Plan shall continue in effect for the period
fixed by the Board, except that no Non-Qualified Stock Option shall be exercisable after the expiration of
10 years from the date it is granted.

5.3 Vesting. To ensure that the Company will achieve the purposes of and receive the benefits
contemplated in this Plan, the Board, at its discretion, may establish a vesting schedule, change such vesting
schedule or provide for no vesting schedule for options granted under the Plan. In establishing a vesting
schedule, the Board may set a ""Base Date'', meaning a reference date for the specific option grant and
optionee. If no Base Date is established by the Board for a specific option grant, then the date of grant of the
option by the Board shall constitute the Base Date.

5.4 Nontransferability. Each option granted under this Plan and the rights and privileges conferred
hereby may not be transferred, assigned, pledged or hypothecated in any manner (whether by operation of law
or otherwise) other than by will or by the applicable laws of descent and distribution or, with respect to Non-
Qualified Stock Options, pursuant to a qualified domestic relations order. The foregoing notwithstanding, the
Board on conditions it determines may permit the transferability of a Non-Qualified Stock Option by an
optionee solely to members of the optionee's family or to one or more trusts or partnerships for the benefit of
such family members. Any purported transfer or assignment in violation of this provision shall be void.

5.5 Termination of Options.

5.5.1 Generally. Unless otherwise determined by the Board or specified in the optionee's Option
Agreement, if the optionee's employment or service with the Company and its subsidiaries terminates for any
reason other than for cause, resignation, retirement, disability or death, and unless by its terms the option
sooner terminates or expires, then the optionee may exercise, for a three-month period, that portion of the
optionee's option which was exercisable at the time of such termination of employment or service (provided
the conditions of Section 5.6.4 and any other conditions specified in the Option Agreement shall have been
met by the date of exercise of such option). For purposes of this Section 5.5, references to employment or
service with the Company, and similar references, shall include the Company or any of its subsidiaries.

5.5.2 For Cause; Resignation.

(a) If an optionee is terminated for cause or resigns in lieu of dismissal, any option granted
hereunder shall be deemed to have terminated as of the time of the first act which led or would have led
to the termination for cause or resignation in lieu of dismissal, and such optionee shall thereupon have no
right to purchase any shares of Common Stock pursuant to the exercise of such option, and any such
exercise shall be null and void. Termination for ""cause'' shall include (i) the violation by the optionee of
any reasonable rule or policy of the Board or the optionee's superiors or the chief executive officer or the
President of the Company that results in damage to the Company or which, after notice to do so, the
optionee fails to correct within a reasonable time; (ii) any willful misconduct or gross negligence by the
optionee in the responsibilities assigned to him or her; (iii) any willful failure to perform his or her job as
required to meet the objectives of the Company; (iv) any wrongful conduct of an optionee which has an
adverse impact on the Company or which constitutes a misappropriation of the assets of the Company;
(v) unauthorized disclosure of confidential information; or (vi) the optionee's performing services for any
other company or person which competes with the Company while he or she is employed by or provides

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services to the Company, without the prior written approval of the Chairman or President of the
Company. ""Resignation in lieu of dismissal'' shall mean a resignation by an optionee of employment with
or service to the Company if (i) the Company has given prior notice to such optionee of its intent to
dismiss the optionee for circumstances that constitute cause, or (ii) within two months of the optionee's
resignation, the Chairman or President of the Company or the Board determines, which determination
shall be final and binding, that such resignation was related to an act which would have led to a
termination for cause.

(b) If an optionee resigns from the Company, the right of the optionee to exercise his or her option
shall be suspended for a period of two months from the date of resignation, unless the Chairman or the
President of the Company or the Board determines otherwise in writing. Thereafter, unless there is a
determination that the optionee resigned in lieu of dismissal, the option may be exercised at any time
prior to the earlier of (i) the expiration date of the option, or (ii) the expiration of three months after the
date of resignation, for that portion of the optionee's option which was exercisable at the time of such
resignation (provided the conditions of Section 5.6.4 and any other conditions specified in the Option
Agreement shall have been met at the date of exercise of such option).

5.5.3 Retirement. Unless otherwise determined by the Board, if an optionee's employment or service
with the Company is terminated with the Company's approval for reasons of age, the Option may be exercised
at any time prior to the earlier of (a) the expiration date of the option or (b) the expiration of three months
after the date of such termination of employment or service, for that portion of the optionee's option which
was exercisable at the time of such termination of employment or service (provided the conditions of
Section 5.6.4 and any other conditions specified in the Option Agreement shall have been met at the date of
exercise of such option).

5.5.4 Disability. Unless otherwise determined by the Board, if an optionee's employment or relation-
ship with the Company terminates because of a permanent and total disability (as defined in Sec-
tion 22(e)(3) of the Code), the Option may be exercised at any time prior to the earlier of (a) expiration date
of the Option or (b) the expiration of 12 months after the date of such termination for up to the full number of
shares of Common Stock covered thereby, including any portion not yet vested (provided the conditions of
Section 5.6.4 and any other conditions specified in the Option Agreement shall have been met by the date of
exercise of such Option).

5.5.5 Death. Unless otherwise determined by the Board, in the event of the death of an optionee while
employed by or providing service to the Company, the Option may be exercised at any time prior to the earlier
of (a) the expiration date of the Option or (b) the expiration of 12 months after the date of death by the
person or persons to whom such optionee's rights under the option shall pass by the optionee's will or by the
applicable laws of descent and distribution for up to the full number of shares of Common Stock covered
thereby, including any portion not yet vested (provided the conditions of Section 5.6.4 and any other
conditions specified in the Option Agreement shall have been met by the date of exercise of such Option).

5.5.6 Extension of Exercise Period. The Board, at the time of grant or at any time thereafter, may
extend the three-month and 12-month exercise periods to any length of time not longer than the original
expiration date of the option, and may increase the portion of an option that is exercisable, subject to such
terms and conditions as the Board may determine; provided, that any extension of the exercise period or other
modification of an Incentive Stock Option shall be subject to the written agreement and acknowledgment by
the optionee that the extension or modification disqualifies the option as an Incentive Stock Option.

5.5.7 Failure to Exercise Option. To the extent that the option of any deceased optionee or of any
optionee whose employment or service terminates is not exercised within the applicable period, all rights to
purchase shares of Common Stock pursuant to such options shall cease and terminate.

5.5.8 Leaves. For purposes of this Section 5.5, employment shall be deemed to continue while the
optionee is on military leave, sick leave or other bona fide leave of absence (as determined by the Board) in
accordance with the policies of the Company.

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5.6 Exercise.

5.6.1 Procedure. Subject to the provisions of Section 5.3 above, each Option may be exercised in
whole or in part; provided, however, that no fewer than 100 shares (or the remaining shares then purchasable
under the Option, if less than 100 shares) may be purchased upon any exercise of any Option granted
hereunder and that only whole shares will be issued pursuant to the exercise of any Option (the number of
100 shares shall not be changed by any transaction or action described in Section 8 unless the Board
determines that such a change is appropriate). Options shall be exercised by delivery to the Secretary of the
Company or his or her designated agent of written notice of the number of shares with respect to which the
Option is exercised, together with payment in full of the exercise price.

5.6.2 Payment. Payment of the option exercise price shall be made in full at the time the written
notice of exercise of the option is delivered to the Secretary of the Company or his or her designated agent and
shall be in cash or check or pursuant to irrevocable instructions to a stock broker to deliver the amount of sales
proceeds necessary to pay the appropriate exercise price and withholding tax obligations, all in accordance
with applicable governmental regulations, for the shares of Common Stock being purchased. The Board may
determine at the time the option is granted for Incentive Stock Options, or at any time before exercise for
Non-Qualified Stock Options, that additional forms of payment will be permitted. Unless otherwise
determined by the Board, any Common Stock provided in payment of the purchase price must have been
previously acquired and held by the optionee for at least six months.

5.6.3 Withholding. Prior to the issuance of shares of Common Stock upon the exercise of an option,
the optionee shall pay to the Company the amount of any applicable federal, state, local and other tax
withholding obligations. In addition, the optionee shall pay to the Company promptly any required federal,
state and local withholding obligations arising out of a disqualifying disposition of shares acquired upon
exercise of an Incentive Stock Option. The Company may withhold any distribution in whole or in part until
the Company is so paid. The Company shall have the right to withhold such amount from any other amounts
due or to become due from the Company, as the case may be, to the optionee, including salary (subject to
applicable law) or to retain and withhold a number of shares having a market value not less than the amount
of such taxes required to be withheld by the Company to reimburse it for any such taxes and cancel (in whole
or in part) any such shares so withheld.

5.6.4 Conditions Precedent to Exercise. The Board may establish conditions precedent to the exercise

of any option, which shall be described in the relevant Option Agreement.

5.7 Foreign Qualified Grants. Options under this Plan may be granted to officers and employees of
the Company or any of its subsidiaries and other persons described in Section 4 who reside in foreign
jurisdictions as the Board may determine from time to time. The Board may adopt such supplements to the
Plan as are necessary to comply with the applicable laws of such foreign jurisdictions and to afford optionees
favorable treatment under such laws; provided, however, that no award shall be granted under any such
supplement on terms which are more beneficial to such optionees than the terms permitted by this Plan.

5.8 Corporate Mergers, Acquisitions, Etc. The Board may also grant options under this Plan having
terms, conditions and provisions that vary from those specified in this Plan provided that such options are
granted in substitution for, or in connection with the assumption of, existing options granted, awarded or issued
by another corporation and assumed or otherwise agreed to be provided for by the Company pursuant to or by
reason of a transaction involving a corporate merger, consolidation, acquisition of property or stock,
reorganization or liquidation to which the Company is a party.

5.9 Holding Period. Unless otherwise determined by the Board, if a person subject to Section 16 of
the Exchange Act exercises an option within six months of the date of grant of the option, the shares of
Common Stock acquired upon exercise of the option may not be sold until six months after the date of grant of
the option.

5.10 Option Agreements. Options granted under this Plan shall be evidenced by written stock option
agreements (""Option Agreements'') which shall contain such terms, conditions, limitations and restrictions as

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the Board shall deem advisable and which are consistent with this Plan. All Option Agreements shall include
or incorporate by reference the applicable terms and conditions contained in this Plan.

6. Stock Bonuses. The Board may award shares under this Plan as stock bonuses. Shares awarded as a
bonus shall be subject to the terms, conditions (including performance standards) and restrictions determined
by the Board. The restrictions may include restrictions concerning transferability and forfeiture of the shares
awarded, together with any other restrictions determined by the Board. The Board may require the recipient to
sign an agreement as a condition of the award, but may not require the recipient to pay any monetary
consideration other than amounts necessary to satisfy all federal, state, local and other tax withholding
requirements. The agreement may contain any terms, conditions, restrictions, representations and warranties
required by the Board. The certificates representing the shares awarded shall bear any legends required by the
Board. The Company may require any recipient of a stock bonus to pay to the Company in cash or by check
upon demand amounts necessary to satisfy any applicable federal, state, local and other tax withholding
requirements. If the recipient fails to pay the amount demanded, the Company or the Employer may withhold
that amount from other amounts payable to the recipient, including salary, subject to applicable law. With the
consent of the Board, a recipient may satisfy this obligation, in whole or in part, by instructing the Company to
withhold from any shares to be issued or by delivering to the Company other shares of Common Stock;
provided, however, that the number of shares so withheld or delivered shall not exceed the minimum amount
necessary to satisfy the required withholding obligation. Upon the issuance of a stock bonus, the number of
shares reserved for issuance under the Plan shall be reduced by the number of shares issued, less the number
of shares withheld or delivered to satisfy withholding obligations.

7. Restricted Stock. The Board may issue shares under this Plan for any consideration (including
services and promissory notes) determined by the Board. Shares issued under this Plan shall be subject to the
terms, conditions (including performance standards) and restrictions determined by the Board. The restric-
tions may include restrictions concerning transferability, repurchase by the Company and forfeiture of the
shares issued, together with any other restrictions determined by the Board. All Common Stock issued
pursuant to this Section 7 shall be subject to an agreement, which shall be executed by the Company and the
prospective recipient of the shares before the delivery of certificates representing the shares to the recipient.
The purchase agreement may contain any terms, conditions, restrictions, representations and warranties
required by the Board. The certificates representing the shares shall bear any legends required by the Board.
The Company may require any recipient of restricted stock to pay to the Company in cash or by check upon
demand amounts necessary to satisfy any applicable federal, state, local and other tax withholding require-
ments. If the recipient fails to pay the amount demanded, the Company or the Employer may withhold that
amount from other amounts payable to the recipient, including salary, subject to applicable law. With the
consent of the Board, a recipient may satisfy this obligation, in whole or in part, by instructing the Company to
withhold from any shares to be issued or by delivering to the Company other shares of Common Stock;
provided, however, that the number of shares so withheld or delivered shall not exceed the minimum amount
necessary to satisfy the required withholding obligation. Upon the issuance of restricted stock, the number of
shares reserved for issuance under the Plan shall be reduced by the number of shares issued, less the number
of shares withheld or delivered to satisfy withholding obligations.

8. Adjustments Upon Changes in Capitalization.

8.1 Stock Splits, Capital Stock Adjustments. The aggregate number and class of shares for which
options and awards may be granted under this Plan, the number and class of shares covered by each
outstanding option and award and the exercise or purchase price per share thereof (but not the total price),
and each such option and award, shall all be proportionately adjusted for any increase or decrease in the
number of issued shares of Common Stock of the Company resulting from a stock split, stock dividend or
consolidation of shares or any like capital stock adjustment.

8.2 Effect of Merger, Sale of Assets, Liquidation or Dissolution.

8.2.1 Termination Unless Assumption or Substitution. Upon the effective date of a merger, consolida-
tion or plan of exchange (other than a merger, consolidation or plan of exchange involving the Company in
which the holders of voting securities of the Company immediately prior to such transaction own at least 50%

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of the voting power of the outstanding securities of the surviving corporation or a parent of the surviving
corporation after such transaction), or a sale of all or substantially all the assets of the Company, or a
liquidation or dissolution of the Company, the Plan and any option theretofore granted hereunder shall
terminate, and all restrictions and conditions (other than payment) of awards granted pursuant to Section 6 or
Section 7 shall terminate, unless provisions be made in writing in connection with such transaction for the
continuance of the Plan and for the assumption of options and awards theretofore granted, or the substitution
for such options or awards, with new options and awards covering the shares of a successor corporation, or a
parent, affiliate or subsidiary thereof, with appropriate adjustments as to number and kind of shares and prices
thereof, in which event the Plan and the options and awards granted under it, or the new options or awards
substituted therefor, shall continue in the manner and under the terms so provided.

8.2.2 Exercise and Vesting.

If provision is not made pursuant to the preceding Section 8.2.1 in
connection with such a transaction for the continuance of the Plan and for the assumption of options and
awards, or the substitution for such options and awards of new options and awards covering the shares of a
successor employer corporation or a parent, affiliate or subsidiary thereof, then each optionee under the Plan
shall be entitled, prior to the effective date of any such transaction, to exercise the option for the full number
of shares covered thereby, including any portion not yet vested (provided that the conditions of Section 5.6.4
and any other conditions specified in the Option Agreement shall have been met at the date of exercise of such
option) and all restrictions and conditions (other than payment) of awards shall lapse.

8.3 Fractional Shares.

In the event of any adjustment in the number of shares covered by any option
or award, any fractional shares resulting from such adjustment shall be disregarded and each such option and
award shall cover only the number of full shares resulting from such adjustment.

8.4 Determination of Board to Be Final. All adjustments under this Section 8 shall be made by the
Board, and its determination as to what adjustments shall be made, and the extent thereof, shall be final,
binding and conclusive. Unless an optionee agrees otherwise, any change or adjustment to an Incentive Stock
Option shall be made, if possible, in such a manner so as not to constitute a ""modification,'' as defined in
Section 424(h) of the Code, and so as not to cause the optionee's Incentive Stock Option to fail to continue to
qualify as an Incentive Stock Option.

9. Securities Regulations.

9.1 Compliance with Law. Shares of Common Stock shall not be issued with respect to an option or
award granted under this Plan unless the exercise of such option and the issuance and delivery of such shares
pursuant to such option or award complies with all relevant provisions of law, including, without limitation,
any applicable state securities laws, the Securities Act of 1933, as amended, the Exchange Act, the rules and
regulations promulgated thereunder, applicable laws of foreign countries and other jurisdictions and the
requirements of any quotation service or stock exchange upon which the shares may then be listed, and shall
be further subject to the approval of counsel for the Company with respect to such compliance, including the
availability of an exemption from registration for the issuance and sale of any shares hereunder. The inability
of the Company to obtain, from any regulatory body having jurisdiction, the authority deemed by the
Company's counsel to be necessary for the lawful issuance and sale of any shares hereunder or the
unavailability of an exemption from registration for the issuance and sale of any shares hereunder shall relieve
the Company of any liability with respect of the nonissuance or sale of such shares as to which such requisite
authority shall not have been obtained.

9.2

Investment Purpose. As a condition to the exercise of an option or receipt of stock pursuant to an
award, the Company may require the optionee or awardee to represent and warrant at the time of any such
exercise or receipt that the shares of Common Stock are being acquired only for investment and without any
present intention to sell or distribute such shares if, in the opinion of counsel for the Company, such a
representation is required by any relevant provision of the aforementioned laws. The Company may place a
stop-transfer order against any shares of Common Stock on the official stock books and records of the
Company, and a legend may be stamped on stock certificates to the effect that the shares of Common Stock
may not be pledged, sold or otherwise transferred unless an opinion of counsel is provided (concurred in by
counsel for the Company) stating that such transfer is not in violation of any applicable law or regulation. The

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Board may also require such other action or agreement by the optionees as may from time to time be
necessary to comply with the federal and state securities laws. THIS PROVISION SHALL NOT
OBLIGATE THE COMPANY TO UNDERTAKE REGISTRATION OF THE OPTIONS OR STOCK
THEREUNDER OR ANY AWARDS UNDER THIS PLAN.

10. Amendment and Termination.

10.1 Plan. The Board may at any time suspend, amend or terminate this Plan, provided that, except as
set forth in Section 8, the approval of the Company's shareholders is necessary within 12 months before or
after the adoption by the Board of any amendment that will:

(a) increase the number of shares of Common Stock that are to be reserved for the issuance under

this Plan;

(b) permit the granting of stock options or awards to a class of persons other than those presently

permitted to receive stock options or awards under this Plan; or

(c) require shareholder approval under applicable law, including Section 16(b) of the Exchange
Act, or the regulations of any securities market or exchange on which the Common Stock is then listed
for trading or quotation.

10.2 Options. Subject to the requirements of Section 422 of the Code with respect to Incentive Stock
Options and to the terms and conditions and within the limitations of this Plan, the Board may modify or
amend outstanding options and awards granted under this Plan, provided that, without the prior approval of
the Company's shareholders, no such modification or amendment, except for adjustments made pursuant to
Section 8.1 or as described in Section 8.2.1, shall reduce the exercise price of outstanding options issued under
this Plan, or cancel or amend outstanding options issued under this Plan for the purpose of repricing, replacing
or regranting such options with an exercise price that is less than the original exercise price (as adjusted
pursuant to Section 8.1 or as described in Section 8.2.1) of such options. The modification or amendment of
an outstanding option shall not, without the consent of the optionee or awardee, impair or diminish any of his
or her rights or any of the obligations of the Company under such option or award. Except as otherwise
provided in this Plan, no outstanding option or award shall be terminated without the consent of the optionee
or awardee. Unless the optionee agrees otherwise, any changes or adjustments made to outstanding Incentive
Stock Options granted under this Plan shall be made in such a manner so as not to constitute a
""modification,'' as defined in Section 424(h) of the Code, and so as not to cause any Incentive Stock Option
issued hereunder to fail to continue to qualify as an Incentive Stock Option as defined in Section 422(b) of
the Code.

10.3 Automatic Termination. Unless sooner terminated by the Board, this Plan shall terminate ten
years from the date on which this Plan is adopted by the Board. No option or award may be granted after such
termination or during any suspension of this Plan. The amendment or termination of this Plan shall not,
without the consent of the optionee or awardee, alter or impair any rights or obligations under any option and
award theretofore granted under this Plan.

11. Miscellaneous.

11.1 Time of Granting Options. The date of grant of an option shall, for all purposes, be the date on
which the Company completes the required corporate action relating to the grant of an option; the execution
of an Option Agreement and the conditions to the exercise of an option shall not defer the date of grant.

11.2 No Status as Shareholder. The recipient of any award under the Plan shall have no rights as a
shareholder with respect to any shares of Common Stock until the date the recipient becomes the holder of
record of those shares. Except as otherwise expressly provided in the Plan, no adjustment shall be made for
dividends or other rights for which the record date occurs before the date the recipient becomes the holder of
record.

11.3 Status as an Employee. Nothing in the Plan or any award pursuant to the Plan shall (i) confer
upon any employee any right to be continued in the employment of an Employer or interfere in any way with

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the Employer's right to terminate the employee's employment at will at any time, for any reason, with or
without cause, or to decrease the employee's compensation or benefits, or (ii) confer upon any person engaged
by an Employer any right to be retained or employed by the Employer or to the continuation, extension,
renewal or modification of any compensation, contract or arrangement with or by the Employer.

11.4 Reservation of Shares. The Company, during the term of this Plan, at all times will reserve and
keep available such number of shares of Common Stock as shall be sufficient to satisfy the requirements of
this Plan.

12. Effectiveness of This Plan. This Plan shall become effective upon adoption by the Board so long as
it is duly approved by the Company's shareholders any time within 12 months after the adoption of this Plan.
No option granted under this Plan to any officer or director of the Company shall become exercisable,
however, until the Plan is approved by the shareholders, and any options and awards granted prior to such
approval shall be conditioned upon and are subject to such approval.

Adopted by the Board of Directors as of March 8, 2006, and approved by the Shareholders on June

2006.

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2005

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

For the Transition Period From

Commission Ñle number: 0-26820

CRAY INC.

(Exact name of registrant as speciÑed in its charter)

Washington
(State or Other Jurisdiction of
Incorporation or Organization)

411 First Avenue South, Suite 600
Seattle, Washington
(Address of Principal Executive OÇce)

93-0962605
(I.R.S. Employer
IdentiÑcation No.)

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

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Indicate by check mark if the Registrant is a well-known seasoned issuer, as deÑned in Rule 405 of the

Securities Act: Yes n No ¥

Indicate by check mark if the Registrant is not required to Ñle reports pursuant to Section 13 or Section 15(d)

of the Act: Yes n No ¥

Indicate by check mark whether the Registrant (1) has Ñled all reports required to be Ñled by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to Ñle such reports), and (2) has been subject to such Ñling requirements for the past
90 days: Yes ¥ No n

Indicate by check mark if disclosure of delinquent Ñlers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant's knowledge, in deÑnitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¥

Indicate by check mark whether the registrant is a large accelerated Ñler, an accelerated Ñler, or a non-
accelerated Ñler. See deÑnition of ""accelerated Ñler and large accelerated Ñler'' in Rule 12b-2 of the Exchange Act.
(Check one): n Large accelerated Ñler ¥ Accelerated Ñler n Non-accelerated

Indicate by check mark whether the registrant is a shell company (as deÑned in Rule 12b-2 of the Exchange

Act) Yes n No ¥

The aggregate market value of the Common Stock held by non-aÇliates of the Registrant as of June 30, 2005,
was approximately $108,175,000, based upon the closing price of $1.24 per share reported for such date on the
Nasdaq National Market System.

As of April 17, 2006, there were 91,750,299 shares of Common Stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement to be delivered to shareholders in connection with the Registrant's Annual

Meeting of Shareholders to be held on June 6, 2006, are incorporated by reference into Part III.

CRAY INC.

FORM 10-K
For Fiscal Year Ended December 31, 2005

INDEX

PART I

Item 1.
BusinessÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 1A. Risk Factors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 1B. Unresolved StaÅ Comments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 2.
Legal Proceedings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 3.
Item 4.
Submission of Matters to a Vote of Security HoldersÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item E.O. Executive OÇcers of the Company ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

PART II

Item 5.

Item 6.
Item 7.

Market for the Company's Common Equity, Related Shareholder Matters and Issuer
Repurchases of Equity SecuritiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Selected Financial Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Management's Discussion and Analysis of Financial Condition and Results of
OperationsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Financial Statements and Supplementary Data ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 8.
Changes in and Disagreements with Accountants on Accounting and Financial
Item 9.
Disclosure ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 9A. Controls and Procedures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other Information ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Item 9B.

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PART III

Item 10.
Item 11.
Item 12.

Item 13.
Item 14.

Directors and Executive OÇcers of the Company ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Executive Compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Security Ownership of Certain BeneÑcial Owners and Management and Related
Shareholder Matters ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Certain Relationships and Related Transactions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Principal Accountant Fees and Services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Page

1
13
29
29
29
30
31

33
34

35
50
51

53
53
57

58
58

58
58
58

Item 15.

Exhibits and Financial Statement Schedules ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

PART IV

Cray, Cray-1, UNICOS and UNICOS/mk are federally registered trademarks of Cray Inc., and
Cray Y-MP, Cray C90, Cray J90, Cray T90, Cray T3E, Cray SV1, Cray SV1ex, Cray X1, Cray X1E,
Cray XT3 and Cray XD1 are trademarks of Cray Inc. Other trademarks used in this report are the property of
their respective owners.

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertain-
ties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to diÅer
materially from those expressed or implied by such forward-looking statements. All statements other than
statements of historical fact are statements that could be deemed forward-looking statements, including any
projections of earnings, revenue or other Ñnancial items; any statements of the plans, strategies and objectives
of management for future operations; any statements concerning proposed new products, services or
developments; any statements regarding future economic conditions or performance; statements of belief and
any statement of assumptions underlying any of the foregoing. We assume no obligation to update these
forward-looking statements.

The risks, uncertainties and assumptions referred to above include Öuctuating operating results with
possibility of periodic losses and uneven and possibly negative cash Öows; need for increased product revenue
and margin, particularly from our Cray XT3 system and upgrade and successor systems; the technical
challenges of developing new supercomputer systems on time and budget; the timing of product orders,
shipments and customer acceptances; the timing and level of government support for supercomputer system
development; whether we will be awarded a phase 3 contract under the DARPA High Productivity
Computing Systems program; our dependency on third-party suppliers to build and deliver components timely
that meet our speciÑcations; the challenge of maintaining expense growth at modest levels while increasing
revenue; our ability to attract, retain and motivate key employees, including executive oÇcers and managers;
and other risks that are described from time to time in our reports Ñled with the Securities and Exchange
Commission (""SEC'' or ""Commission''), including but not limited to the items discussed in ""Risk Factors''
set forth in Item 1A below in this report, and in subsequently Ñled reports.

In this report, we rely on and refer to information and statistics regarding the markets for various
products. We obtained this information from third-party sources, discussions with our customers and our own
internal estimates. We believe that these third-party sources are reliable, but we have not independently
veriÑed them and there can be no assurance that they are accurate.

Item 1. Business

General

PART I

We are dedicated solely to the supercomputing market. We have concentrated our product roadmap on
building balanced systems combining highly capable processors (whether developed by ourselves or others)
along with highly scalable software with very high speed interconnect and communications capabilities
throughout the entire computing system, not solely from processor-to-processor. We believe we are very well
positioned to meet the high performance computing market's demanding needs by providing superior
supercomputer systems with performance and cost advantages over low-bandwidth and cluster systems when
sustained performance on challenging applications and workloads and total cost of ownership are taken into
account.

Our 2005 product revenue primarily came from sales of our three principal products, the Cray X1E, Cray
XT3 and Cray XD1 systems, and government funding for our Red Storm and Cascade development projects.
We also derive revenue from providing maintenance and support services to the worldwide installed base of
Cray computers and professional services that leverage our technical knowledge. See ""Product OÅerings,
Projects and Services'' below.

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Our revenue, net income or loss and cash balances are likely to Öuctuate signiÑcantly from quarter to
quarter and within a quarter due to the high average sales prices and limited number of sales of our larger
products, the timing of purchase orders and product deliveries, our general policy of not recognizing product
revenue for our larger systems until customer acceptance and other contractual provisions have been fulÑlled,
and the uncertain timing of payments for product sales, maintenance services, government research and
development funding, and inventory.

We were incorporated under the laws of the State of Washington in December 1987. Our corporate
headquarter oÇces are located at 411 First Avenue South, Suite 600, Seattle, Washington, 98104-2860, our
telephone number is (206) 701-2000 and our website address is: www.cray.com. The contents of our website
are not incorporated by reference into this Annual Report on Form 10-K or our other SEC reports and Ñlings.

Our History

In many ways our current history began on April 1, 2000, when we, as Tera Computer Company,
acquired the operating assets of the Cray Research division from Silicon Graphics, Inc. (""SGI''), and
renamed ourselves Cray Inc. Tera Computer Company was founded in 1987 with the purpose of developing a
new supercomputer system based on multithreaded architecture. In early 2000 we were still in the
development stage with limited revenue and approximately 125 employees, almost all of whom were located in
our Seattle oÇce.

Cray Research, Inc., founded in 1972 by Seymour Cray, pioneered the use of vector systems in a variety
of market sectors and dominated the supercomputer market in the late 1970's and 1980's. Cray Research
introduced a series of vector-based systems, including the Cray 1, Y-MP, C90, J90, T90 and SV1 systems.
Cray Research also developed leading high-bandwidth massively parallel systems, notably the Cray T3E
system, using Alpha microprocessors from Digital Equipment and later Compaq Computer. In 1996 SGI
acquired Cray Research and cancelled the development of the successors to the only two U.S. produced
capability-class supercomputers at the time, the Cray T90 and T3E systems. In 1997 the U.S. government
imposed extensive anti-dumping duties on Japanese vector supercomputers, eÅectively preventing them from
entering the U.S. market. These developments combined to eliminate the availability of high-bandwidth
computer systems in the United States high performance computing market, greatly diminishing the
U.S. market's access to these systems. In 1998 SGI and the Department of Defense (""DOD'') entered into a
cost-sharing contract for the development of the Cray X1 system (then code-named the Cray SV2). In 1999
SGI announced that it would consider oÅers to purchase the Cray Research division.

Cray Research Acquisition

On April 1, 2000, we acquired the operating assets of the Cray Research business unit from SGI and
changed our corporate name to Cray Inc. In that transaction, we acquired the Cray product lines, the Cray X1
development project and related cost-sharing contract, a worldwide service organization supporting Cray
supercomputers installed at customer sites, integration and Ñnal assembly operations, software products and
related experience and expertise, approximately 775 employees, product and service inventory, real property
located in Chippewa Falls, Wisconsin, and the Cray brand name. Pursuant to a technology agreement, SGI
assigned to us various patents and other intellectual property and licensed to us the rights to other patents and
intellectual property. As part of the acquisition, we assumed responsibility for the cost of servicing the
Cray T90 vector computers. We agreed with SGI that we would not utilize speciÑed technology to develop
speciÑc successor products to the Cray T3E product line, and we agreed to limit our use of SGI's IRIX
operating system to the Cray X1 product family.

Post-Acquisition

Following the acquisition, we integrated our approximately 900 employees into one company, either had
service, sales and other contracts assigned to us or entered into new contracts with customers and vendors,
continued the development of the Cray X1 system and continued to sell the then-existing Cray products,
principally the Cray T3E and SV1 systems.

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In May 2001 the U.S. anti-dumping order against Japanese vector supercomputers was lifted, NEC
Corporation invested $25 million in us and we became a distributor of the NEC SX series of supercomputers,
with exclusive rights in North America and non-exclusive rights outside of North America. In 2003 NEC sold
its investment in us, cancelled our exclusive rights and we became a non-exclusive distributor worldwide.

In 2001 and 2002 we focused our development eÅorts on the Cray X1 system; initial deliveries of the
Cray X1 system began in late 2002. The Cray X1 system, designed for the high end of the supercomputer
market, was the only new product we were selling in 2003 and the Ñrst three quarters of 2004. In 2004 we
developed the Cray X1E system that signiÑcantly increased the system's processor speed and capability; the
Ñrst Cray X1E system customer shipment occurred at the end of 2004.

In mid-2002 we began our Red Storm development project with Sandia National Laboratories to design
and deliver a new high-bandwidth, massively parallel processing supercomputer system. The Red Storm
hardware system was shipped in installments to Sandia, with the Ñnal hardware shipment in the Ñrst quarter of
2005, with further installation of component upgrades as they become available. Working with Sandia, we
developed and installed system software designed to run applications programs across the entire system of over
10,000 processors. Recently the Red Storm system became the Ñrst computer system to surpass the one
terabyte-per-second performance mark on the PTRANS interconnect bandwidth test, a key indicator of the
network's total communications capability. The Red Storm project provided the development basis for a
commercial product, our Cray XT3 system, targeting the need for highly scalable, high-bandwidth,
microprocessor-based supercomputers. The Cray XT3 system initial customer shipment occurred in the fourth
quarter of 2004, with full production ramp in the Ñrst half of 2005, and we expect that the Cray XT3 and
planned upgrade and successor systems will provide a majority of our product revenue in 2006 and be an
important revenue contributor in succeeding years.

In mid-2002 we also began work under a contract awarded by the Defense Advanced Research Projects
Agency (""DARPA'') pursuant to its High Productivity Computing Systems (HPCS) program to develop a
system capable of sustained performance in excess of one petaÖops (1,000 trillion Öoating point operations per
second), which we call our Cascade program. We are currently completing phase 2 (the research phase) of
this project, which ends in mid-2006, and we intend to bid on phase 3 (the prototype phase) later this spring;
phase 3 awards are expected to be announced in July 2006.

On April 1, 2004, we acquired OctigaBay Systems Corporation, a privately-held company located in
Burnaby, B.C., Canada. OctigaBay was developing a balanced, high-bandwidth system, designed to be highly
reliable and easy-to-use, targeted for the midrange market. We renamed OctigaBay Systems Corporation as
Cray Canada Inc. and renamed the OctigaBay product as the Cray XD1 system. Initial commercial shipments
of the Cray XD1 system began late in the third quarter of 2004, with full production ramp in the Ñrst half of
2005. We plan to combine the capabilities of the Cray XD1 system with our Cray XT3 system into a single
product in 2007.

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Discussions that relate to periods prior to April 1, 2000, refer to our operations as Tera Computer
Company, and discussions that relate to periods after April 1, 2000, refer to our combined operations as
Cray Inc.

The High Performance Computing Industry

Since the pioneering Cray-1 system arrived in 1976, supercomputers Ì often deÑned simply as the most
powerful class of computers at any time Ì have contributed substantially to the advancement of knowledge
and the quality of human life. Problems of major economic, scientiÑc and strategic importance typically are
addressed by supercomputers, which usually sell for several millions of dollars each, years before becoming
tractable with less capable systems. For scientiÑc applications, the increased need for computing power has
been driven by highly challenging problems that can be solved only through numerically intensive computation
and large data set manipulation. For engineering applications, high performance computers boost productivity
and decrease risk and the time to market for companies and products in a broad range of industries. The
U.S. government has recognized that the continued development of high performance computer systems is of

critical importance to national defense and the economic, scientiÑc and strategic competitiveness of the
United States.

Increasing Demand for Supercomputer Power

Many applications promising future competitive and scientiÑc advantage demand 10 to 1,000 times more
supercomputer power than anything available today. We believe there are three principal factors driving the
demand in the high performance computing market: the continuing demand for advanced design and
simulation capability, continuing concerns about national security issues and the recognized need to advance
scientiÑc research for domestic competitiveness of many countries around the world.

The demand for design capabilities grows seemingly without limit. Weather forecasting and climate
modeling centers need increasing computer speeds to handle larger volumes of data to produce more accurate
and localized short-term and longer-term forecasts and climate change models. Aerospace Ñrms envision more
eÇcient planes and space vehicles. Automotive companies are targeting increased passenger cabin comfort,
better fuel mileage and improved safety and handling. Using genomic and proteomic technologies for drug
development are areas of intensive research and substantial spending by research centers and biotechnology
and pharmaceutical companies.

Governments have a wide range of unmet security needs, heightened by an emphasis on anti-terrorism.
These needs primarily relate to burgeoning cryptanalysis requirements arising from a more diverse and
growing number of sources and requirements for rapid and accurate analysis and integration of information
from many disparate sources. In addition, governments need better simulation and modeling of a wide range of
weapons and the computational ability to address various classiÑed applications.

In 2002 the Japanese government announced the completion of the Japanese Earth Simulator project.
This high-bandwidth, vector-based system remains acknowledged as one of the world's most powerful
installed computer systems with high sustained operating performance on real applications. The Japanese
Earth Simulator validated our proposition that high-bandwidth and sustained performance are critical, and has
provided Japan with the opportunity to lead in scientiÑc research in Ñelds such as weather and climate,
geophysics, nanotechnology and metallurgy.

The Advantages of Bandwidth

When we speak of ""bandwidth,'' we mean the rate at which processors can communicate with other

processors, with the system's internal memory subsystem and with input/output (""I/O'') connections.

Today's high performance computer market is replete with low-bandwidth systems and oÅ-the-shelf
commodity-based cluster systems that loosely link together multiple commodity servers or personal computers
by means of commercially available interconnect products. In recent years, the speed and capabilities of
oÅ-the-shelf interconnect systems and processors have continued to improve, and independent software
vendors have adapted their application codes to exploit the capabilities and partially mask the weaknesses of
these systems. These systems oÅer competitive price/performance on small problems and larger problems
lacking communications complexity.

We are dedicated solely to the supercomputing market. Although we are a comparatively small company,
we have invested signiÑcantly to develop advanced supercomputing systems. We diÅerentiate ourselves from
our competitors primarily by emphasizing the processing and communication capabilities of our systems. We
have concentrated our product roadmap on building balanced systems combining highly capable processors
(whether developed by ourselves or others) along with scalable software with very high speed interconnect and
communication capabilities throughout the entire computing system. Our supercomputer systems are
""balanced'' in that our systems are fast not only between processors but also between processors and memory
and I/O subsystems, allowing the entire system to scale to deliver the highest levels of capability so that users
may run their largest and most challenging problems signiÑcantly faster. Competitive systems may use
processors with higher rated or theoretical speeds than some of our systems Ì although at 18 gigaÖops
(billions of Öoating point operations per second) our Cray X1E processor is currently one of the world's

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fastest Ì but even in those cases our systems typically outperform competing products on the most
challenging applications by using their high-bandwidth communications and scaling software capabilities to
deliver more data to the Cray processors and keep them busier and more eÇcient, especially at large scale.

As we design our supercomputer systems for the needs of the high performance computing market, we
say they are ""purpose-built'' for this market. Vendors of low-bandwidth systems, such as Dell and several
other companies building clusters with commercially available commodity technology, design and build their
processors and systems to meet the requirements of their larger commercial computer markets Ì for servers
and personal computers Ì and then attempt to leverage these commercial server-based products into the
supercomputer market.

Low-bandwidth and cluster systems may oÅer higher theoretical peak performance, for equivalent cost,
than do our systems. Theoretical peak performance is the highest theoretical possible speed at which a
computer system could, but never does, operate (obtained simply by multiplying the number of processors by
the designed rated peak speed of each processor, assuming no bottlenecks or ineÇciences). Sustained
performance, always lower than peak, is the actual speed at which a supercomputer system runs an application
program. The sustained performance of low-bandwidth and cluster systems on complex applications frequently
is a small fraction, often less than 5-10%, of their theoretical peak performance, and as these systems become
larger, their eÇciency declines even further, sometimes below 1% for the most challenging applications. Our
systems, designed for balanced total system communications capability, provide high actual sustained
performance on diÇcult computational problems, even though in some cases they may have a lower
theoretical peak performance than competitors' systems. While sustained performance may vary widely on
diÅerent applications, our systems generally operate on a sustained basis from 1.5 to 10 times that of
competitors' systems. We expect our systems to provide price/performance advantages over low-bandwidth
and cluster systems when actual performance on real applications is taken into account.

The advent of the Cray X1 system in late 2002 provided the Ñrst new high-bandwidth alternative for the
U.S. high-end high performance computer customers since the mid-1990's. Our introduction in late 2004 of
the Cray XT3 and Cray XD1 systems extended the availability of high-bandwidth systems to systems that use
commodity processors.

The High Performance Computing Market

Industry analyst Ñrm, International Data Corporation (""IDC''), provides information regarding the high
performance computing systems market, including historical data and projections. IDC preliminarily esti-
mates that the revenue for the entire high performance technical computing market totaled approximately
$9.1 billion in 2005. IDC segments the high performance computing systems market based on prices and, at
the higher end, intended use. IDC descriptions and estimates of revenue in recent years for each of these
segments (preliminary estimates for 2005) follow:

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‚ Capability. Systems conÑgured and purchased to solve the largest, most demanding problems, and
generally priced at $1 million or more. The size of the capability segment has ranged in recent years
from about $800 million to $1.2 billion, with 2005 estimated revenue of $870 million.

‚ Enterprise. Systems purchased to support technical applications in throughput environments and sold

for $1.0 million or more, with 2005 estimated revenue of $1.2 billion.

‚ Divisional. Systems purchased to support technical applications in throughput environments and sold

for $250,000 to $999,999, with 2005 estimated revenue of $1.9 billion.

‚ Departmental. Systems purchased to support technical applications in throughput environments and

sold for $50,000 to $250,000, with 2005 estimated revenue of $2.9 billion.

‚ Workgroup. Systems purchased to support technical applications in throughput environments and

sold for less than $50,000, with 2005 estimated revenue of $2.2 billion.

We focus on the capability segment of the high performance computing market where the features we are
known for Ì high speed processors coupled with very fast communications Ì are widely recognized as

necessary to solve the world's most diÇcult computing problems. With the Cray XT3 and Cray XD1 systems,
our addressable market expanded into parts of the enterprise segment.

Our Target Market and Customers

Our target markets for 2006 and beyond principally include the government/classiÑed, scientiÑc research,
weather/environmental, and automotive, aerospace and manufacturing markets. In certain of our targeted
markets, such as the government/classiÑed and scientiÑc research markets, customers have their own
application programs and are accustomed to using new, less proven systems. Other target customers, such as
automotive and aerospace Ñrms and some governmental agencies, require third-party application programs in
production environments.

Government/ClassiÑed

Government agencies have represented a signiÑcant segment for Cray Research and ourselves for many
years. Certain governmental departments continue to provide funding support for our research and develop-
ment eÅorts to meet their objectives. We expect long-term spending on national security and defense to
increase. Current and target customers for our products include DOD classiÑed customers and parts of the
Department of Energy, which funds the Sandia National Laboratories, Los Alamos National Laboratory and
Lawrence Livermore National Laboratory, and certain foreign counterparts.

ScientiÑc Research

The scientiÑc research segment includes both unclassiÑed governmental and academic research laborato-
ries and centers. The DOD, through its Defense High Performance Computing Modernization Program, funds
a number of research organizations. Network Computing Services, Inc., the system integrator for the Army
High Performance Computing Research Center in Minneapolis, the U.S. Army Corps of Engineers'
Engineering, Research and Development Center (ERDC) in Vicksburg, Mississippi, the Corp's Major Shared
Resource Center, and the Arctic Region Supercomputing Center in Fairbanks, for example, were early
purchasers of our Cray X1 system, and the Army Center upgraded its Cray X1 system to a Cray X1E system.
The OÇce of Science in the Department of Energy, which funds the Oak Ridge National Laboratory,
Argonne National Laboratory and National Energy Research ScientiÑc Computing Center, is a key target
customer as is the National Aeronautics and Space Administration. Oak Ridge National Laboratory is a
signiÑcant customer for Cray X1, X1E and XT3 systems and related services. The Pittsburgh Supercomputing
Center, funded by the National Science Foundation, has acquired a Cray XT3 system with 10 teraÖops
(trillions of calculations per second) peak performance, and ERDC recently accepted a Cray XT3 system
with 20 teraÖops peak performance. The Maui High Performance Computing Center, a U.S. Air Force
Research Laboratory's Directed Energy Directorate facility funded by the Defense High Performance
Computing Modernization Program, acquired a Cray XD1 system with a peak performance of about
1.4 teraÖops to increase the Center's capabilities in space surveillance and image processing. Cray XD1
systems have been acquired by governmental and academic research laboratories and centers in Italy,
Germany, India, the United Kingdom and the United States.

Weather/Environmental

Weather forecasting and climate modeling applications require increasing speed and larger volumes of
data and thus are targets for our high-bandwidth systems. Cray supercomputers are used in weather centers
worldwide, from the United Kingdom to Korea. We have installed Cray X1 and Cray X1E systems at the
Spanish National Institute of Meteorology and the Korea Meteorological Administration, where the
Cray X1E system is the most powerful operational weather forecasting system in the world.

Automotive, Aerospace and Manufacturing

These industries use supercomputers to design lighter, safer and more durable vehicles as well as to study
wind noise and airÖow around the vehicle and in many other computer-aided engineering applications. Several

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of the major automobile companies and aerospace companies are Cray customers. We have installed a
Cray X1 system at The Boeing Company, which uses the system primarily to run structural analysis and
computational Öuid dynamics codes. The Cray XD1 system, especially in larger conÑgurations, has demon-
strated early impressive results on certain automotive crash, computational Öuid dynamics and other important
manufacturing applications, with both Toyota Auto Body and Sony Corporation in Japan as recent customers.

Product OÅerings, Projects and Services

Our supercomputing products provide high-bandwidth and other capabilities needed for exploiting new
and existing market opportunities. Among supercomputer vendors, our intent is to oÅer the most scalable and
highest (sustained) performing systems in the high performance computing market. Our goal is to bring major
enhancements and/or new products to market every 12 to 24 months using both custom and commodity
processor-based supercomputers.

Current Products

Cray XT3 System

The Cray XT3 system uses Advanced Micro Devices Inc. (""AMD'') single-core and dual-core
OpteronTM processors connected via our high-bandwidth interconnect network. It incorporates a massively
parallel optimized operating system and a standards-based programming environment designed to deliver very
high sustained application performance in conÑgurations from 200 to 30,000 processors. The Cray XT3 system
features a tightly integrated management system to provide high reliability and to run full-system applications
to completion. The Cray XT3 system is based on the Red Storm architecture we co-developed with Sandia
National Laboratories. We began shipments of early versions of the Cray XT3 system in the fourth quarter of
2004, with full production ramp in the Ñrst half of 2005. Our selling focus for the Cray XT3 systems covers a
range of peak performance from one to over 100 teraÖops. List selling prices for a one cabinet system start at
under $2 million. We expect the Cray XT3 system, including planned upgrade and successor systems, to
provide a majority of our product revenue in 2006 and to be an important revenue contributor in succeeding
years.

Cray X1E System

In late 2002 we completed hardware development of the new Cray X1 system, which incorporates in its
design both vector-processing capabilities from the long line of Cray Research vector systems and massively
parallel capabilities analogous to those of our prior generation Cray T3E system. Designed to provide eÇcient
scalability and high-bandwidth to run complex applications at high sustained speeds, the Cray X1 system is an
""extreme performance'' supercomputer aimed at the high end of the vector processing and massively parallel
systems markets. We commenced delivering production systems late in the fourth quarter of 2002. In 2003 we
enhanced the Cray X1 system hardware and software, ported application programs to provide the features and
stability required in a production environment by governmental and industrial users, and delivered ever-larger
integrated systems. The Cray X1E system, Ñrst shipped in December 2004, nearly triples the peak
performance of the Cray X1 system and features one of the world's most powerful processors, at 18 gigaÖops.
Our selling focus for the Cray X1E system covers a range of performance from 500 gigaÖops to 20 teraÖops.
Many of our Cray X1 customers upgraded to Cray X1E systems. The last Cray X1E system will ship in 2006
as we Ñnish development of a successor system, code-named ""BlackWidow,'' designed to improve system
performance and scalability for delivery in 2007.

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Cray XD1 System

The Cray XD1 system, like the Cray XT3 system, is a purpose-built, balanced high-bandwidth system
that employs standard microprocessors but is designed for the mid-range market. It provides superior
sustained application performance employing the direct connected processor architecture to link processors
directly to each other and memory, eliminating interconnect bottlenecks and providing greater bandwidth and
lower latency than typical cluster systems currently available. The Cray XD1 system leverages high volume

technologies such as AMD's HyperTransport and Opteron technologies. It also uses a Linux-based operating
system in connection with our automated management infrastructure and provides the opportunity to
accelerate application performance through the use of Ñeld programmable gate arrays. Our selling focus for
the Cray XD1 system ranges from 58 gigaÖops to over 2.5 teraÖops with processor counts from 12 to more
than 512. List prices for one unit (chassis) systems start at under $100,000, with multiple units providing
enhanced application scaling performance. We plan to combine the capabilities of the Cray XD1 system with
our Cray XT3 system into a single product in 2007.

Resale of Products of Other Companies

We oÅer the NEC SX series of vector supercomputers on a non-exclusive basis, and sell to our
supercomputer customers storage systems from DataDirect Networks, Inc., Engenio Storage Group of LSI
Logic Corporation, and Advanced Digital Information Corporation. We do not expect to record signiÑcant
revenue in 2006 from this activity.

Current Projects

Cascade Project

In mid-2002 DARPA selected Cray and four other companies for phase 1 of its HPCS program leading
to the development of a commercially available high productivity system capable of running real-world
applications with sustained performance in excess of one petaÖops by 2010. In addition to having high
sustained performance, the resulting system is to be designed to be much easier to program, more broadly
applicable and more robust than current designs. In mid-2003 we signed a phase 2 research agreement with
DARPA that provided us and our research partners, Stanford University, California Institute of Technology/
Jet Propulsion Laboratories and the University of Notre Dame, with just under $50 million over three years to
investigate advanced design concepts for the petaÖops system. IBM and Sun Microsystems received similar
awards. We expect to complete phase 2 in July 2006 and we are preparing our bid for phase 3, the prototype
phase. In July 2006 DARPA is expected to select one or two vendors for phase 3 with initial prototype
deliveries scheduled for late 2010. Phase 3 awards are expected to be in the range of $200 million to
$250 million each, payable over about Ñve years, with awardees contributing a signiÑcant portion of the total
costs.

Red Storm

In mid-2002 we contracted with Sandia National Laboratories to design and deliver a new massively
parallel 40-teraÖop processing system, called Red Storm, that uses over 10,000 Opteron processors from AMD
connected via our low-latency, high-bandwidth interconnect network based on HyperTransport technology.
The Red Storm project involves critical network and operating system development. We completed delivery
and installation of the Red Storm hardware at Sandia in the Ñrst quarter of 2005, with subsequent installation
of certain component upgrades as they become available. Together with Sandia, we developed and installed
system software designed to run applications programs across the entire system. In November 2005 we
announced that we will expand the Red Storm system to more than 14,000 Opteron processors with a peak
performance of more than 50 teraÖops (trillions of calculations per second) from its current 40-teraÖop
capacity.

Other Research and Development Activities

We are involved in several substantial research projects to develop vector, multithreaded and commodity
processor-based oÅerings that will continue to advance performance and scalability. These activities include
successors to the Cray XT3 system, with an upgrade system scheduled for delivery in the fourth quarter of
2006; a successor to the Cray X1/X1E line, code-named BlackWidow, with initial product deliveries
scheduled for 2007; and continued development of our multithreaded system, code-named our Eldorado
project, with initial product deliveries scheduled for 2007. We have established a long-term vision, which we
refer to as ""Adaptive Supercomputing,'' to support the anticipated future needs of high performance

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computing customers. With Adaptive Supercomputing, the concept of heterogeneous computing Ì access to
multiple processor technologies Ì is expanded to a fully integrated view of both hardware and software
supporting multiple processing technologies within a single system. We believe we have a signiÑcant
foundation in making this vision a reality because of our unique background in custom processor architectures,
including vector and multithreaded technologies, as well as commodity and new co-processor technologies
such as Ñeld programmable gate arrays. Our plan is to increasingly integrate these processing technologies
over the next few years into a single Linux-based platform. We expect to include powerful compilers and
related software that will analyze and match application code to the most appropriate processing elements,
which is expected to allow programmers to write code in a more natural way and users to beneÑt from
substantially better performance.

These projects are expensive undertakings in terms of dollars, people and time. We seek government
funding, such as funding provided for the Red Storm, Cascade, Cray X1/X1E, BlackWidow and Eldorado
projects, to help defray the costs of this advanced research and development.

Services

Our extensive worldwide maintenance and support organization provides us with a competitive advantage
and a predictable Öow of revenue and cash. Support services are provided under separate maintenance
contracts with our customers. These contracts generally provide for support services on an annual basis,
although some cover multiple years. While most customers pay for support monthly, others pay on a quarterly
or annual basis.

Our professional services organization supports our emphasis on providing solutions rather than just
computer systems to our customers. This organization provides consulting, integration of Cray products,
custom hardware and software engineering, advanced computer training, site engineering, data center
operation and project management services. These services leverage our reputation and skills for services and
industry technical leadership.

Technology

Our leadership in the high performance computer industry depends on successful development and
introduction of new products and enhancements to existing products. Our research and development activities
are focused on system architecture, hardware and software necessary to implement our product roadmap.

Architecture

We believe we are the only company in the world with signiÑcant demonstrated expertise in four primary
processor technologies: vector processing, massively parallel processing, multithreading and co-processing with
Ñeld programmable gate arrays.

Cray Research pioneered the use of vector systems, from the Cray-1 to the Cray T90 systems. These
systems traditionally have used a moderate number (one to 32) of very fast custom processors in connection
with a shared memory. Vector processing has proven to be highly eÅective for many scientiÑc and engineering
application programs that have been written to maximize the number of long vectors. The system stemming
from our BlackWidow project will have the same basic attributes as our current Cray X1E system but will
provide increased performance and scalability.

Massively parallel processing architectures typically link hundreds or thousands of standard or commod-
ity processors to work either on multiple tasks at the same time or together in concert on a single
computationally-intensive task. We focus on building massive parallel processing systems with scalable
architectures using high-bandwidth interconnect networks. These systems are best suited for large computing
problems that can be segmented into many parts and distributed across a large number of processors. Both the
Cray XT3 and the Cray XD1 systems are based on this concept.

Multithreading technology was the core concept behind the original supercomputers designed by Tera
Computer. We are currently developing a new generation of multithreading systems as part of our Eldorado

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project which is being designed to deliver high sustained speed on challenging applications requiring sparse
access to very large data sets, provide scalability as systems increase in size and have balanced I/O capability.
The multithreading processors make the system latency tolerant and, with shared memory, are able to address
data anywhere in the system.

The Cray XD1 system introduced the concept of reconÑgurable computing with Ñeld programmable gate
arrays to our product portfolio. The Ñeld programmable gate arrays can be reconÑgured or reprogrammed to
implement speciÑc functionality more suitable and more eÇciently than on a general-purpose processor.

Hardware

We have extensive experience in designing all of the components of high performance computer
systems Ì the processors, the interconnect system and controls, the I/O system and the supporting cooling
infrastructure Ì to operate together. Our hardware research and development experience includes:

‚ Integrated circuit design Ì we have experience in designing custom and standard cell integrated
circuits. Our processors and other integrated circuits have special features that let them use the high
available memory bandwidth eÇciently.

‚ High speed interconnect systems Ì we design high speed interconnect systems using a combination of
custom I/O circuits, high density connectors and carefully chosen transmission media together with
complex memory and cache controls to operate with our network protocols and highly optimized logic
design. We are investigating the use of optical interconnects for future systems.

‚ Printed circuit board design Ì our printed circuit boards are some of the most sophisticated in the

world, some with more than 40 layers packed with wires and inter-layer connections.

‚ System I/O Ì we design high performance I/O interfaces that deliver high-bandwidth transfer rates

and large capacity storage capabilities using low cost devices in highly reliable conÑgurations.

‚ Packaging and cooling Ì we use very dense packaging in order to produce systems with the necessary
bandwidth at reasonable costs. This generates more heat per unit volume. We use specialized cooling
techniques to address this issue, including immersion, conductive and spray cooling using various
liquids and high volume air cooling.

Our hardware engineers are located primarily in our Chippewa Falls, Wisconsin, and Seattle, Washing-

ton, oÇces.

Software

We have extensive experience in designing and developing software for high performance computer
systems. This includes the operating system, the hardware supervisory system and the programming
environment. Our software research and development experience includes:

‚ Operating Systems Ì For our Cray XT3 and Cray XD1 systems, we exploit and enhance commer-
cially available versions of the Linux operating system. Additionally, on our Cray XT3 systems, we
develop and support a micro-kernel for the compute resources. On the Cray X1E, multithreading and
NEC SX systems, we currently provide and support separate UNIX-based operating systems. In the
future, we anticipate that all of our systems will exploit commercial versions of Linux for all nodes.

‚ Hardware Supervisory Systems (HSS) Ì 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 Ì For our Cray XT3 and Cray XD1 systems, we exploit commercially
available compilers and tools. We also provide Cray developed tools that make our systems easier to
optimize. For our Cray X1E and multithreading systems, we develop our own compilers and tools.

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We purchase or license software technologies from third parties when necessary to provide appropriate

support to our customers, while focusing our own resources where we believe we add the highest value.

Our software personnel are located principally in our Mendota Heights, Minnesota, and Seattle,

Washington, oÇces.

Sales and Marketing

We primarily sell our products through a direct sales force that operates throughout the United States
and in Europe, Canada, Japan and Asia-PaciÑc. We serve smaller foreign markets through sales representa-
tives. About half of our sales force is located in the United States and Canada, with the rest overseas. Our
marketing staÅ has a strategic focus on our target markets and those solutions that will facilitate our
customers' success in solving their most challenging scientiÑc and engineering problems. Our marketing
personnel are located in the United States and Canada.

In 2005, one customer, Oak Ridge National Laboratory (""ORNL''), accounted for approximately 18% of
our total revenue. In 2004, one customer, Sandia National Laboratories, through our Red Storm project,
accounted for 27% of our total revenue. In 2003, one customer, ORNL, accounted for 11% of our total
revenue. Agencies of the United States government, both directly and indirectly through system integrators
and other resellers, accounted for approximately 55% of our 2005 revenue, 72% of our 2004 revenue and 74%
of our 2003 revenue. Information with respect to our international operations and export sales is set forth in
Note 17 Ì Segment Information of the Notes to Consolidated Financial Statements.

Manufacturing and Procurement

While we design many of the hardware components for all of our products, we subcontract the
manufacture of, or buy common-oÅ-the-shelf technology for, all major assemblies of our systems, including
integrated circuits, printed circuit boards, Öex circuits, memory modules, machined enclosures and support
structures, cooling systems, high performance cables and other items to third-party suppliers. Our manufactur-
ing strategy is on build-to-order systems, focusing on obtaining competitive assembly and component costs and
concentrating on the Ñnal assembly, test and quality assurance stages. This strategy allows us to avoid the large
capital commitment and overhead associated with establishing full-scale manufacturing facilities and to
maintain the Öexibility to adopt new technologies as they become available without the risk of equipment
obsolescence, provide near real-time conÑguration changes to exploit faster and/or less expensive technolo-
gies, and provide a higher level of large scale system quality. We perform Ñnal system integration, testing and
check out of our hardware systems. Our manufacturing personnel are located in Chippewa Falls, Wisconsin.

Our systems incorporate some components that are available from one or limited sources, often
containing Cray proprietary designs. Such components include integrated circuits, interconnect systems and
certain memory devices. Prior to development of a particular product, proprietary components are competi-
tively bid to a shortlist of technology partners. The technology partner that provides the best solution for the
component is generally awarded the contract for the life of the component. Once we have engaged a
technology partner, changing our product designs to utilize another supplier's integrated circuits would be a
costly and time-consuming process. We also have sole or limited sources for less critical components, such as
peripherals, power supplies, cooling and chassis hardware. We obtain key integrated circuits from IBM for our
Cray X1E and Cray XT3 systems, from Texas Instruments Incorporated (""TI'') for our BlackWidow project
and from Taiwan Semiconductor Manufacturing Company for our Eldorado project and commodity
processors from AMD for our Cray XT3 and Cray XD1 systems. Our procurements from these vendors are
primarily through purchase orders. We have chosen to deal with sole sources in speciÑc cases due to the
availability of speciÑc technologies, economic advantages and other factors. Reliance on single or limited
source vendors involves several risks, including the possibility of shortages of key components, long lead times,
reduced control over delivery schedules and changes in direction by vendors. See ""Item 1A. Risk Factors Ì
Our reliance on third-party supplies poses signiÑcant risks to our business and prospects'' below.

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Competition

The high performance computing market is very competitive. Many of our competitors are established
companies that are well known in the high performance computing market, including IBM, NEC, Hewlett-
Packard, SGI, Dell, Bull S.A. and Sun Microsystems. Most of these competitors have substantially greater
research, engineering, manufacturing, marketing and Ñnancial resources than we do.

We also compete with systems builders and resellers of systems that are constructed from commodity
components using microprocessors manufactured by Intel, AMD, IBM and others. These competitors include
the previously named companies as well as smaller Ñrms, such as Linux Networx and Verari Systems, that
beneÑt from the low research and development costs needed to assemble systems from commercially available
commodity products. These companies have capitalized on developments in parallel processing and increased
computer performance in commodity-based networking and cluster systems. While these companies' products
are more limited in applicability and scalability, they have achieved growing market acceptance. They oÅer
signiÑcant performance and price/peak performance on smaller problems and on larger problems lacking
complexity, which is a part of the growing capacity computing marketplace (as opposed to the capability
marketplace that is our focus). Such companies, because they can oÅer high peak performance per dollar,
often put pricing pressure on us in competitive procurements.

Internationally we compete primarily with IBM, Hewlett-Packard, Sun Microsystems, SGI and NEC.
While the Ñrst four companies oÅer large systems based on commodity processors, NEC also oÅers vector-
based systems with a large suite of ported application programs. We have non-exclusive rights to market NEC
vector processing supercomputers throughout the world. As in the United States, high performance computing
suppliers like Dell, Linux Networx and Bull oÅer systems with signiÑcantly better price/peak performance.

We compete primarily on the basis of product performance, breadth of features, price/performance,
scalability, quality, reliability, service and support, corporate reputation, brand image and account relation-
ships. Our market approach is more focused than our competitors, as we concentrate solely on supercomput-
ing, with products designed for the needs of this speciÑc market. We oÅer systems that provide greater
performance on the largest, most diÇcult computational problems and superior price/performance on many
important applications in the capability market. Our systems often oÅer total cost of ownership advantages as
they typically use less electric power and cooling for operations and cooling and occupy less space than low-
bandwidth and cluster systems.

Intellectual Property

We attempt to protect our trade secrets and other proprietary rights through formal agreements with our
employees, customers, suppliers and consultants, and through patent protection. Although we intend to protect
our rights vigorously, there can be no assurance that our contractual and other security arrangements will be
successful. There can be no assurance that such arrangements will not be terminated or that we will be able to
enter into similar arrangements on favorable terms if required in the future. In addition, if such agreements
were breached, there can be no assurance that we would have adequate remedies for any breach.

We have a number of patents and pending patent applications relating to our hardware and software
systems. We license certain patents and other intellectual property from SGI as part of our acquisition of the
Cray Research operations. These licenses contain restrictions on our use of the underlying technology,
generally limiting the use to historic Cray products, vector processor computers and the Cray X1/X1E system.
Our general policy is to seek patent protection for those inventions and improvements likely to be incorporated
into our products and services or to give us a competitive advantage. While we believe our patents and
applications have value, no single patent or group of patents is in itself essential to us as a whole or to any of
our key products. Any of our proprietary rights could be challenged, invalidated or circumvented and may not
provide signiÑcant competitive advantage.

There can be no assurance that the steps we take will be adequate to protect or prevent the
misappropriation of our intellectual property. We may infringe or be subject to claims that we infringe the
intellectual property rights of others. Litigation may be necessary in the future to enforce patents we obtain,

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and to protect copyrights, trademarks, trade secrets and know-how we own, or to defend infringement claims
from others. Such litigation could result in substantial expense to us and a diversion of our eÅorts.

Employees

As of December 31, 2005, we employed 787 employees. We have no collective bargaining agreement with
our employees. We have not experienced a work stoppage and believe that our employee relations are very
good.

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports Ñled or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange
Act are available free of charge at our website at www.cray.com as soon as reasonably practicable after we Ñle
such reports with the SEC electronically. In addition, we have set forth our Code of Business Conduct,
Corporate Governance Guidelines, the charters of our Board committees and other governance documents on
our website, www.cray.com, under ""Investors Ì Corporate Governance.''

Item 1A. Risk Factors.

The following factors should be considered in evaluating our business, operations and prospects; they may
aÅect our future results and Ñnancial condition and they may aÅect an investment in our securities. Factors
speciÑc to our 3.0% Convertible Senior Subordinated Notes due 2024 (the ""Notes'') and our common stock
are set forth under the subheading ""Risk Factors Pertaining to Our Notes and Our Common Stock'' below.

Risk Factors Pertaining to Our Business and Operations

Our operating results may Öuctuate signiÑcantly. Our operating results are subject to signiÑcant
Öuctuations due to the factors listed below, which make planning revenue and earnings for any speciÑc period
very diÇcult. We experienced net losses in each full year of our development-stage operations prior to 2002.
For 2002 we had net income of $5.4 million and for 2003 we had net income of $63.2 million (including an
income tax beneÑt of $42.2 million, much of which came from the reversal of a valuation allowance against
deferred tax assets). For 2004 we had a net loss of $207.4 million (including an expense for in-process
research and development of $43.4 million and an income tax expense of $59.1 million, of which $58.9 million
related to the establishment of a valuation allowance against deferred tax assets) and for 2005 we had a net
loss of $64.3 million.

Whether we will achieve anticipated revenue and net income on a quarterly and annual basis in 2006 and

subsequent years depends on a number of factors, including:

‚ successfully selling the Cray XT3, Cray X1E and Cray XD1 systems, including upgrades and successor
systems, new products, and the timing and funding of government purchases, especially in the United
States;

‚ the level of product margin contribution in any given period;

‚ maintaining our other product development projects on schedule and within budgetary limitations;

‚ the level of revenue recognized in any given period, particularly for the high average sales prices and
limited number of sales of our larger systems in any quarter, including the timing of product
acceptances by customers and contractual provisions aÅecting revenue recognition;

‚ revenue delays or losses due to customers postponing purchases to await 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

aÅected by the timing of such funding;

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‚ the terms and conditions of sale or lease for our products;

‚ whether we conclude that all or some part of our recorded goodwill has been impaired, which may be
due to changes in our business plans and strategy and/or a decrease in our fair value (i.e., the market
value of our outstanding shares of common stock); and

‚ the impact of expensing our stock-based compensation under Statement of Financial Accounting

Standards No. 123(R), Share-Based Payment, (""SFAS No. 123(R)'').

The timing of orders and shipments and quarterly and annual results also could be aÅected by additional

events outside our control, such as:

‚ the timely availability of acceptable components in suÇcient quantities to meet customer delivery

schedules;

‚ timing of government funding for products and research and development contracts;

‚ changes in levels of customer capital spending;

‚ the introduction or announcement of competitive products;

‚ the receipt and timing of necessary export licenses; and

‚ currency Öuctuations, international conÖicts or economic crises.

Because of the numerous factors aÅecting our revenue and results of operations, we cannot assure our
investors that we will have net income on a quarterly or annual basis in the future. We currently anticipate that
our quarterly results in 2006 will vary signiÑcantly, with a major portion of our revenue to be recognized in the
second half of the year. Delays in product development, receipt of orders or product acceptances could have a
substantial adverse eÅect on our 2006 results.

Failure to sell Cray XT3 and upgrade systems in planned quantities and margins would adversely aÅect
2006 revenue and earnings. We expect that a majority of our product revenue in 2006 will come from a
limited number of sales of the Cray XT3 system and an upgraded system to governmental purchasers in the
United States and overseas. We have not yet signed contracts for a majority of these system sales, and if we
fail to receive such contracts, our 2006 performance would be adversely aÅected. We do not expect to
complete development of the upgrade system until the fourth quarter of 2006, and thus completion of delivery,
installation and customer acceptance in the fourth quarter is at signiÑcant risk. The availability of an upgrade
system may also adversely aÅect sales of Cray XT3 systems in 2006 if customers decide to wait until 2007 to
receive the upgrade system. We also face signiÑcant margin pressure for our Cray XT3 system and other
commodity processor-based products from competitors.

Improved future performance is highly dependent on increased product revenue and margins.

In 2005,
we had lower revenue and margins than anticipated for our principal products. Product revenue was adversely
aÅected by delays in product shipments due to development delays, including system software development for
large systems, and at times by the availability of key components from third party vendors. Product margins
have been adversely impacted by competitive pressures, lower volumes than planned and higher than
anticipated manufacturing variances, including scrap, rework and excess and obsolete inventory. We
sometimes do not meet all of the contract requirements for customer acceptance of our systems, which has
resulted in contract penalties. Most often these penalties adversely aÅect 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. The risk of contract penalties is increased
when we bid for new business prior to completion of product development.

To improve our Ñnancial performance, we need to receive higher margin orders, particularly for the Cray
XT3 and its upgrade system; deliver shipments of new products on time, particularly the upgrade to the Cray
XT3 system in the fourth quarter of 2006; limit negative manufacturing variances, contract penalties and other
charges that adversely aÅect product margin; and complete the Red Storm project without additional losses.

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Our inability to overcome the technical challenges of completing the development of our supercomputer
systems would adversely aÅect our revenue and earnings in 2006 and beyond. Our success in 2006 and in the
following years depends on completing development of hardware and software enhancements to the Cray XT3
systems, including the timely and successful introduction of dual-core processor technology and successfully
completing, shipping and recognizing revenue for an upgrade to the Cray XT3 system by the fourth quarter of
2006. We also must successfully and timely complete several key projects on our product roadmap, including
the products based on our BlackWidow and Eldorado projects for 2007 revenue and successor systems to the
Cray XT3. These hardware and software development eÅorts are lengthy and technically challenging
processes, and require a signiÑcant investment of capital, engineering and other resources. Our engineering
and technical personnel resources are limited, have suÅered from increased turnover, and our employee
restructurings have strained our engineering resources further. Unanticipated performance and/or develop-
ment issues may require more engineers or time or testing resources than are available currently. Given the
breadth of our engineering challenges and our limited resources, we periodically review the anticipated
contributions and expense of our product programs to determine their long-term viability. We may not be
successful in meeting our development schedules for technical reasons and/or because of insuÇcient hardware
and software engineering resources. Delays in completing the design of the hardware components, including
several custom integrated circuits, and developing requisite system software, operating system software
stability, needed software features and integrating the full systems, would make it diÇcult for us to develop
and market these systems timely and successfully and could cause a lack of conÑdence in our capabilities
among our key customers. We have suÅered signiÑcantly from product delays in the past, especially in 2004
and 2005, that adversely aÅected our Ñnancial performance, and may incur similar delays in the future, which
would adversely aÅect our revenue and earnings.

If we lose government support for development of our supercomputer systems, our research and
development expenses and capital requirements would increase and our ability to conduct research and
development would decrease. A few government agencies and research laboratories fund a signiÑcant portion
of our development eÅorts, including our vector and multithreaded products, which signiÑcantly reduces our
reported level of net research and development expenses. To date, our 2006 development contracts for our
BlackWidow and Eldorado projects are not funded fully or have not yet been completed. Agencies of the
U.S. government historically have facilitated the development of, and have constituted a market for, new and
enhanced very high performance computer systems. U.S. government agencies may delay or decrease funding
of our future product development eÅorts due to a change of priorities, international political developments,
overall budgetary considerations or for any other reason. Any delay in completing the currently planned
contracts for these projects or a delay or decrease in other governmental support would cause an increased
need for capital, increase signiÑcantly our research and development expenditures and adversely impact our
proÑtability and our ability to implement our product roadmap.

We will be adversely aÅected if we are not awarded a contract for phase 3 of the DARPA HPCS
Program. Proposals for phase 3 of the DARPA HPCS program are due in late April 2006 and awards for
phase 3 are to be announced in mid-2006. In addition to ourselves, we expect that IBM and Sun
Microsystems, the other participants in phase 2, will submit proposals. Phase 3 awards are for the delivery of
prototype systems by late 2010 and are expected to be in the range of $200 million to $250 million payable
over about Ñve years, with awardees to contribute a signiÑcant portion of the cost. We anticipate that there will
be one or two awardees. Our 2006 plan is based on a successful phase 3 proposal. Winning a phase 3 award
likely will result in increased research and development expenditures by us for the cost-sharing portion of the
program. If we do not receive a phase 3 award, we would look for alternative funding for all or some portion of
our proposal, which may not be available. We would need to revise our long-term development plans and
possibly redeploy and/or reduce our engineering staÅ. We also may experience decreased conÑdence in us and
our long-term viability from our customers, particularly U.S. governmental agencies. If we do not receive a
phase 3 award, our expenses in 2006 likely will increase and our longer-term revenue and earnings probably
would be adversely aÅected.

We face last-time buy decisions aÅecting all of our products, which may adversely aÅect our revenue
and earnings. We face a last-time-buy deadline for a key component for our Cray XT3 and successor

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systems and our Eldorado project. We expect to no longer produce the Cray XD1 past 2006, and must plan
our inventory purchases accordingly. We may have to place such last-time-buy orders and inventory purchases
before we know all possible sales prospects. In determining last-time-by orders and inventory purchases, we
may either estimate low, in which case we limit the number of possible sales of products and reduce potential
revenue, or we may estimate too high, and incur inventory obsolescence write-downs. Either way, our earnings
would be adversely aÅected.

To be successful we need to establish the value of our high-bandwidth sustained performance systems,
increase diÅerentiation of our massively parallel commodity processor-products and reduce doubts about our
long-term viability. We are a comparatively small company dedicated solely to the supercomputing market.
We have concentrated our product roadmap on building balanced systems combining highly capable
processors with very high speed interconnect and communications capabilities throughout the entire comput-
ing system. We achieve performance diÅerentiation from our competitors through our custom processors in
our vector-based and multithreading products, although the markets for those products may be limited in size.
We need to establish greater performance diÅerentiation from our competitors in our Cray XT3 and successor
massively parallel products in order to command higher margins. The market for such products is much larger
but currently replete with low-bandwidth systems and oÅ-the-shelf commodity-based cluster systems oÅered
by larger competitors with signiÑcant resources and smaller companies with minimal research and develop-
ment expenditures. Many customers are able to meet their computing needs through the use of such systems,
and are willing to accept lower capability and less accurate modeling in return for lower acquisition costs.
Vendors of such systems, because they can oÅer high peak performance per dollar, often put pricing pressure
on us in competitive procurements. In addition, even when we have the best technical solution, our Ñnancial
losses in 2004 and 2005 may raise questions with our customers and potential customers about our long-term
viability. Our long-term success may be adversely aÅected if we are not successful in establishing the value of
our balanced high-bandwidth systems with the capability of solving challenging problems quickly to a market
beyond our core of customers, largely certain agencies of the U.S. and other governments, that require systems
with the performance and features we oÅer.

Our reliance on third-party suppliers poses signiÑcant risks to our business and prospects. We
subcontract the manufacture of substantially all of our hardware components for all of our products, including
integrated circuits, printed circuit boards, connectors, cables, power supplies, and certain memory parts, on a
sole or limited source basis to third-party suppliers. We use contract manufacturers to assemble our
components for all of our systems. We also rely on third parties to supply key software capabilities, such as Ñle
systems and storage subsystems. We are subject to substantial risks because of our reliance on these and other
limited or sole source suppliers. For example:

‚ if a supplier did not provide components that met our speciÑcations in suÇcient quantities, then

production and sale of our systems would be delayed;

‚ if a reduction or an interruption of supply of our components occurred, either because of a signiÑcant
problem with a supplier not providing parts on time or providing parts that later prove to be defective or
a single-source supplier deciding to no longer provide those components to us, 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 or we may not be able to so redesign
such components; see also ""We face last-time buy decisions aÅecting all of our products, which may
adversely aÅect our earnings and prospects,'' above;

‚ if we were unable to locate a supplier for a key component, we would be unable to complete and deliver

our products;

‚ one or more suppliers could make strategic changes in their product oÅerings, which might delay,

suspend manufacture or increase the cost of our components or systems; and

‚ some of our key suppliers are small companies with limited Ñnancial and other resources, and
consequently may be more likely to experience Ñnancial and operational diÇculties than larger, well-
established companies.

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Our products must meet demanding speciÑcations, such as integrated circuits that perform reliably at
high frequencies in order to meet acceptance criteria. From time to time in 2004 and 2005 we incurred delays
in the receipt of key components for the Cray X1E, Red Storm, Cray XT3 and the Cray XD1 systems, which
delayed product shipments and acceptances. The delays in product shipments and acceptances adversely
aÅected 2004 and 2005 revenue and margins, and may continue to so. We have also received parts that later
proved defective, particularly for the Cray XD1 system, which adversely aÅects our margins and customer
conÑdence.

We have used IBM as a key foundry supplier of our integrated circuits for many years. In 2004 IBM
informed us that it would no longer act as our foundry supplier on a long-term basis, although it will continue
production of components for our current products for a limited time. We have negotiated a termination of the
relationship with IBM and completed a general contract with TI to act as our foundry for certain key
integrated circuits for our BlackWidow project in 2006 and successor products in subsequent years. We need
to develop a mutually beneÑcial relationship with TI on a long-term basis, including negotiating and
completing agreements for the design and delivery of speciÑc components. If we do not conclude such
agreements or if TI is not able to meet our schedules successfully, we will be adversely aÅected.

Our Cray XT3 and Cray XD1 systems utilize AMD Opteron processors, as do our planned successor
products. Our Eldorado project is based on processors from Taiwan Semiconductor Manufacturing Company.
If any of these suppliers suÅers delays or cancels the development of enhancements to its processors, our
product revenue would be adversely aÅected. Changing our product designs to utilize another supplier's
integrated circuits would be a costly and time-consuming process.

Lower than anticipated sales of new supercomputers and the termination of maintenance contracts on
older and/or decommissioned systems would further reduce our service revenue and margins from mainte-
nance service contracts. High performance computer systems are typically sold with maintenance service
contracts. These contracts generally are for annual periods, although some are for multi-year periods, and
provide a predictable revenue base. Our revenue from maintenance service contracts has declined from
approximately $95 million in 2000 to approximately $42 million in 2005. While we expect our maintenance
service revenue to stabilize over the next year, we may have periodic revenue and margin declines as our older,
higher margin service contracts are ended and newer, lower margin contracts are established, based on the
timing of system withdrawals from service. Adding service personnel to new locations when we win contracts
where we have previously had no presence and servicing installed products when we discover defective
components in the Ñeld create additional pressure on service margins.

We face increased liquidity risk if we do not receive cash Öow from operating activities as planned.
During 2005, we incurred a net loss of $64.3 million and used $36.7 million of cash in operating activities.
Although we generated cash from operations in the second half of 2005 of approximately $40.5 million, we
used signiÑcant working capital in the Ñrst half of 2005 to fund our operating loss, increased inventory
purchases, increased accounts receivable and additional equipment purchases associated with the introduction
of three new products. Our plans project that our current cash resources, including our credit facility, and cash
to be generated from operating activities should be adequate for at least the next 12 months, although we may
face short-term dislocations between receipts and expenditures. Our plans assume customer acceptances and
subsequent collections from several large customers, as well as cash receipts on new bookings. Should
acceptances and payments be delayed signiÑcantly, we could face a signiÑcant liquidity challenge which may
require us to pursue additional initiatives to reduce costs further, including reductions in inventory purchases
and commitments and/or seek additional Ñnancing. There can be no assurance that we will be successful in
our eÅorts to achieve future proÑtable operations or generate suÇcient cash from operations, or that we would
be able to obtain additional funding through a Ñnancing in the event our Ñnancial resources became
insuÇcient. Financing, even if available, may not be available on satisfactory terms, may contain restrictions
on our operations, and if involving equity or debt securities could reduce the percentage ownership of our
shareholders, may cause additional dilution to our shareholders and the securities may have rights, preferences
and privileges senior to the Notes and our common stock.

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We may not meet the covenants imposed by our current credit agreement. We are subject to various
Ñnancial and other covenants related to our line of credit with Wells Fargo Foothill, Inc. If we were to fail to
satisfy any of the covenants, we could be subject to fees and/or the possible termination of the credit facility.
We failed to meet a covenant with regard to minimum EBITDA for 2005, which was waived by Wells Fargo
Foothill, Inc. Termination of our credit facility would have a material adverse impact on our liquidity.

We were not successful in completing the Red Storm project on time and on budget, which adversely
aÅected our 2004 and 2005 earnings and could adversely aÅect our future earnings and Ñnancial condition.
Falling behind schedule and incurring cost overruns on the Red Storm project adversely aÅected our cash Öow
and earnings in 2004 and 2005, and we recognized an estimated loss of $7.6 million in 2004 and recognized
additional losses of $7.7 million in 2005 on that project. It is possible that we may have additional losses on the
Red Storm contract in 2006. Although we have made considerable progress on the Red Storm project,
achieved a series of critical milestones, and clariÑed the path to system acceptance, failure to complete the
Red Storm system or to receive full payment for the Red Storm system would result in the recognition of
additional losses, and if severe enough, could result in a contract default or termination. Such delays, default
declaration and/or termination could materially adversely aÅect other transactions with other
U.S. government agencies, our 2006 results and our Ñnancial condition.

If the U.S. government purchases fewer supercomputers, our revenue would be reduced and our earnings
would be adversely aÅected. Historically, sales to the U.S. government and customers primarily serving the
U.S. government have represented a signiÑcant market for supercomputers, including our products. From
January 1, 2001, through December 31, 2002, approximately $101 million of our product revenue was derived
from sales to various agencies of the U.S. government; in 2003 and 2004, approximately $145 million and
$78 million, respectively, of our product revenue was derived from such sales. In 2005, approximately
$84 million of our product revenue was derived from U.S. government sales. Our 2006 plan is based on
signiÑcant sales to U.S. government agencies, particularly of Cray XT3 and successor systems. Sales to
government agencies may be aÅected by factors outside our control, such as changes in procurement policies,
budget considerations, domestic crisis, and international political developments. If agencies and departments
of the United States or other governments were to stop, reduce or delay their use and purchases of
supercomputers, our revenue and earnings would be reduced, which could lead to reduced proÑtability or
losses.

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If we are unable to compete successfully in the high performance computer market, our revenue will
decline. The performance of our products may not be competitive with the computer systems oÅered by our
competitors. Many of our competitors are established companies well known in the high performance
computing market, including IBM, NEC, Hewlett-Packard, SGI, Dell, Bull S.A. and Sun Microsystems.
Most of these competitors have substantially greater research, engineering, manufacturing, marketing and
Ñnancial resources than we do.

Internationally we compete primarily with IBM, Hewlett-Packard, Sun Microsystems, SGI, and NEC.
While the Ñrst four companies oÅer large systems based on commodity processors, NEC also oÅers vector-
based systems with a large suite of ported application programs. We have non-exclusive rights to market NEC
vector processing supercomputers throughout the world. As in the United States, commodity high perform-

ance computing suppliers like Dell, Linux Networx and Bull oÅer systems with signiÑcantly better price/peak
performance.

Periodic announcements by our competitors of new high performance computer systems (or plans for
future systems) and price adjustments may reduce customer demand for our products. Many of our potential
customers already own or lease very high performance computer systems. Some of our competitors oÅer trade-
in allowances or substantial discounts to potential customers, and engage in other aggressive pricing tactics,
and we have not always been able to match these sales incentives. We have in the past and may again be
required to provide substantial discounts to make strategic sales, which may reduce or eliminate any positive
margin on such transactions, or to provide lease Ñnancing for our products, which would result in a deferral of
our receipt of cash for these systems. These developments limit our revenue and resources and reduce our
ability to be proÑtable.

Our market is characterized by rapidly changing technology, accelerated product obsolescence and
continuously evolving industry standards. Our success depends upon our ability to sell our current products,
and to develop successor systems and enhancements in a timely manner to meet evolving customer
requirements. We may not succeed in these eÅorts. Even if we succeed, products or technologies developed by
others may render our products or technologies noncompetitive or obsolete. A breakthrough in architecture or
software technology could make low-bandwidth and cluster systems even more attractive to our existing and
potential customers. Such a breakthrough would impair our ability to sell our products and reduce our revenue
and earnings.

If we cannot retain, attract and motivate key personnel, we may be unable to eÅectively implement our
business plan. Our success also depends in large part upon our ability to retain, attract and motivate highly
skilled management, technical, marketing, sales and service personnel. The loss of and failure to replace key
engineering management and personnel could adversely aÅect multiple development eÅorts. Turnover of our
research and development personnel was higher than normal in 2005 due to programmatic decisions and
aggressive hiring pressure from competitors and other high technology companies, resulting in increased risks
to our ability to complete product development projects on schedule. We face staÇng shortages and high
workloads in many key areas, including sales leadership, engineering, Ñeld services, marketing, Ñnance and
legal. We need to develop and implement succession plans for key personnel, some of whom are approaching
retirement age.

Recruitment for senior management and highly skilled technical, sales and other personnel is very
competitive, and we may not be successful in either attracting or retaining such personnel. As part of our
strategy to attract and retain personnel, we oÅer equity compensation through stock options and restricted
stock grants. However, given the Öuctuations of the market price of our common stock and concerns about our
long-term viability, potential employees may not perceive our equity incentives as attractive, and current
employees whose options have exercise prices signiÑcantly above current market values for our common stock
may choose not to remain employed by us. We expect to seek shareholder approval for a new equity incentive
plan that would provide additional authorized options and restricted stock to provide appropriate hiring and
retention incentives; if our shareholders do not approve the new plan, we may be limited in our ability to
provide such incentives. In addition, due to the intense competition for qualiÑed employees, we may be
required to increase the level of compensation paid to existing and new employees, which could materially
increase our operating expenses.

New European environmental rules may adversely aÅect our operations.

In 2006 members of the
European Union (EU) and certain other European countries will implement the Restrictions on Hazardous
Substances (RoHS) Directive, which prohibits or limits the use in electrical and electronic equipment of the
following substances: lead, mercury, cadmium, hexavalent, chromium, polybrominated biphenyls, and
polybrominated diphenyl ethers. After July 1, 2006, a U.S. company shipping products to the EU or such
other European countries that do not comply with RoHS could have its products detained and could be
subject to penalties. We have decided not to ship any Cray X1E or Cray XD1 systems to Europe after July 1,
2006, due to these restrictions, and we are working with our suppliers to assure RoHS compliance with respect
to our other products. We may have to redesign and re-qualify certain components in order to meet RoHS

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requirements, may face increased engineering expenses in this process, and could face shipment delays,
penalties and possible product detentions or seizures if a regulatory authority determines that one of our
products is not RoHS compliant.

A separate EU Directive on Waste Electrical and Electronic Equipment (WEEE) was scheduled to
become eÅective in August 2005, but many EU member states have delayed its implementation. Under the
WEEE Directive, companies that put electrical and electronic equipment on the EU market must register
with individual member states, mark their products, submit annual reports, provide recyclers with information
about product recycling, and either recycle their products or participate in or fund mandatory recycling
schemes. In addition, some EU member states require recycling fees to be paid in advance to ensure funds are
available for product recycling at the end of the product's useful life or de-installation. We have begun to mark
our products as required by the WEEE Directive and are registering with those EU member states where our
products are sold. Each EU member state is responsible for implementing the WEEE Directive and some
member states have not yet established WEEE registrars or established or endorsed the recycling schemes
required by the WEEE Directive. We are actively monitoring implementation of the WEEE Directive by the
member states. Compliance with the WEEE Directive could increase our costs and any failure to comply with
the WEEE Directive could lead to monetary penalties.

Class action and derivative lawsuits are pending and additional lawsuits may be Ñled. We and certain
of our former and current oÇcers and directors have been named as defendants in a consolidated class action
lawsuit pending in federal district court for the Western District of Washington alleging certain violations of
the federal securities laws. A consolidated derivative action purporting to be brought on our behalf against
certain of our former and current oÇcers and directors is also pending in the same federal district court. A
similar consolidated derivative action is pending in a state court in King County, Washington. These cases are
still in their early stages. Additional lawsuits may be Ñled against us. See ""Item 3. Legal Proceedings'' below
for a description of this litigation. An adverse result in the federal securities cases could have a material
negative Ñnancial impact on us. Regardless of the outcome, it is likely that such actions would cause a
diversion of our management's time, resources and attention, and the expense of defending the litigation may
be costly.

We are subject to the risk of additional litigation and regulatory proceedings or actions in connection
with the restatement of prior period Ñnancial statements. We have restated our previously issued Ñnancial
statement for the Ñscal year 2004, including interim periods in 2004. We may in the future be subject to class
action suits, other litigation or regulatory proceedings arising in relation to the restatement of our prior period
Ñnancial statements. Any expenses incurred in connection with this potential litigation or regulatory
proceeding not covered by available insurance or any adverse resolution of this potential litigation or regulatory
proceeding could have a material adverse impact on us. Regardless of the outcome, it is likely that such
actions or proceedings would cause a diversion of our management's time, resources and attention, and the
expense of defending any litigation or proceeding may be costly.

The adoption of SFAS 123(R) will lower our earnings and may adversely affect the market price of our
common stock. We have used stock-based compensation, primarily stock options and an employee stock
purchase plan, as a key component in our employee compensation. We previously granted stock options to each
new employee and to all employees on an annual basis. We believe we have structured these programs to align the
incentives for employees with those of our long-term shareholders. We are reviewing our stock-based compensation
programs and their structure in light of the imposition of SFAS 123(R) which became effective for us on
January 1, 2006. In previous years, as we have reported in the notes to our financial statements, our stock option
program, as currently structured, would add approximately $7 million to $26 million of additional non-cash expense
annually and consequently would reduce our operating results by that amount. These estimates are based on use of
the Black-Scholes valuation method. In the first half of 2005, we accelerated the vesting of our outstanding
employee stock options with a per share exercise price of $1.47 or higher, resulting in the complete vesting of
almost all of our then outstanding options, and we granted new stock options that vested on or before December 31,
2005, in order in part to minimize this expense, at least in the short-term. We recently have granted some stock
options to certain new employees with four-year vesting periods and have issued restricted stock grants to certain
employees and officers, which will be recorded as an expense in 2006 and subsequent years. We do not know how

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analysts and investors will react to the additional expense recorded in our statement of operations rather than in the
notes, which may adversely affect the market price of our common stock.

U.S. export controls could hinder our ability to make sales to foreign customers and our future
prospects. The U.S. government regulates the export of high performance computer systems such as our
products. Occasionally we have experienced delays in receiving appropriate approvals necessary for certain
sales, which have delayed the shipment of our products. Delay or denial in the granting of any required
licenses could make it more diÇcult to make sales to foreign customers, eliminating an important source of
potential revenue.

We incorporate software licensed from third parties into the operating systems for our products and any
signiÑcant interruption in the availability of these third-party software products or defects in these products
could reduce the demand for our products. The operating system software we develop for our high
performance computer systems contains components that are licensed to us under ""open source'' software
licenses. Our business could be disrupted if this software, or functional equivalents of this software, were either
no longer available to us or no longer oÅered to us on commercially reasonable terms. In either case we would
be required either to redesign our operating system software to function with alternate third-party software, or
develop these components ourselves, which would result in increased costs and could result in delays in
product shipments. Furthermore, we might be forced to limit the features available in our current or future
operating system software oÅerings. Our Cray XD1 and Cray XT3 systems utilize software system variants
that incorporate Linux technology. The SCO Group, Inc. has Ñled and threatened to Ñle lawsuits against
companies that operate Linux for commercial purposes, alleging that such use of Linux infringes The SCO
Group's rights. It is possible that The SCO Group could assert a claim of infringement against us with respect
to our use of Linux technology. The open source licenses under which we have obtained certain components of
our operating system software may not be enforceable. Any ruling by a court that these licenses are not
enforceable, or that Linux-based operating systems, or signiÑcant portions of them, may not be copied,
modiÑed or distributed as provided in those licenses, would adversely aÅect our ability to sell our systems. In
addition, as a result of concerns about The SCO Group's lawsuit and open source generally, we may be forced
to protect our customers from potential claims of infringement by The SCO Group or other parties. In any
such event, our Ñnancial condition and results of operations may be adversely aÅected.

We also incorporate proprietary software from third parties, such as for Ñle systems, job scheduling and
storage subsystems. We have experienced some functional issues in the past with implementing such software
with our supercomputer systems. These issues, if repeated, may result in additional expense by us in
integrating this software more fully and/or loss of customer conÑdence.

We have recently formed a new senior management team that must work together eÅectively for us to be
successful.
In 2005 we revamped our senior management team, obtaining the services of Margaret A.
Williams as Senior Vice President responsible for research and development, Brian C. Henry as Executive
Vice President and Chief Financial OÇcer, Jan C. Silverman as Senior Vice President responsible for
corporate strategy and business development and Steven L. Scott as Senior Vice President and Chief
Technology OÇcer, and Peter J. Ungaro was elevated to Chief Executive OÇcer. We recently added a new
vice president/corporate controller and a new vice president responsible for human resources. Additional
changes to our senior management team, and the integration of new senior executives, could result in some
disruption to our business while these new executives become familiar with our business culture and model
and establish their management systems. If our new management team, including any additional senior
executives who join us in the future, is unable to work together eÅectively to implement our strategies, manage
our operations and accomplish our business objectives, our ability to grow our business and successfully meet
operational challenges could be severely impaired. The loss of any key senior management could have a
signiÑcant impact on our eÅorts to improve operating results.

While we believe that we have adequate internal control over Ñnancial reporting as of December 31,
2005, as of the end of each subsequent Ñscal year we are required to evaluate our internal control over
Ñnancial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse results from such
future evaluations could result in a loss of investor conÑdence in our Ñnancial reports and have an adverse

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eÅect on our stock price. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our
Annual Report on Form 10-K for the Ñscal year ended December 31, 2004, we are required to furnish a report
by our management on our internal control over Ñnancial reporting. Such report must contain, among other
items, an assessment of the eÅectiveness of our internal control over Ñnancial reporting as of the end of each
Ñscal year, including a statement as to whether or not our internal control over Ñnancial reporting is eÅective.
This assessment must include disclosure of any material weaknesses in our internal control over Ñnancial
reporting identiÑed by management. Such report must also contain a statement that our independent
registered public accounting Ñrm has issued an attestation report on management's assessment of such internal
control. In our amended 2004 Annual Report on Form 10-K/A, we identiÑed and described a number of
material weaknesses in our internal control over Ñnancial reporting, which required our assessment that our
internal control over Ñnancial reporting was not eÅective, and our independent registered public accounting
Ñrm disclaimed an opinion with respect to our management's assessment of our internal control over Ñnancial
reporting as of December 31, 2004.

We implemented remediation plans to address the identiÑed material weaknesses, and our management
has concluded, as set forth under ""Item 9A. Controls and Procedures,'' below, that our internal control over
Ñnancial reporting was eÅective as of December 31, 2005, and we received a favorable opinion from our
independent registered public accounting Ñrm with respect to our management's assessment, also as set forth
under ""Item 9A. Controls and Procedures,'' below. However, each year we must continue to monitor and
assess our internal control over Ñnancial reporting and determine whether we have any material weaknesses.
Depending on their nature and severity, any future material weaknesses could result in our having to restate
Ñnancial statements, could make it diÇcult or impossible for us to obtain an audit of our annual Ñnancial
statements or could result in a qualiÑcation of any such audit. In such events, we could experience a number of
adverse consequences, including our inability to comply with applicable reporting and listing requirements, a
loss of market conÑdence in our publicly available information, delisting from Nasdaq, loss of Ñnancing
sources such as our line of credit, and litigation based on the events themselves or their consequences.

We may infringe or be subject to claims that we infringe the intellectual property rights of others.
Third parties may assert intellectual property infringement claims against us, and such claims, if proved, could
require us to pay substantial damages or to redesign our existing products. Regardless of the merits, any claim
of infringement requires management attention and causes us to incur signiÑcant expense to defend.

We may not be able to protect our proprietary information and rights adequately. We rely on a
combination of patent, copyright and trade secret protection, nondisclosure agreements and licensing
arrangements to establish, protect and enforce our proprietary information and rights. We have a number of
patents and have additional applications pending. There can be no assurance, however, that patents will be
issued from the pending applications or that any issued patents will protect adequately those aspects of our
technology to which such patents will relate. Despite our eÅorts to safeguard and maintain our proprietary
rights, we cannot be certain that we will succeed in doing so or that our competitors will not independently
develop or patent technologies that are substantially equivalent or superior to our technologies. The laws of
some countries do not protect intellectual property rights to the same extent or in the same manner as do the
laws of the United States. Although we continue to implement protective measures and intend to defend our
proprietary rights vigorously, these eÅorts may not be successful.

Risk Factors Pertaining to our Notes and Our Common Stock

Our indebtedness may adversely aÅect our Ñnancial strength. With the sale of the Notes, we incurred
$80.0 million of indebtedness. As of December 31, 2005, we had no other outstanding indebtedness for money
borrowed and no material equipment lease obligations. We have a $30.0 million secured credit facility which
supports the issuance of letters of credit, of which $11.3 million were outstanding as of December 31, 2005
(the outstanding letters of credit were reduced to $1.4 million as of February 1, 2006), and provides us the
remaining availability for potential borrowing. As of February 6, 2006, the line of credit also supports a
forward currency contract designated as a cash Öow hedge on a speciÑc sales contract. See Note 20 Ì
Subsequent Events of the Notes to Consolidated Financial Statements, below. We may incur additional

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indebtedness for money borrowed, which may include borrowing under new credit facilities or the issuance of
new debt securities. The level of our indebtedness could, among other things:

‚ make it diÇcult or impossible for us to make payments on the Notes;

‚ increase our vulnerability to general economic and industry conditions, including recessions;

‚ require us to use cash Öow from operations to service our indebtedness, thereby reducing our ability to
fund working capital, capital expenditures, research and development eÅorts and other expenses;

‚ limit our Öexibility in planning for, or reacting to, changes in our business and the industry in which we

operate;

‚ 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.

Our existing and any future credit facilities may adversely aÅect our ability to make payments under the
Notes. Our existing senior secured credit agreement contains covenants relating to our business, including
covenants that require us to maintain or achieve speciÑed Ñnancial performance standards, and contains
speciÑed events of default. We anticipate that any future credit facility would contain similar types of
provisions. Our failure to comply with any of those covenants or the occurrence of any of those speciÑed events
of default, if not cured (to the extent cure is permitted under the agreement) or waived, could result in the
acceleration of our indebtedness under the existing or any future credit facilities. If our credit facility is in
default, we will be required by the indenture, or in certain cases after a notice from our lender pursuant to the
indenture, to suspend or defer payments under the Notes. Because our credit facility constitutes senior
indebtedness, any enforcement by the Note holders of their rights under the indenture to such payments could
lead to our insolvency and a proceeding in which our senior and secured indebtedness would have priority over
claims under the Notes.

We will require a signiÑcant amount of cash to service our indebtedness and to fund planned capital
expenditures, research and development eÅorts and other corporate expenses. Our ability to make payments
on our indebtedness, including the Notes, and to fund planned capital expenditures, research and development
eÅorts and other corporate expenses will depend on our future operating performance and on economic,
Ñnancial, competitive, legislative, regulatory and other factors. Many of these factors are beyond our control.
Our business may not generate suÇcient cash Öow from operations and future borrowings may not be available
to us in an amount suÇcient to enable us to pay our indebtedness, including the Notes, or to fund our other
needs.

If we are unable to generate suÇcient cash Öow to enable us to pay our indebtedness, we may need to

pursue one or more alternatives, such as:

‚ reducing our operating expenses;

‚ reducing or delaying capital expenditures or research and development;

‚ selling assets;

‚ raising additional equity capital and/or debt; and

‚ seeking legal protection from our creditors.

Any reduction in operating expenses, reduction or delay in capital expenditures, or sale of assets may
materially and adversely aÅect our future revenue prospects. In addition, we may not be able to raise
additional equity capital or debt on commercially reasonable terms or at all. Finally, any of the above actions
may not provide suÇcient cash to repay our indebtedness, including the Notes.

There are no covenants in the indenture for the Notes restricting our ability or the ability of our
subsidiaries to incur future indebtedness or restricting the terms of any such indebtedness. The indenture
governing the Notes does not contain any Ñnancial or operating covenants or restrictions on the amount or
terms of indebtedness that we or any of our subsidiaries may incur. We may therefore incur additional debt

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without limitation by the indenture for the Notes, including senior indebtedness, to which the Notes are
contractually subordinated, and secured indebtedness, to which the Notes are eÅectively subordinated. In
addition, our subsidiaries may incur additional debt to which the Notes are structurally subordinated, without
limitation. We or our subsidiaries may also agree to terms of any such indebtedness that may restrict our
Öexibility in complying with our obligations under the Notes. If we or any of our subsidiaries incur additional
indebtedness, the related risks that we and they now face may intensify. Our credit facility, however, currently
restricts our ability, directly or through our subsidiaries, to incur additional indebtedness.

The Notes are subordinated in right of payment to our existing and future senior indebtedness. The
Notes are our general unsecured senior subordinated obligations. The Notes rank junior in right of payment to
our existing and future senior indebtedness, including our existing line of credit, and equal in right of payment
with any future indebtedness or other obligation that is not, by its terms, either senior or subordinated to the
Notes. The indenture for the Notes does not limit our ability to incur additional indebtedness of any kind. In
the event of our bankruptcy, liquidation or reorganization, the note holders will share in any assets available to
our general creditors, only after all obligations to the holders of senior indebtedness have been paid. The note
holders do not have the right to limit the amount of senior indebtedness or the competing claims of our general
creditors.

The Notes are eÅectively subordinated to our secured indebtedness and are structurally subordinated to
all indebtedness and other liabilities of our current and future subsidiaries. The Notes are general
unsecured obligations and are eÅectively subordinated to our current and future secured indebtedness to the
extent of the assets securing the indebtedness. The indenture for the Notes does not limit our ability to incur
secured indebtedness. In the event of bankruptcy, liquidation or reorganization or upon acceleration of our
secured indebtedness and in certain other events, our assets pledged in support of secured indebtedness will
not be available to pay our obligations under the Notes. As a result, we may not have suÇcient assets to pay
amounts due on any or all of the Notes.

In addition, the Notes are structurally subordinated to all indebtedness and other liabilities of our current
and future subsidiaries. Note holders do not have any claim as a creditor against our subsidiaries, and
indebtedness and other liabilities, including trade payables, of our subsidiaries eÅectively are senior to Note
holders' claims against our subsidiaries. The indenture for the Notes does not limit the ability of our
subsidiaries to incur indebtedness or other liabilities. In the event of a bankruptcy, liquidation or reorganiza-
tion of any of our subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled
to payment on their claims from assets of that subsidiary before any assets are made available for distribution
to our direct creditors.

We and one of our subsidiaries, Cray Federal Inc., are obligated for all indebtedness under our senior
secured credit agreement with Wells Fargo Foothill, Inc., and that agreement is secured by all of our assets
and those of Cray Federal Inc. and by pledges of the stock of our subsidiaries, and is supported by guaranties
by certain of our subsidiaries.

In certain circumstances, holders of senior debt can require us to suspend or defer cash payments due in
If we are in default as to any payment obligation under any Senior Debt, as deÑned in
respect of the Notes.
the indenture governing the Notes, including a payment default that results from the acceleration of such
Senior Debt as a result of a non-payment default, we will be prohibited, under the terms of the indenture from
making any further cash payments in respect of the Notes until such default has been cured or waived or shall
have ceased to exist. In addition, if we incur a non-payment default under any Designated Senior Debt, as
deÑned in the indenture, the holder or holders may provide, or cause to be provided, a notice to the indenture
trustee that will have the eÅect of prohibiting any further cash payments in respect of the Notes for a period
not exceeding 179 days from the date on which the trustee receives the notice or until such default is earlier
cured or waived. A holder of Designated Senior Debt may have the right to accelerate such debt as a result of
the non-payment default during the 179 day blockage period or otherwise, in which event future payments in
respect of the Notes will be prohibited as described above. Our obligations under our existing senior secured
credit agreement constitute Senior Debt and Designated Senior Debt under the indenture.

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Unless a condition to conversion is met prior to the maturity of the Notes, the Notes will not be
convertible at any time. The Notes are convertible only upon the occurrence of stated conditions. If none of
these conditions occurs during the term of the Notes, the Notes will never be convertible and the holders may
never have an opportunity to realize any appreciation in value based on the value of our common stock.

Upon conversion of the Notes, we may pay cash or a combination of cash and shares of our common
stock in lieu of issuing shares of our common stock. Therefore, Note holders may receive no shares of our
common stock or fewer shares than the number into which their Notes are convertible. We have the right to
satisfy our conversion obligation to Note holders by issuing shares of our common stock into which the Notes
are convertible, paying the cash value of the shares of our common stock into which the Notes are convertible,
or a combination thereof. In addition, we have the right to irrevocably elect to satisfy our conversion obligation
in cash with respect to the principal amount of the Notes to be converted after the date of such election.
Accordingly, upon a conversion of a Note, a holder may not receive any shares of our common stock, or it
might receive fewer shares of our common stock relative to the conversion value of the Note. Our liquidity
may be reduced to the extent that we choose to deliver cash rather than shares of our common stock upon
conversion of Notes.

If a principal conversion settlement election is made, we may not have suÇcient funds to pay the cash
settlement upon conversion.
If we make a principal conversion settlement election, upon conversion of the
Notes, we will be required to satisfy our conversion obligation relating to the principal amount of such Notes
in cash. If a signiÑcant number of holders were to tender their Notes for conversion at any given time, we may
not have the Ñnancial resources available to pay the principal amount in cash on all such Notes tendered for
conversion.

The conversion rate of the Notes may not be adjusted for all dilutive events, including third-party tender
or exchange oÅers, that may adversely aÅect the trading price of the Notes or our common stock issuable
upon conversion of the Notes. The conversion rate of the Notes is subject to adjustment upon speciÑed
events, including speciÑed issuances of stock dividends on our common stock, issuances of rights or warrants,
subdivisions, combinations, distributions of capital stock or assets, cash dividends and issuer tender or
exchange oÅers. The conversion rate will not be adjusted upon other events, such as third-party tender or
exchange oÅers, that may adversely aÅect the trading price of the Notes or our common stock.

If we pay cash dividends on our common stock, Note holders may be deemed to have received a taxable
dividend without the receipt of cash.
If we pay cash dividends on our common stock and there is a resulting
adjustment to the conversion rate, a Note holder could be deemed to have received a taxable dividend subject
to U.S. federal income tax without the receipt of any cash.

If we elect to settle upon conversion in cash or a combination of cash and shares of common stock, there
will be a delay in settlement. Upon conversion, if we elect to settle in cash or a combination of cash and
shares of our common stock, there will be a signiÑcant delay in settlement. In addition, because the amount of
cash or common stock that a Note holder will receive in these circumstances will be based on the sale price of
our common stock for an extended period between the conversion date and such settlement date, holders will
bear the market risk with respect to the value of the common stock for such extended period.

Some signiÑcant corporate transactions may not constitute a fundamental change, in which case we
would not be obligated to oÅer to repurchase the Notes. Upon the occurrence of a fundamental change, as
deÑned in the indenture governing the Notes, which includes speciÑed change of control events, we will be
required to oÅer to repurchase all outstanding Notes. The fundamental change provisions, however, will not
require us to oÅer to repurchase the Notes in the event of some signiÑcant corporate transactions. For
example, various transactions, such as leveraged recapitalizations, reÑnancings, restructurings or acquisitions
initiated by us, would not constitute a change of control and, therefore, would not constitute a fundamental
change requiring us to repurchase the Notes. Other transactions may not constitute a fundamental change
because they do not involve a change in voting power or beneÑcial ownership of the type described in the
deÑnition of fundamental change. Accordingly, Note holders may not have the right to require us to
repurchase their Notes in the event of a signiÑcant transaction that could increase the amount of our

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indebtedness, adversely aÅect our capital structure or any credit ratings or otherwise adversely aÅect the
holders of Notes.

In addition, a fundamental change includes a sale of all or substantially all of our properties and assets.
Although there is limited law interpreting the phrase ""substantially all,'' there is no precise established
deÑnition of the phrase under the laws of New York, which govern the indenture and the Notes, or under the
laws of Washington, our state of incorporation. Accordingly, a Note holder's ability to require us to repurchase
Notes as a result of a sale of less than all of our properties and assets may be uncertain.

Our Notes may not be rated or may receive a lower rating than investors anticipate, which could cause a
decline in the trading volume and market price of the Notes and our common stock. We do not intend to
seek a rating on the Notes, and we believe it is unlikely the Notes will be rated. If, however, one or more rating
agencies rates the Notes and assigns a rating lower than the rating expected by investors, or reduces any rating
in the future, the trading volume and market price of the Notes and our common stock may be adversely
aÅected.

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. On December 1, 2009,
December 1, 2014 and December 1, 2019, holders of the Notes may require us to purchase their Notes for
cash. In addition, holders may also require us to purchase their Notes upon a fundamental change, as deÑned
in the indenture governing the Notes. Our ability to repurchase the Notes in such events may be limited by
law, and by the terms of other indebtedness, including the terms of senior indebtedness, we may have
outstanding at the time of such events. Our existing senior secured credit facility does not permit us to
repurchase any of the Notes without the prior written consent of the lender, including any repurchase
following a fundamental change as deÑned in the indenture. Any subsequent credit facility may include similar
provisions. If we do not have suÇcient funds, we will not be able to repurchase the Notes tendered to us for
purchase. If a repurchase event occurs, we expect that we would require third-party Ñnancing to repurchase
the Notes, but we may not be able to obtain that Ñnancing on favorable terms or at all. Our failure to
repurchase tendered Notes at a time when the repurchase is required by the indenture would constitute a
default under the indenture. In addition, a default under the indenture or the occurrence of a fundamental
change which results in any Note holder delivering a fundamental change purchase notice electing repurchase
of any notes each constitutes a default under our existing senior secured credit facility and could lead to
defaults under other existing and future agreements governing our indebtedness. In these circumstances, the
subordination provisions in the indenture governing the Notes may limit or prohibit payments to Note holders.
If, due to a default, the repayment of the related indebtedness were to be accelerated after any applicable
notice or grace periods, we may not have suÇcient funds to repay the indebtedness or repurchase the Notes.

The make whole premium payable on Notes that are converted in connection with certain fundamental
changes may not adequately compensate Note holders for the lost option time value of the Notes as a result
of that fundamental change.
If any of certain fundamental changes occurs on or prior to December 1, 2009,
we will under certain circumstances pay a make whole premium on the Notes that are converted in connection
with such fundamental change. The amount of the make whole premium and additional shares delivered
depends on the date on which the fundamental change becomes eÅective and the price paid per share of our
common stock in the transaction constituting the fundamental change, as deÑned in the indenture governing
the Notes. Although the make whole premium is designed to compensate Note holders for the lost option
value of the Notes as a result of the fundamental change, the amount of the make whole premium is only an
approximation of the lost value and may not adequately compensate Note holders for the loss. In addition, if a
fundamental change occurs after December 1, 2009, or if the applicable price is less than or equal to $3.51 per
share or greater than $10.50 per share (in each case, subject to adjustment), then we will not pay any make
whole premium. Also, a holder may not receive the make whole premium payable upon conversion until the
fundamental change repurchase date relating to the applicable fundamental change, or even later, which could
be a signiÑcant period of time after the date the holder has tendered its Notes for conversion.

There are restrictions on the Note holders' ability to transfer or resell the Notes without registration
under applicable securities laws, and if we fail to fulÑll our obligations to keep eÅective the registration

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statement covering the resale of the Notes, we will be required to pay additional interest on the Notes
aÅected by that failure and to issue additional shares of common stock on Notes converted during such
failure and satisÑed by us in common stock. We sold the Notes under an exemption from registration under
applicable U.S. federal and state securities laws. The registration statement covering the resale of the Notes
and underlying common stock became eÅective in July 2005. Under the registration rights agreement, we are
permitted to suspend the use of the eÅective registration statement for speciÑc periods of time for certain
speciÑed reasons. If we fail to fulÑll our obligations speciÑed in the registration rights agreement governing the
Notes, we will be required to pay additional interest on Notes adversely aÅected by such failure. Such
additional interest will accrue from the date of such failure at a rate per year equal to 0.25% for the Ñrst
90 days, and 0.50% thereafter, on the principal amount of such Notes until such failure is cured or until the
registration statement is no longer required to be kept eÅective and is payable on the scheduled interest
payment dates. If a holder converts Notes during a registration default, no accrued and unpaid additional
interest will be paid with respect to the Notes converted, but the holder would receive on any conversion that
we elect to satisfy in common stock 103% of the number of shares of our common stock that such holder
would have received in the absence of such default. We would have no other liability for monetary damages
for a failure to fulÑll our registration obligations.

There is no active market for the Notes and if an active trading market does not develop for these Notes,
the holders of the Notes may be unable to resell them. The Notes are a new issue of securities for which the
only current trading market is the Nasdaq's screen-based automated trading system known as PORTAL,
which facilitates the trading of unregistered securities eligible to be resold by qualiÑed institutional buyers
pursuant to SEC Rule 144A. The resale of the Notes is registered under the Securities Act. Any Notes resold
using an eÅective prospectus will no longer be eligible for trading in the PORTAL market. Moreover, if
enough Notes are converted, redeemed or sold pursuant to an eÅective prospectus, trading of Notes in the
PORTAL market may become inactive or may cease altogether. In that event, and in the absence of an
alternative trading market, there would exist no organized market for the Notes from which their market value
could be determined or realized. We do not intend to list the Notes on any national securities exchange or to
seek the admission of the Notes for trading in the Nasdaq National Market or SmallCap Market. We have
been advised by Bear, Stearns & Co. Inc. that it is currently making a market in the Notes. However, it is not
obligated to do so and any market-making activities with respect to the Notes may be discontinued at any time
without notice. In addition, market-making activity is subject to the limits imposed by law.

Further, even if a market in the Notes develops, the Notes could trade at prices lower than the initial
oÅering price. In addition, the liquidity of, and the trading market for, the Notes may be adversely aÅected by
many factors, including prevailing interest rates, the markets for similar securities, general economic
conditions, our Ñnancial condition, performance and prospects and general declines or disruptions in the
market for non-investment grade debt.

Our stock price is volatile. The stock market has been and is subject to price and volume Öuctuations
that particularly aÅect the market prices for small capitalization, high technology companies like us. The
trading price of our common stock is subject to signiÑcant Öuctuations in response to many factors, including
our quarterly operating results (particularly if they are less than our or analysts' previous estimates), changes
in analysts' estimates, our capital raising activities, announcements of technological innovations by us or our
competitors and general conditions in our industry.

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 Ñnancing. As of December 31, 2005, we had
outstanding:

‚ 90,973,506 shares of common stock, and 78,840 shares of common stock issuable upon exchange of
certain exchangeable securities issued in connection with the acquisition of OctigaBay Systems
Corporation in April 2004 (all 78,840 exchangeable shares were exchanged for an equivalent number
of shares of our common stock in January 2006);

‚ warrants to purchase 5,634,049 shares of common stock;

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‚ stock options to purchase an aggregate of 18,000,580 shares of common stock, of which 17,982,045

options were then exercisable; and

‚ Notes convertible into up to 22,792,016 shares of common stock.

Almost all of our outstanding shares of common stock may be sold without substantial restrictions, with
certain exceptions including approximately two million shares held by executive oÇcers and key managers
that may be forfeited and are restricted against transfer until June 30, 2007. Almost all of the shares of
common stock that may be issued on exercise of the warrants and options will be available for sale in the
public market when issued, subject in some cases to volume and other limitations. The warrants outstanding at
December 31, 2005, consisted of warrants to purchase 294,641 shares of common stock, with exercise prices
ranging from $4.50 to $6.00 per share, expiring between May 21, 2006, and September 3, 2006, warrants to
purchase 200,000 shares of common stock, with an exercise price of $1.65 per share, expiring on May 30,
2009, and warrants to purchase 5,139,408 shares of common stock, with an exercise price of $2.53 per share,
expiring on June 21, 2009. We have authorized 5,000,000 shares of undesignated preferred stock, although no
shares are currently outstanding. The Notes are not now convertible, and only become convertible upon the
occurrence of certain events. We have registered the resale of the Notes and of the underlying common stock
under the Securities Act of 1933, as amended, which facilitates transferability of those securities. Sales in the
public market of substantial amounts of our common stock, including sales of common stock issuable upon the
exercise of warrants, options and Notes, may depress prevailing market prices for the common stock. Even the
perception that sales could occur may impact market prices adversely. The existence of outstanding warrants,
options and Notes may prove to be a hindrance to our future Ñnancings. Further, the holders of warrants,
options and Notes may exercise or convert them for shares of common stock at a time when we would
otherwise be able to obtain additional equity capital on terms more favorable to us. Such factors could impair
our ability to meet our capital needs.

Provisions of our Articles of Incorporation and Bylaws could make a proposed acquisition that is not
approved by our Board of Directors more diÇcult. Provisions of our Restated Articles of Incorporation and
Bylaws could make it more diÇcult for a third party to acquire us. These provisions could limit the price that
investors might be willing to pay in the future for our common stock. For example, our Articles of
Incorporation and Bylaws provide for:

‚ removal of a director only in limited circumstances and only upon the aÇrmative 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;

‚ calling 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;

‚ amendments to our Restated Articles of Incorporation require the aÇrmative vote of not less than two-
thirds of the outstanding shares entitled to vote on the amendment, unless the amendment was
approved by a majority of our continuing directors, who are deÑned 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.

These provisions could delay, defer or prevent a merger, consolidation, takeover or other business

transaction between us and a third party.

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We do not anticipate declaring any cash dividends on our common stock. We have never paid any
dividends on our common stock, and we do not anticipate paying any cash dividends on our common stock in
the foreseeable future. In addition, our credit facility prohibits us, and any future credit facility is likely to
prohibit us, from paying cash dividends without the consent of our lender.

Item 1B. Unresolved StaÅ Comments

None.

Item 2. Properties

Our principal properties as of April 1, 2006, were as follows:

Location of Property

Uses of Facility

Approximate
Square Footage

Chippewa Falls, WI ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Manufacturing, hardware development,

228,000

central service and warehouse

Seattle, WAÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Executive oÇces, hardware and software

59,600

development, sales and marketing

Mendota Heights, MNÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Software development, sales and marketing

55,000

operations

We own 179,000 square feet of manufacturing, development, service and warehouse space in Chippewa
Falls, Wisconsin, and lease the remaining space described above. The real property we own in Chippewa Falls,
Wisconsin, is pledged as collateral in favor of Wells Fargo Foothill, Inc. See Note 14 Ì Convertible Notes
Payable and Lines of Credit of the Notes to Consolidated Financial Statements, below. We lease
19,000 square feet of oÇce space in Burnaby, British Columbia, Canada; we are reducing our operations in
that oÇce. The lease expires at the end of 2006.

We also lease a total of approximately 9,600 square feet, primarily for sales and service oÇces, in various
domestic locations. In addition, various foreign sales and service subsidiaries have leased an aggregate of
approximately 17,300 square feet of oÇce space. We believe our facilities are adequate to meet our needs in
2006.

Item 3. Legal Proceedings

Beginning on May 25, 2005, we and certain current and former oÇcers were served with six securities
class action complaints Ñled in the U.S. District Court for the Western District of Washington. On
October 19, 2005, the Court ordered the consolidation of these cases into a single action, and on November 15,
2005, the plaintiÅs Ñled an amended consolidated complaint. PlaintiÅs seek to represent a class of purchasers
of our securities from October 23, 2002, through May 9, 2005. The consolidated complaint alleges federal
securities law violations in connection with the issuance of various reports, press releases and statements in
investor telephone conference calls, and seeks unspeciÑed damages, interest, attorneys' fees, costs and other
relief. On December 19, 2005, we and the individual defendants moved to dismiss the consolidated complaint,
which motion is pending before the Court.

On June 3 and June 17, 2005, two shareholder derivative complaints were Ñled in the U.S. District Court
for the Western District of Washington against members of our Board of Directors and certain current and
former oÇcers. The derivative plaintiÅs purport to act on our behalf and assert allegations substantially similar
to those asserted in the putative class action complaints, as well as allegations of breach of Ñduciary duty,
abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment. The complaints
seek to recover on our behalf unspeciÑed damages and seek attorney's fees, costs and other relief. On
August 29, 2005, the Court ordered the consolidation of these two cases into a single action, and in October
2005 we were served with an amended derivative complaint containing substantially identical allegations as in
the earlier complaints. On November 18, 2005, we and the individual defendants moved to dismiss the
consolidated derivative complaint, which motions are pending before the Court.

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On January 9, 2006, we were served in two additional shareholder derivative complaints Ñled in the
Superior Court of the State of Washington for King County against members of our Board of Directors and
certain current and former oÇcers and former directors. The derivative plaintiÅs purport to act on our behalf
and make allegations substantially similar to those asserted in the consolidated derivative case previously Ñled
in the U.S. District Court for the Western District of Washington. The complaints seek to recover on our
behalf unspeciÑed damages and seek attorneys' fees, costs and other relief. On February 15, 2006, the two
state court derivative actions were consolidated by order of the Court. On April 5, 2006, we and the individual
defendants moved to dismiss the state court derivative action, which motions are pending before the Court.

We are indemnifying our current and former oÇcers and directors named in each of the foregoing actions,
subject to an undertaking by each of them to repay the advanced fees and costs if it is ultimately determined
that he or she is not entitled to such indemniÑcation.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of our shareholders during the fourth quarter of 2005.

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Item E.O. Executive OÇcers of the Company

Our executive oÇcers, as of April 17, 2006, were as follows:

Name

Peter J. UngaroÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Brian C. Henry ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Christopher JehnÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Kenneth W. Johnson ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Steven L. Scott ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Jan C. Silverman ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Margaret A. Williams ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Age

37
49
63
64

40
55
48

Position

Chief Executive OÇcer and President
Executive Vice President and Chief Financial OÇcer
Vice President
Senior Vice President, General Counsel and Corporate
Secretary
Senior Vice President and Chief Technology OÇcer
Senior Vice President
Senior Vice President

Peter J. Ungaro has served as Chief Executive OÇcer and as a member of our Board of Directors since
August 2005 and as President since March 2005; he previously served as Senior Vice President responsible for
sales, marketing and services since September 2004 and before then served as Vice President responsible for
sales and marketing from when he joined us in August 2003. Prior to joining us, he served as Vice President,
Worldwide Deep Computing Sales for IBM since April 2003. Prior to that assignment, he was IBM's vice
president, worldwide high performance computing sales, a position he held since February 1999. He also held
a variety of other sales leadership positions since joining IBM in 1991. Mr. Ungaro received a B.A. in business
administration from Washington State University.

Brian C. Henry joined us in May 2005 as Executive Vice President and Chief Financial OÇcer. He has
20 years of experience as a technology company chief Ñnancial oÇcer. Mr. Henry joined Cray after having
served as executive vice president and chief Ñnancial oÇcer of Onyx Software Corporation, a full suite
customer relationship management company, which he joined in 2001. He previously served from 1999 to
2001 as executive vice president and chief Ñnancial oÇcer of Lante Corporation, a public internet consulting
company focused on e-markets and collaborative business models. From 1998 to 1999 he was chief operating
oÇcer, information management group, of Convergys Corporation, which he helped spin-oÅ from Cincinnati
Bell Inc., a diversiÑed service company where he served as executive vice president and chief Ñnancial oÇcer
from 1993 to 1998. From 1983 to 1993 he was with Mentor Graphics Corporation in key Ñnancial
management roles, serving as chief Ñnancial oÇcer from 1986 to 1993. Mr. Henry received his B.S. degree
from Portland State University and an M.B.A. at Harvard University where he was a Baker Scholar.

Christopher Jehn serves as Vice President responsible for government programs, a position he has held
since joining us in July 2001. He served as the Assistant Director for National Security in the Congressional
Budget OÇce from 1998 to 2001. From 1997 to 1998, he was a member of the Commission on Service
members and Veterans Transition Assistance, and also served in 1997 as the Executive Director of the
National Defense Panel. Mr. Jehn was a Senior Vice President at ICF Kaiser International, Inc., from 1995 to
1997. Prior to 1995, he held executive positions at the Institute for Defense Analyses and the Center for Naval
Analyses and served as Assistant Secretary of Defense for Force Management and Personnel from 1989 to
1993. He received a B.A. from Beloit College and a Master's degree in economics from the University of
Chicago.

Kenneth W. Johnson serves as Senior Vice President, General Counsel and Corporate Secretary. He has
held the position of General Counsel and Corporate Secretary since joining us in September 1997. From
September 1997 to December 2001 he also served as Vice President Finance and Chief Financial OÇcer and
he again served as Chief Financial OÇcer from November 2004 to May 2005. Prior to joining us, Mr. Johnson
practiced law in Seattle for 20 years with Stoel Rives LLP and predecessor Ñrms, where his practice
emphasized corporate Ñnance. Mr. Johnson received an A.B. degree from Stanford University and a J.D.
degree from Columbia University Law School.

Steven L. Scott has served as Senior Vice President since October 2005. He originally served as an
employee, having joined Cray Research in 1992, through mid-July 2005, and rejoined us in October, 2005. He

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was named as Chief Technology OÇcer in October 2004. He is responsible for designing the integrated
infrastructure that will drive our next generation of supercomputers. Prior to his appointment as Chief
Technology OÇcer, Dr. Scott held a variety of technology leadership positions. He was formerly the chief
architect of the Cray X1 system and was instrumental in the design of the Red Storm supercomputer system.
Dr. Scott holds fourteen U.S. patents in the areas of interconnection networks, cache coherence, synchroniza-
tion mechanisms, and scalable parallel architectures. Dr. Scott has served on numerous program committees
and as an associate editor for the IEEE Transactions on Parallel and Distributed Systems, and is a noted
expert in high performance computer architecture and interconnection networks. In 2005 he was the recipient
of both the Seymour Cray Computing Award from the IEEE Computer Society and the Maurice Wilkes
Award from the Association of Computing Machinery. He received his B.S. in electrical and computing
engineering, M.S. in computer science and Ph.D. in computer architecture all from the University of
Wisconsin where he was a Wisconsin Alumni Research Foundation and Hertz Foundation Fellow.

Jan C. Silverman joined us in November 2005 as Senior Vice President responsible for corporate strategy
and business development. In this capacity, he is responsible for our business and marketing strategies and
leads our product management and marketing organizations. Mr. Silverman has 20 years of computer systems
experience. From 1999 to 2005 he held senior marketing positions at SGI, including Senior Vice President
Strategic Initiatives from 2004 to 2005, Senior Vice President and General Manager, Industry Solutions and
Service Group in 2003, Senior Vice President Worldwide Marketing from 2000 to 2003 and Vice President
Product Marketing responsible for servers, storage and graphics from 1999 to 2000. Before joining SGI,
Mr. Silverman was with Hewlett-Packard from 1989 to 1999, holding senior product marketing positions in
Hewlett-Packard's server and workstation groups and also led its early Internet program and microprocessor
strategy. Prior to joining Hewlett-Packard, he was with Apollo Computer and Lockheed Martin in
management and research and development positions. Mr. Silverman holds a B.S. degree in mechanical
engineering from Rensselaer Polytechnic Institute and an M.S. degree in computer science from Lehigh
University.

Margaret A. ""Peg'' Williams is Senior Vice President responsible for our software and hardware research
and development eÅorts, including our current and future products and projects. Dr. Williams, who has more
than 20 years of experience in the high performance computing industry, joined us in May 2005. From 1997
through 2005, she held various positions with IBM including Vice President of Database Technology and
Director and then Vice President of HPC Software and AIX Development (1998-2004). She also led the user
support team at the Maui High Performance Computing Center from 1993 through 1996. From 1987 through
1993, Dr. Williams held various positions in high performance computing software development at IBM.
Dr. Williams holds a B.S. in mathematics and physics from Ursinus College and an M.S. in mathematics and
a Ph.D. in applied mathematics from Lehigh University.

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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

Our common stock is traded on the Nasdaq National Market under the symbol CRAY; prior to April 1,
2000, our stock traded under the symbol TERA. On April 17, 2006, we had 91,750,299 shares of common
stock outstanding that were held by 782 holders of record.

The quarterly high and low sales prices of our common stock for the periods indicated are as follows:

2004

2005

High

Low

High

Low

First QuarterÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Second Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Third Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Fourth Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$11.75
8.03
6.68
4.83

$6.06
5.84
2.85
3.02

$4.91
2.75
1.41
1.73

$2.08
1.18
0.85
0.89

We have not paid cash dividends on our common stock and we do not anticipate paying any cash
dividends on our common stock in the foreseeable future. In addition, our credit facility prohibits us from
paying cash dividends without the consent of our lender.

Unregistered Sales of Securities

In connection with the acquisition of OctigaBay Systems Corporation on April 1, 2004, we reserved
4,840,421 shares of our Common Stock for issuance upon exchange of exchangeable securities issued to
certain OctigaBay shareholders by our Nova Scotia subsidiary. In the quarter ended December 31, 2005, we
issued an aggregate of 25,200 shares of our common stock upon exchange of the exchangeable shares.

In connection with the surrender to our landlord, Merrill Place, LLC, of certain space in our Seattle,
Washington headquarters oÇce and related amendments to our lease in the fourth quarter of 2005, we issued
an aggregate of 70,000 shares of our common stock to our landlord.

The issuances of the shares described above, because of the nature of the investors and the manner in
which the oÅering was conducted, were exempt from the registration provisions of the Securities Act of 1933
under Sections 4(2) and 4(6) and the rules and regulations thereunder and, with respect to the shares issued
upon exchange of exchangeable shares, also under Regulation S under the Securities Act.

Issuer Repurchases

We did not repurchase any of our equity securities in the fourth quarter of 2005.

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Item 6. Selected Financial Data

The following table presents selected historical consolidated Ñnancial data for Cray Inc. and its

subsidiaries, which is derived from our audited consolidated Ñnancial statements:

Years Ended December 31,

2001

2002

2003

2004
(Restated)(2)

2005

(In thousands, except for per share data)

Operating Data:
Revenue:

Product ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
ServiceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 51,105
82,502

$ 76,519
78,550

$175,004
61,958

95,901
49,948

$152,098
48,953

Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

133,607

155,069

236,962

145,849

201,051

Operating Expenses:

Cost of product revenue ÏÏÏÏÏÏÏÏÏÏÏÏ
Cost of service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and development ÏÏÏÏÏÏÏÏÏÏ
Marketing and sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
General and administrative ÏÏÏÏÏÏÏÏÏÏ
In-process research and development

charge ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Restructuring, severance and

impairment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Amortization of goodwill ÏÏÏÏÏÏÏÏÏÏÏÏ

Income (loss) from operations ÏÏÏÏÏÏÏÏÏ
Other income (expense), net ÏÏÏÏÏÏÏÏÏÏ
Interest income (expense), netÏÏÏÏÏÏÏÏÏ

Income (loss) before income taxes ÏÏÏÏÏ
Provision (beneÑt) for income taxes ÏÏÏÏ

30,657
41,181
53,926
19,961
9,226

41,187
42,581
32,861
20,332
8,923

97,354
40,780
37,762
27,038
10,908

104,196
30,338
53,266
34,948
19,451

43,400

3,802
6,981

(32,127)
(336)
(1,771)

(34,234)
994

1,878
Ì

7,307
3,104
(2,832)

7,579
2,176

5,403

4,019
Ì

19,101
1,496
444

21,041
(42,207)

8,182
Ì

(147,932)
(699)
365

(148,266)
59,092

139,518
29,032
41,711
25,808
16,145

9,750
Ì

(60,913)
(1,421)
(3,462)

(65,796)
(1,488)

$ 63,248

$(207,358)

$(64,308)

0.11

0.10

0.94

0.81

(2.49)

$ (0.73)

(2.49)

$ (0.73)

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Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$(35,228)

Basic net income (loss) per common

share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Diluted net income (loss) per common

share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(0.87)

Cash Flow Data:

Cash provided by (used in):

Operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Financing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Depreciation and amortization ÏÏÏÏÏÏÏÏÏ
Purchases of property and equipment ÏÏÏ

$(26,641)
(9,472)
44,045
14,157
9,472

$ (8,689)
(5,992)
25,335
15,364
6,038

$ (8,713)
(41,169)
65,079
15,860
6,599

$ (52,656)
(29,908)
84,153
17,179
12,518

$(36,705)
41,731

(137)

19,578
3,982

Other Data:

Ratio of earnings to Ñxed charges (1)ÏÏÏ

3.4

52.6

Balance Sheet Data:
Cash, cash equivalents, restricted cash and

short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Obligations under capital leases ÏÏÏÏÏÏÏÏÏÏ

$ 12,377
127,087
768

$ 23,916
145,245
393

$ 74,343
291,589
152

87,422
310,504
823

$ 46,026
273,005
154

Total debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Shareholders' equityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

14,944
14,804

(In thousands, except for per share data)
80,000
121,965

Ì
222,633

4,144
58,615

Years Ended December 31,

2001

2002

2003

2004
(Restated)(2)

2005

80,000
65,947

(1) The ratio of earnings to Ñxed charges is computed by dividing earnings by Ñxed charges. Earnings consist
of net income (loss) plus provision (beneÑt) for income taxes and Ñxed charges. Fixed charges consist of
interest expense, including amortization of fees paid for the line of credit and Convertible Senior
Subordinated Note oÅering, plus the portion of operating rental expense management believes represents
the interest component of rent expense. The pretax net loss for the years ended December 31, 2001, 2004
and 2005 was not suÇcient to cover Ñxed charges by approximately $34.2 million, $148.3 million and
$65.8 million, respectively. As a result, the ratio of earnings to Ñxed charges has not been computed for
these periods.

(2) See Note 2 Ì Restatement of Previously Issued Financial Statements of the Notes to the Consolidated

Financial Statements.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The information set forth in ""Management's Discussion and Analysis of Financial Condition and Results
of Operations'' below includes ""forward-looking statements'' within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, and is subject to
the safe harbor created by those Sections. Factors that realistically could cause results to diÅer materially from
those projected in the forward-looking statements are set forth in this section and earlier in this report under
""Item 1A. Ì Risk Factors,'' beginning on page 14. The following discussion should also be read in
conjunction with the Consolidated Financial Statements and accompanying Notes thereto.

Restatement of Consolidated Financial Statements

We have restated our previously issued Ñnancial statements as of and for the year ending December 31,
2004, including interim periods in 2004, to correct a $3.3 million non-cash error with respect to revenue
recognized under one of our product development contracts. We have determined that certain costs were
incorrectly charged to this contract in 2004. The contract is accounted for under the percentage of completion
method of accounting. As restated, 2004 revenue was decreased by $3.3 million, cost of product revenue was
decreased by $3.1 million, research and development expense was increased by $3.1 million, and net loss was
increased by $3.3 million. There was no impact on our cash or short-term investment position.

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All amounts referenced for 2004 in this Annual Report, including the following discussion and analysis of

our Ñnancial condition and results of operations, reÖect the relevant amounts on a restated basis.

See Note 2 Ì Restatement of Previously Issued Financial Statements of the Notes to Consolidated
Financial Statements for a summary of the eÅects of these changes to our consolidated statement of
operations for 2004 and consolidated balance sheet as of December 31, 2004.

Overview and Executive Summary

We design, develop, manufacture, market and service high performance computer systems, commonly
known as supercomputers. These systems provide capability and capacity far beyond typical server-based
computer systems and address challenging scientiÑc and engineering computing problems for government,
industry and academia. During 2005, our revenue primarily came from sales of our Cray XT3, Cray X1E and
Cray XD1 systems, from government funding for our Red Storm and Cascade development projects and from
providing maintenance and other services to our customers.

We are dedicated solely to the supercomputing market. We have concentrated our product roadmap on
building balanced systems combining highly capable processors (whether developed by ourselves or by others)
along with highly scalable software with very high speed interconnect and communications capabilities
throughout the entire computing system, not solely from processor-to-processor. We believe we are very well
positioned to meet the high performance computing market's demanding needs by providing superior
supercomputer systems with performance and cost advantages over low-bandwidth and cluster systems when
sustained performance on challenging applications and workloads and total cost of ownership are taken into
account.

Strategic Focus

We are focused on strategies that we believe will improve our Ñnancial results and increase returns for our
shareholders. Our Ñnancial goals include sustained annual revenue growth, annual operating income improve-
ment, and increased operating cash Öows. Our revenue, results of operations and cash balances are likely to
Öuctuate signiÑcantly from quarter-to-quarter and within a quarter. These Öuctuations are due to such factors
as the high average sales prices and limited number of sales of our larger products, the timing of product
orders and deliveries, our revenue recognition accounting policy under which we generally do not recognize
product revenue until customer acceptance and other contractual provisions have been fulÑlled, the timing of
cash receipts for product sales, maintenance services, government research and development funding and our
purchases of inventory. Given the nature of our business, our revenue, receivables and other related accounts
are likely to be concentrated among a few customers.

To achieve these goals over time, we are focused on recapturing the leadership position in the capability-
class supercomputing market (which represents the largest and most complex systems in the world),
estimated to be a $800 million to $1.2 billion market in recent years. Our total addressable market, which we
view as the capability market and those parts of the enterprise market where we have competitive advantages,
is approximately $1.5 billion. To further this goal, we have aligned our research and development and sales and
marketing eÅorts to achieve our Adaptive Supercomputing vision, which is intended to integrate multiple
processing technologies into a single, highly scalable system to provide high performance and enhanced user
productivity. Our Adaptive Supercomputing vision, which we will roll out over time starting in 2007,
incorporates many of our technical strengths Ì massively parallel, vector, multithreading and other hardware
co-processing technologies and high-bandwidth networks Ì into a single system.

Summary of 2005 Results

Revenue increased by $55.2 million or 38% from 2004 due to initial product sales of our Cray XT3 and
Cray XD1 products and a 38% year-over-year increase in Cray X1/X1E sales, partially oÅset by lower revenue
recognized on our Cascade and Red Storm projects.

Loss from operations improved to a loss of $60.9 million in 2005 from a loss of $147.9 million in 2004.
The improvement was primarily due to three factors: a $21.2 million increase in gross margin on higher 2005
sales; $24.0 million of operating cost containment and improvements due to the second quarter restructuring
activities, including workforce reduction and pay reduction program and increased government funding of
research and development; and a $43.4 million charge in 2004 for the write-oÅ of in process research and
development in connection with the acquisition of OctigaBay Systems.

Net cash used in operations improved in 2005 from a use of cash of $52.7 million in 2004 to a use of cash
of $36.7 million in 2005. Cash balances increased $4.3 million during 2005 and we did not borrow amounts
under our line of credit agreement. However, during 2005 we sold $34.3 million of short-term investments and
utilized $11.4 million of cash previously restricted during the year.

Market Overview and Challenges

The most signiÑcant trend in the high performance computing market is the continuing expansion and
acceptance of low-bandwidth and cluster systems using microprocessors manufactured by Intel, AMD, IBM
and others with commercially available commodity networking and other components throughout the high

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performance computing market, especially in capacity computing situations. These systems may oÅer higher
theoretical peak performance for equivalent cost, and vendors of such systems often put pricing pressure on us
in competitive procurements, even at times in capability market procurements.

To compete against these systems in the longer term, we need to incorporate greater performance
diÅerentiation across our products. We believe we will have such diÅerentiation through our new vector-based
product being developed in our BlackWidow project and our new multithreaded product being developed in
our Eldorado project. These products, which focus initially on a narrower market than our commodity
processor products, are expected to be available in 2007. One of our challenges is to broaden the markets for
these products. We must add greater performance diÅerentiation to our high-bandwidth massively parallel
commodity processor-based products, such as the Cray XT3 and successor systems, while balancing the
business strategy trade-oÅs between using commodity parts, which are available to our competitors, and
proprietary components, which are both expensive and time-consuming to develop. We intend to grow our
share of the capability market and concentrate on those parts of the enterprise market where we have
competitive advantages.

Our success depends on several other factors, including timely, eÇcient execution of our research and
development plans which should provide us with leading-edge technologies. We must eÅectively market and
sell products that utilize these technologies as diÅerentiated products and continue to broaden our geographic
markets in Europe and Asia. We need to continue to successfully obtain co-development funding for certain of
our research and development eÅorts. Longer term, our Adaptive Supercomputing vision incorporates our
broad technical strengths into a single system, reducing our expected development costs. Our ability to
innovate and execute in these areas will determine the extent to which we are able to grow existing revenue
proÑtably despite the high level of competitive activity. There continue to be competitive pressures that we
must respond to related to pricing, product performance and availability of application software. We must
manage each of these factors, as well as maintain mutually beneÑcial relationships with our customers, in
order to compete eÅectively and achieve our business goals.

Our product costs are subject to Öuctuations, particularly due to changes in our production levels. Higher
sales volumes allow us to achieve lower component pricing and recover our Ñxed overhead more eÅectively
than if volumes are low. Technological changes in our products may result in writing down certain inventories
below cost based upon their estimated future use. Our operating costs are subject to Öuctuations due to the
timing and level of development co-funding and other factors. As our international business expands, we must
manage our foreign currency risks as we enter into agreements that are not denominated in the U.S. dollar and
not naturally hedged by expenses that are incurred in the same foreign currency.

The major uncertainties that should be considered in evaluating our business, operations and prospects
and that could aÅect our future results and Ñnancial condition are set forth above under ""Item 1A. Risk
Factors.''

Critical Accounting Policies and Estimates

This discussion as well as disclosures included elsewhere in this Annual Report on Form 10-K are based
upon our consolidated Ñnancial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America (""U.S. GAAP''). The preparation of these
Ñnancial statements requires us to make estimates and judgments that aÅect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingencies. In preparing our Ñnancial statements
in accordance with U.S. GAAP, there are certain accounting policies that are particularly important. These
include revenue recognition, inventory valuation, goodwill and intangible assets, income taxes, the accounting
for loss contracts and stock-based compensation. We believe these accounting policies and others set forth in
Note 3 Ì Summary of SigniÑcant Accounting Policies of the Notes to Consolidated Financial Statements
should be reviewed as they are integral to understanding our results of operations and Ñnancial condition. In
some cases, these policies represent required accounting. In other cases, they may represent a choice between
acceptable accounting methods or may require substantial judgment or estimation.

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Additionally, we consider certain judgments and estimates to be signiÑcant, including those related to
valuation estimates of deferred tax assets, valuation of inventory at the lower of cost or market, estimates to
complete for percentage of completion accounting on the Red Storm and Cascade contracts and impairment
of goodwill and other intangible assets. We base our estimates on historical experience, current conditions and
on other assumptions that we believe to be reasonable under the circumstances. Actual results may diÅer from
these estimates under diÅerent assumptions or conditions.

Our management has discussed the selection of signiÑcant accounting policies and the eÅect of

judgments and estimates with the Audit Committee of our Board of Directors.

Revenue Recognition

We recognize revenue when it is realized or realizable and earned. In accordance with the Securities and
Exchange Commission StaÅ Accounting Bulletin (""SAB'') No. 104, Revenue Recognition in Financial
Statements, we consider revenue realized or realizable and earned when we have persuasive evidence of an
arrangement, the product has been shipped or the services have been provided to our customer, title and risk of
loss for products has passed to our customer, the sales price is Ñxed or determinable, no signiÑcant unfulÑlled
obligations exist and collectibility is reasonably assured. In addition to the aforementioned general policy, the
following are the speciÑc revenue recognition policies for each major category of revenue and for multiple-
element arrangements.

Products: We recognize revenue from our product lines, as follows:

‚ Cray X1/X1E and Cray XT3 Product Lines: We recognize revenue from product sales upon
customer acceptance of the system, when we have no signiÑcant unfulÑlled obligations stipulated by
the contract that aÅect the customer's Ñnal acceptance, the price is 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 signiÑcant
unfulÑlled obligations stipulated by the contract, the price is 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 unfulÑlled obligations.

Revenue from contracts that require us to design, develop, manufacture or modify complex information
technology systems to a customer's speciÑcations is recognized using the percentage of completion method for
long-term development projects under AICPA Statement of Position 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts. Percentage of completion is measured based on
the ratio of costs incurred to date compared to the total estimated costs. Total estimated costs are based on
several factors, including estimated labor hours to complete certain tasks and the estimated cost of purchased
components or services. Estimates may need to be adjusted from quarter to quarter, which would impact
revenue and margins on a cumulative basis. To the extent the estimate of total costs to complete the contract
indicates a loss, such amount is recognized in full at that time.

Services: Revenue for the maintenance of computers is recognized ratably over the term of the
maintenance contract. Maintenance contracts that are paid in advance are recorded as deferred revenue. We
consider Ñscal funding clauses as contingencies for the recognition of revenue until the funding is assured.
High performance computing service revenue is recognized as the services are rendered.

Multiple-Element Arrangements. We commonly enter into transactions that include multiple-element
arrangements, which may include any combination of hardware, maintenance and other services. In
accordance with Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables, when some elements are delivered prior to others in an arrangement and all of the following
criteria are met, revenue for the delivered element is recognized upon delivery and acceptance of such item:

‚ The element could be sold separately;

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‚ 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.

If all of the criteria are not met, revenue is deferred until delivery of the last element as the elements
would not be considered a separate unit of accounting and revenue would be recognized as described above
under our product line or service revenue recognition policies. We consider the maintenance period to
commence upon installation and acceptance of the product, which may include a warranty period and
accordingly allocate a portion of the sales price as a separate deliverable which is recognized as service revenue
over the entire service period.

Inventory Valuation

We record our inventory at the lower of cost or market. We regularly evaluate the technological
usefulness and anticipated future demand of our inventory components. Due to rapid changes in technology
and the increasing demands of our customers, we are continually developing new products. Additionally,
during periods of product or inventory component upgrades or transitions, we may acquire signiÑcant
quantities of inventory to support estimated current and future production and service requirements. As a
result, it is possible that older inventory items we have purchased may become obsolete, be sold below cost or
be deemed in excess of quantities required for production or service requirements. When we determine it is not
likely we will recover the cost of inventory items through future sales, we write down the related inventory to
our estimate of its market value. During 2005, we charged a total of $5.8 million for write down of inventory of
which $3.2 million was related to Cray X1E inventory, $2.0 million was related to Cray XD1 inventory, and
$0.6 million was related to Cray XT3 inventory. In 2004, we wrote down Cray X1 inventory by $8.3 million
and Cray XD1 inventory by $0.2 million, for a total of $8.5 million.

Because the products we sell have high average sales prices and because a high number of our prospective
customers receive funding from U.S. or foreign governments, it is diÇcult to estimate future sales of our
products and the timing of such sales. It also is diÇcult to determine whether the cost of our inventories will
ultimately be recovered through future sales. While we believe our inventory is stated at the lower of cost or
market and that our estimates and assumptions to determine any adjustments to the cost of our inventories are
reasonable, our estimates may prove to be inaccurate. We have sold inventory previously reduced in part or in
whole to zero, and we may have future sales of previously written down inventory. We also may have
additional expense to write down inventory to its estimated market value. Adjustments to these estimates in
the future may materially impact our operating results.

Goodwill and Other Intangible Assets

Approximately 21% of our total assets as of December 31, 2005, consisted of goodwill resulting from our
acquisition of the Cray Research business unit assets from SGI in 2000 and our acquisition of OctigaBay
Systems Corporation in April 2004. We no longer amortize goodwill associated with the acquisitions, but we
are required to conduct ongoing analyses of the recorded amount of goodwill in comparison to its estimated
fair value. We currently have one operating segment and reporting unit. As such, we evaluate any potential
goodwill impairment by comparing our net assets against the market value of our outstanding shares of
common stock. We performed annual impairment tests eÅective January 1, 2006 and January 1, 2005, and
determined that our recorded goodwill was not impaired.

The analysis of whether the fair value of recorded goodwill is impaired and the number and nature of our
reporting units involves a substantial amount of judgment. Future changes related to the amounts recorded for
goodwill could be material depending on future developments and changes in technology and our business.

In connection with our 2004 acquisition of OctigaBay Systems Corporation, we assigned $6.7 million of
value to core technology. In December 2005 we announced plans to further integrate our technology
platforms, and combine the Cray XD1 and the Cray XT3 products into a uniÑed product oÅering. The
expected undiscounted cash Öows from the product using the core technology were not suÇcient to recover the

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carrying value of the asset. We performed a fair value assessment similar to the original valuation and
determined the asset had no continuing value. We wrote oÅ the unamortized balance of our core technology
intangible asset of $4.9 million Accordingly, we recorded a $4.9 million charge in 2005 to ""Restructuring,
Severance and Impairment'' in the accompanying Consolidated Statements of Operations. In connection with
this charge, we reversed the remaining deferred tax liability of $1.5 million that was established in the
purchase accounting as amortization of this intangible asset was not deductible for income tax purposes.

Accounting for Income Taxes

Deferred tax assets and liabilities are determined based on diÅerences between Ñnancial reporting and tax
bases of assets and liabilities and operating loss and tax credit carryforwards and are measured using the
enacted tax rates and laws that will be in eÅect when the diÅerences and carryforwards are expected to be
recovered or settled. In accordance with Statement of Financial Accounting Standards (""SFAS'') No. 109,
Accounting for Income Taxes, a valuation allowance for deferred tax assets is provided when it is estimated
that it is more likely than not that all or a portion of the deferred tax assets may not be realized through future
operations. This assessment is based upon consideration of available positive and negative evidence, which
includes, among other things, our most recent results of operations and expected future proÑtability. We
consider our actual historical results to have stronger weight than other more subjective indicators when
considering whether to establish or reduce a valuation allowance on deferred tax assets.

The provision for or beneÑt from income taxes represents taxes payable or receivable for the current
period plus the net change in deferred tax assets and liabilities and valuation allowance amounts during the
period. In 2003, we reversed $58.0 million of the valuation allowance against deferred tax assets (principally
U.S. loss carryforwards) based primarily upon our consideration of our most recent proÑtable operating
performance as well as our reasonably expected future performance. Based upon our judgment of the positive
and negative evidence, we concluded that we would more likely than not be able to utilize most of our net
deferred tax asset. In late 2004, we established a valuation allowance and recorded an income tax expense of
$58.9 million based on our losses from operations in 2004 and based on our revised projections indicating
continued challenging Ñnancial results. Based upon our most recent negative operating results, which we
consider as a strong indicator of our future ability to utilize our deferred tax assets, we established a valuation
allowance on certain deferred tax assets (principally U.S. loss carryforwards) created during 2005 in
accordance with SFAS No. 109.

Accounting for Loss Contracts

In accordance with our revenue recognition policy, certain production contracts are accounted for using
the percentage of completion accounting method. We recognize revenue based on a measurement of
completion comparing the ratio of costs incurred to date with total estimated costs multiplied by the contract
value. Inherent in these estimates are uncertainties about the total cost to complete the project. If the estimate
to complete results in a loss on the contract, we will record the amount of the estimated loss in the period the
determination is made. On a regular basis, we update our estimates of total costs. Changes to the estimate may
result in a charge or beneÑt to operations. In 2004, we estimated that the Red Storm contract would result in a
loss of $7.6 million, which was charged to cost of product revenue. During 2005, we increased the estimate of
the loss on the contract by $7.7 million (cumulative loss of $15.3 million) due to additional hardware to be
delivered to satisfy contractual and performance issues. This amount was charged to cost of product revenue.
As of December 31, 2005, and 2004, the balance in the Red Storm loss contract accrual was $5.7 million and
$3.1 million, respectively and is included in other accrued liabilities on the accompanying Consolidated
Balance Sheets.

Stock-Based Compensation

Through December 31, 2005, we accounted for stock-based compensation under the intrinsic value
method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (""APB No. 25''). Under the intrinsic value method, we did not record any expense when stock
options granted were priced at the fair market value of our common stock at the date of grant. Certain of the

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stock options granted in connection with the OctigaBay Systems acquisition in 2004 had exercise prices below
the fair market value of our common stock at the grant date and accordingly, we have recorded compensation
expense over the vesting period based on the intrinsic value method.

In March and May 2005, we accelerated vesting of certain unvested and ""out-of-the-money'' stock
options with exercise prices equal to or greater than the current market price at the date of the acceleration.
These options were accelerated to avoid recording future compensation expense with respect to such options in
2006 and thereafter when we will be using the fair value method of SFAS No. 123(R), Share-Based Payment,
(""SFAS No. 123(R)'') to account for stock-based compensation. We believed that because such options had
exercise prices substantially in excess of the current market value of our stock, the options were not achieving
their original objective. Options to purchase 4.6 million shares of common stock were subject to the
acceleration and the weighted average exercise price of the options subject to the acceleration was $5.33. Due
to this acceleration, an additional $14.9 million is included in the pro forma stock-based compensation expense
for the year ended December 31, 2005. In December 2005, we repriced 1,274,260 existing stock options to
$1.49 per share and also issued 1,237,060 additional stock options at $1.49 per share (fair market price of our
common stock on the date of issuance) that had immediate vesting, in order to enhance short-term retention
and also to avoid future option expense charges.

Commencing January 1, 2006, we adopted SFAS No. 123(R), which requires us to record stock
compensation expense for equity based awards granted, including stock options, for which expense will be
recognized over the service period of the equity based award based on the fair value of the award at the date of
grant. The actual eÅects of adopting SFAS No. 123(R) will be dependent on numerous factors including, but
not limited to, the number of options granted in the future; the valuation model chosen by us to value stock-
based awards; the assumed and actual award forfeiture rate; the accounting policies adopted concerning the
method of recognizing the fair value of awards over the requisite service period; and the transition method
chosen for adopting SFAS No. 123(R). See ""Recent Accounting Pronouncements'' below for further
information.

Recent Accounting Pronouncements

As of December 31, 2005, we accounted for stock-based compensation awards using the intrinsic value
measurement provisions of APB No. 25. Accordingly, we recorded no compensation expense in 2005 and
previous years for stock options granted with exercise prices greater than or equal to the fair value of the
underlying common stock at the date of grant. On December 16, 2004, the Financial Accounting Standards
Board (the ""FASB'') issued SFAS No. 123(R), and in March 2005, the SEC issued StaÅ Accounting
Bulletin No. 107 (""SAB No. 107'') relating to the adoption of SFAS No. 123(R). SFAS No. 123(R)
eliminates the alternative of applying the intrinsic value measurement provisions of APB Opinion No. 25 to
stock compensation awards. Rather, SFAS No. 123(R) requires enterprises to measure the cost of services
received in exchange for an award of equity instruments based on the fair value of the award at the date of
grant.

We adopted SFAS No. 123(R) eÅective January 1, 2006, using the ModiÑed Prospective Application
Method and the Black-Scholes fair value option-pricing model. Under this method SFAS No. 123(R) is
applied to new awards and to awards modiÑed, repurchased, or cancelled after the eÅective date. Additionally,
compensation cost for the portion of awards for which the requisite service has not been rendered (such as
unvested options) that are outstanding as of the date of adoption is recognized as the remaining requisite
services are rendered. The compensation cost relating to unvested awards at the date of adoption is based on
the fair value at the date of grant of those awards as calculated for pro forma disclosures under the original
SFAS No. 123, Stock Based Compensation.

We expect that the adoption of SFAS No. 123(R) will impact our Ñnancial results in the future, as it is
expected to reduce our net income or increase our net losses. As of December 31, 2005, we have unamortized
stock-based compensation expense of $3.0 million, of which $1.9 million is expected to be expensed in 2006.
However, this amount does not reÖect the expense associated with equity awards that are expected to be
granted to employees in 2006. Management is currently reviewing its alternatives for granting equity based

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awards and, while we expect to continue granting equity-based awards to our employees, the type, frequency
and amount of award are still under consideration. Accordingly, the overall eÅect of adopting this new
standard on the Ñnancial results for 2006 has not yet been quantiÑed. The pro forma eÅects on net income and
earnings per share, if we had applied the fair value recognition provisions of the original SFAS No. 123 on
stock compensation awards (rather than applying the intrinsic value measurement provisions of APB No. 25),
are disclosed in Note 3 to the Consolidated Financial Statements Ì Summary of SigniÑcant Accounting
Policies, Stock-Based Compensation of the Notes to Consolidated Financial Statements. Although such pro
forma eÅects of applying the original SFAS No. 123 may be indicative of the eÅects of adopting
SFAS No. 123(R) except for the impact of the acceleration of vesting of substantially all employee stock
options in 2005, the provisions of these two statements diÅer in important respects.

In March 2005, the FASB issued Interpretation (""FIN'') 47, Accounting for Conditional Asset
Retirement Obligations. This clariÑes the term ""conditional asset retirement obligation'' as used in
SFAS No. 143, Accounting for Asset Retirement Obligations, and provides guidance to ensure consistency in
recording legal obligations associated with long-lived tangible asset retirements. The adoption of FIN 47 did
not have a material eÅect on our Ñnancial position, cash Öows or results of operations.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a
replacement of Accounting Principles Board Opinion No. 20, Accounting Changes, and SFAS No. 3,
Reporting Accounting Changes in Interim Financial Statements (""SFAS No. 154''). SFAS No. 154 changes
the requirements for the accounting for, and reporting of, a change in accounting principle. Previously,
voluntary changes in accounting principles were generally required to be recognized by way of a cumulative
eÅect adjustment within net income during the period of the change. SFAS No. 154 requires retrospective
application to prior periods' Ñnancial statements, unless it is impracticable to determine either the period-
speciÑc eÅects or the cumulative eÅect of the change. SFAS No. 154 is eÅective for accounting changes made
in Ñscal years beginning after December 15, 2005; however, the statement does not change the transition
provisions of any existing accounting pronouncements.

In June 2005, the FASB issued StaÅ Position No. FAS 143-1, Accounting for Electronic Equipment
Waste Obligations (""FSP No. 143-1''). The European Union issued a directive to its member states to adopt
legislation regulating the collection, treatment, recovery and disposal of electrical and electronic waste
equipment. The directive distinguished between ""new waste'' and ""historical waste.'' FSP No. 143-1 provides
guidance concerning the accounting for historical waste and states that the obligation associated with
historical waste qualiÑes as an asset retirement obligation to be accounted for in accordance with
SFAS No. 143, Accounting for Asset Retirement Obligations, and FIN No. 47, Accounting for Conditional
Asset Retirement Obligations. We have certain inventory components that must comply with this new
directive but at this time we cannot quantify the impact to our Ñnancial results, as many of the European
Union member states have not Ñnalized legislation.

In November 2005, the FASB issued StaÅ Position No. FAS 115-1 and FAS 124-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, (""FSP No. 115-1''). FSP
No. 115-1 provides accounting guidance for identifying and recognizing other-than-temporary impairments of
debt and equity securities, as well as cost method investments in addition to disclosure requirements. FSP
No. 115-1 is eÅective for reporting periods beginning after December 15, 2005, and earlier application is
permitted. This new pronouncement will be eÅective in 2006 and we do not believe that adoption of FSP
No. 115-1 will have a material eÅect on our Ñnancial position, cash Öows or results of operations.

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Results of Operations

Revenue

Our product and service revenue for the years ended December 31, 2003, 2004 and 2005 were (in

thousands, except for percentages):

Product RevenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Service Revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

December 31,
2004
(Restated)

$ 95,901
66%
$ 49,948
34%

2003

$175,004
74%
$ 61,958
26%

2005

$152,098
76%
$ 48,953
24%

Total Revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$236,962

$145,849

$201,051

Product Revenue

The increase in 2005 product revenue over 2004 levels was due to increased sales of all three of our
principal products, the Cray X1E, the Cray XT3 and the Cray XD1 systems, which became available after a
production ramp-up during the Ñrst half of the year. In 2005, we recorded approximately $22.1 million in
product revenue from the Cascade and Red Storm development projects which was a reduction of
$27.4 million compared to 2004 due to reduced expenditures and associated revenue, in particular on the Red
Storm development project. Product revenue declined in 2004 from 2003 due to signiÑcantly reduced Cray X1
system sales and the inability to recognize revenue on certain Cray X1E and Cray XT3 systems delivered in
the fourth quarter of 2004, oÅset in part by an increase in Red Storm and Cascade development project
revenue of $29.9 million to $49.5 million for 2004.

We expect product as well as total revenue to grow in 2006 by approximately 5% to 15%, with revenue
primarily coming from sales of Cray XT3 and upgrade systems. A wider range of product revenue results is
reasonably possible Ì see ""Item 1A. Risk Factors,'' above. Included in this expected product revenue growth
is approximately $38 million to be recognized for our Cray X1/X1E installation at the Korea Meteorological
Administration (""KMA''). This system was accepted in the fourth quarter of 2005, is in production, and we
have received full payment but contract provisions with regard to signiÑcant unfulÑlled obligations have
delayed our ability to recognize revenue on the contract until the fourth quarter of 2006. We expect our
product revenue to vary from quarter to quarter with nearly 60% of 2006 product revenue expected to be
recognized in the fourth quarter. Our 2006 plan is dependent on having an upgraded version of the Cray XT3
system delivered, installed and accepted by customers before year-end. Product revenue generated from the
phase 2 portion of the Cascade program should end in July 2006. Any future Cascade project funding in
phase 3 may not be recorded as revenue, but rather as a reduction to research and development expense, as we
expect the total amount of funding to be received in phase 3 to be less than the total estimated development
eÅort.

Service Revenue

Service revenue in 2005 decreased slightly from 2004 due to lower revenue on maintenance contracts as
older systems were withdrawn from service. Revenue from professional services increased by $2.8 million from
$3.7 million in 2004 due principally to a contract to refurbish certain components for a customer. Service
revenue decreased in 2004 from 2003 due to expiring maintenance contracts as older systems were withdrawn
from service.

Maintenance services are provided under separate maintenance contracts with our customers. These
contracts generally provide for maintenance services for one year, although some are for multi-year periods,
often with prepayments for the term of the contract. We consider the maintenance period to commence upon
installation of the product, which may include a warranty period. We allocate a portion of the sales price to

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maintenance service revenue based on estimates of fair value. We recognize revenue ratably over the entire
service period. Maintenance service revenue has declined on an annual basis as older systems are withdrawn
from service. While we expect our maintenance service revenue to stabilize over the next year, we may have
periodic revenue and margin declines as our older, high margin service contracts are ended and newer, lower
margin contracts are established, based on the timing of system withdrawals from service. Our newer products
will likely require less hardware maintenance and therefore generate less maintenance revenue than our
historic vector systems.

Operating Expenses

Cost of Revenue

Cost of product revenue and cost of service revenue for the years ended December 31, 2003, 2004 and

2005 were (in thousands, except for percentages):

Cost of Product Revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of product revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cost of Service Revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

December 31,
2004
(Restated)

$104,196
109%
$ 30,338
61%

2005

$139,518
92%
$ 29,032
59%

2003

$97,354
56%
$40,780
66%

Cost of Product Revenue. Cost of 2005 product revenue as a percentage of product revenue, although
improved compared to 2004, was impacted by several factors, including higher sales of the lower margin
Cray XD1 product, an additional $7.7 million charge for a change in the estimate to complete the Red Storm
project due principally to the addition of hardware deliverables to settle contract and performance issues, and
$5.8 million of charges for inventory write-downs, which includes scrap and obsolete inventory. Cost of 2004
product revenue was negatively impacted by inventory write-downs of $8.5 million, a $7.6 million charge to
record the initial estimated loss on the Red Storm project, a $1.0 million adjustment for unabsorbed
manufacturing overhead relating to lower than planned production of Cray X1 systems and signiÑcant revenue
recognized on the Cascade and Red Storm projects, which have a high cost to revenue percentage, with Red
Storm cost equal to revenue. The Red Storm and Cascade research and development costs totaling
$28.6 million, $57.3 million and $18.7 million in 2005, 2004 and 2003, respectively, are reÖected on our
Ñnancial statements as cost of product revenue and the related reimbursements are recorded in our Ñnancial
statements as product revenue. Revenue for 2005, 2004 and 2003 includes $2.1 million, $498,000 and
$316,000, respectively, from the sale of obsolete inventory recorded at a zero cost basis. In 2005, this amount
consisted mainly of the sale of a refurbished Cray T3E supercomputer, one of our legacy systems.

We anticipate increased product margins in 2006, although still below our desired levels. Sales of
Cray XT3 and Cray XD1 systems face margin pressure from the highly competitive clustered systems market.
In addition, we expect total product margin will be adversely aÅected by low margin contribution from the
KMA system, which we expect to recognize in the fourth quarter of 2006, low margin contribution from the
Cascade project in the Ñrst half of the year and anticipated zero margin on revenue from the Red Storm
project, for which we have recorded estimated losses in 2005 and 2004. We also face increased risk of excess
and obsolete inventory as the Cray X1E and Cray XD1 products reach the end of their product life. We also
face increased risk and expense related to compliance with new European environmental rules. See ""Item 1A.
Risk Factors Ì New European environmental rules may adversely aÅect our operations.''

Cost of Service Revenue.

In both 2005 and 2004, our cost of service revenue was favorably impacted by
high margin professional service contracts, service cost reductions implemented in the fourth quarter of 2003
and the second half of both 2004 and 2005, and the completed amortization of legacy spare parts inventory by
March 31, 2004, oÅset in 2005 in part by increased costs incurred to achieve customer acceptances of large
Cray XT3 systems. We expect service costs for 2006 to approximate 58% to 65% of service revenue.

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Research and Development

Research and development expenses for the years ended December 31, 2003, 2004, and 2005 were as

follows (in thousands):

Gross research and development expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Less: Amounts included in cost of product revenue ÏÏÏÏÏÏÏÏÏ
Less: Reimbursed research and development (excludes

December 31,
2004
(Restated)

2005

2003

$ 68,801
(18,714)

$ 98,843
(22,970)

$ 96,257
(19,724)

amounts in revenue)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(12,325)

(22,607)

(34,822)

Net research and development expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 37,762

$ 53,266

$ 41,711

Percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

16%

37%

21%

Net research and development expenses in 2005 primarily reÖect our costs associated with the hardware
and software associated with the Cray X1E, Cray XT3 and Cray XD1 systems, and the Eldorado
multithreaded system, and their upgrade and successor projects. Net research and development expenses in
2004 reÖect our costs associated with the development of the Cray X1E, Cray XT3, Cray XD1 systems and
upgrade and successor projects, including related software development. Research and development expenses
include personnel expenses, depreciation, allocations for certain overhead expenses, software, prototype
materials and outside contracted engineering expenses.

Gross research and development expenses in the table above reÖect all research and development
expenditures, including expenses related to our research and development activities on the Red Storm and
Cascade projects. Research and development expenses on our Red Storm and Cascade projects are reÖected
as cost of product revenue and government co-funding on our other projects are recorded as reimbursed
research and development.

We have received increased government funding each year during this period. In 2005, net research and
development expenses as a percentage of total revenue decreased as compared to 2004 due to higher revenue,
increased funding for our BlackWidow project, and the eÅect of the pay reduction program in the second half
of 2005, partially oÅset by option expense as we accelerated vesting on options issued in connection with the
OctigaBay acquisition in 2004. The higher 2004 percentage of total revenue compared to 2003 is due to lower
revenue earned in 2004 and to increases in research and development expenses for most of our products and
projects (including an increase of approximately $2.0 million to $2.5 million per quarter due to the OctigaBay
acquisition at the beginning of the second quarter in 2004).

In 2006, we expect higher gross research and development expenses but lower net research and
development expenses, based on increased government project funding. This expectation assumes that we will
receive a phase 3 award in the DARPA HPCS program and thus have increased Cascade project activity in
the second half of the year. We will continue to incur development expenses for our Cray XT3 and upgrade
and successor systems and we expect increased activity on our BlackWidow and Eldorado projects. If we
receive a phase 3 DARPA award, our development costs will no longer be fully funded for that work and we
must contribute a portion of such costs that will be recorded in net research and development expenses. We
expect to receive additional funding for our BlackWidow and Eldorado projects, although anticipated
reimbursements on these projects have not yet been fully authorized and all necessary contracts have not been
completed. If these projects are not funded by the government as anticipated, or if we do not receive a phase 3
of DARPA HPCS project, our research and development expense could be much higher than anticipated and
have an adverse impact on our earnings in 2006.

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Other Operating Expenses

Our marketing and sales, general and administrative and restructuring, severance and impairment charges

for the years ended December 31, 2003, 2004 and 2005 were (in thousands):

Marketing and sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Restructuring, severance and impairment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Percentage of total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

2003

$27,038
11%
$10,908
5%
$ 4,019
2%

December 31,
2004

$34,948
24%
$19,451
13%
$ 8,182
6%

2005

$25,808
13%
$16,145
8%
$ 9,750
5%

Marketing and sales. The decrease in 2005 marketing and sales expenses compared to 2004 is due to
lower headcount, the pay reduction program in the second half of 2005 and lower discretionary spending, oÅset
in part by higher commissions on increased product revenue. The increase in 2004 compared to 2003 was
primarily due to an acceleration of expenses related to certain prepaid computer access services no longer
utilized and additional benchmarking, application and sales personnel related to the introduction of our three
new products. We also experienced an unfavorable currency exchange rate in our overseas personnel expenses
in 2004 compared to 2003. We expect marketing and sales expenses to decline in 2006 due to reduced
headcount, oÅset in part by re-establishment of full salaries and increased sales commissions due to higher
potential sales activity.

General and administrative. The decrease in general and administrative expense in 2005 compared to
2004 was primarily due to the eÅects of our reduction-in-force, as well as the pay reduction program in the
second half of 2005; savings from which were oÅset in part by increased fees for external audit, Sarbanes-
Oxley compliance and legal fees. The increase in 2004 compared to 2003 was due primarily to consulting costs
related to Sarbanes-Oxley compliance and additional expenses as a result of our acquisition of OctigaBay,
including additional depreciation, insurance and utilities. We expect general and administrative expenses to
increase slightly in 2006 due to reestablishment of salaries, the executive retention and restricted stock grant
programs instituted in December 2005 and additional personnel in Ñnance.

Restructuring, severance and impairment. Restructuring, severance and impairment charges include
costs related to our eÅorts to reduce our overall cost structure by reducing headcount. During 2005, we
implemented a worldwide reduction in workforce of approximately 90 employees, or 10% of our worldwide
workforce, primarily in manufacturing, sales, service and marketing in the second quarter and we incurred
additional severance charges primarily for the retirement of our former Chief Executive OÇcer, James
Rottsolk, in the third quarter. In the fourth quarter, we implemented an additional reduction of approximately
65 employees from our international sales, service and engineering operations, largely based in our Burnaby,
British Columbia, Canada facility with the remainder in Europe. We expect to incur additional restructuring
and severance costs in 2006 related to this fourth quarter 2005 action.

In connection with the 2004 acquisition of OctigaBay, we allocated $6.7 million of the purchase price to a
core technology intangible asset, which was associated with the Cray XD1 system. In connection with the
fourth quarter 2005 decision to incorporate the Cray XD1 system technology into the Cray XT3 line, as well
as limited expected future beneÑts of the core technology obtained in the acquisition, we evaluated the
carrying value of the unamortized balance of the intangible asset of $4.9 million and determined that the
carrying value of the asset was impaired and accordingly recorded a charge for the $4.9 million in the fourth
quarter of 2005.

The 2004 costs primarily represented severance expenses related to the termination of 114 employees in
the United States and an additional 20 employees throughout the rest of the world in the second half of 2004.
Of the 2003 amount, $3.3 million represented severance expenses related to the termination of 27 employees,

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primarily associated with our service activities in Europe and Japan, and the remaining $721,000 related to
expensing certain technology that we no longer use.

In-Process Research and Development Charge

As part of the acquisition of OctigaBay, we incurred an expense associated with acquired in-process

research and development of $43.4 million in the second quarter of 2004.

Other Income (Expense), net

During 2005, we recorded $1.4 million of net other expense, compared to net other expense of $699,000
in 2004 and net other income of $1.5 million in 2003. Other expense in 2005 and 2004 primarily consisted of
foreign currency losses on the remeasurement of foreign currency balances, principally intercompany balances.
Other income in 2003 primarily consisted of gains resulting from the remeasurement of foreign currency
balances, principally intercompany balances.

Interest Income (Expense), net

Interest income was $741,000 in 2005, $666,000 in 2004 and $657,000 in 2003. Interest income in 2005
and 2004 was related primarily to our cash and short-term investments balances, which, on average, were
consistent with the balances during 2003. The 2003 interest income reÖects our increased average cash
position in 2003 following our public oÅering in February 2003 in which we raised $49.1 million.

Interest expense was $4.2 million in 2005, $301,000 in 2004 and $213,000 in 2003. Interest expense in
2005 represents $2.4 million of interest on our Notes, $1.0 million of non-cash amortization of fees capitalized
in connection with both our line of credit with Wells Fargo Foothill, Inc. (""WFF'') and our long-term debt
oÅering costs, and $765,000 of interest and related fees on our line of credit with WFF. The interest expense
for 2004 reÖects approximately one month of interest on our Notes, one month of amortization of the related
capitalized issuance costs and interest on our capital leases. The interest expense for 2003 reÖects interest on
our term loan for the Ñrst four months of the year and interest on our capital leases.

Taxes

BeneÑt from income taxes in 2005 was $1.5 million, which consisted of a $2.3 million beneÑt for foreign
deferred taxes, oÅset by current tax expense for local, state and foreign tax jurisdictions. We recorded an
income tax provision of $59.1 million in 2004, principally related to the establishment of a $58.9 million
valuation allowance against deferred tax assets, primarily consisting of accumulated net operating losses.
Under the criteria set forth in SFAS No. 109, Accounting for Income Taxes, management concluded that it
was unlikely that the future beneÑts of these deferred tax assets would be realized. In 2003, we recorded an
income tax beneÑt of $42.2 million, principally as a result of the reversal of $58.0 million valuation allowance
on deferred tax assets. There has been no current provision for U.S. federal income taxes for any period. We
have income taxes currently payable due to our operations in certain foreign countries, particularly in Canada
and certain European and Asian countries and in certain states.

As of December 31, 2005, we had tax net operating loss carryforwards of approximately $288 million that

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will begin to expire in 2010 if not utilized.

Net Income (Loss)

Net loss was $64.3 million in 2005 and $207.4 million in 2004, compared to net income of $63.2 million in
2003. The 2005 loss included a $7.7 million charge for additional 2005 estimated losses on the Red Storm
Ñxed-price contract and the restructuring, severance and impairment charges of $9.8 million.

The 2004 net loss included signiÑcant charges consisting of an income tax expense of $59.1 million
principally related to the establishment of a valuation allowance against deferred tax assets, a $43.4 million
write-oÅ of in-process research and development acquired as part of the OctigaBay acquisition, a $7.6 million

charge to recognize the initial loss estimated on the Red Storm Ñxed-price contract, an $8.2 million
restructuring charge, and an $8.5 million write-down of inventory.

Net income for 2003 was favorably impacted by the recognition of an income tax beneÑt for the reversal
of a valuation allowance for deferred tax assets of $58.0 million which was partially oÅset by a $4.0 million
restructuring charge. We reversed the valuation allowance based on our determination at that time that
realization of these assets was more likely than not based on the criteria of SFAS No. 109.

We believe that year-over-year changes in net income are not necessarily predictive of our future net
income results for a variety of reasons. Accordingly, we encourage readers of our Ñnancial statements to
evaluate the eÅect on our operating trends in addition to the eÅect of future income tax provisions and changes
in currency exchange rates that may create signiÑcant additional variability in our future operating results.

Liquidity and Capital Resources

Cash, cash equivalents, restricted cash, short-term investments and accounts receivable totaled
$101.1 million at December 31, 2005, compared to $120.6 million at December 31, 2004. At December 31,
2005, we had working capital of $52.2 million compared to $93.6 million at December 31, 2004. In the fourth
quarter of 2004, we completed an oÅering of our Notes under Rule 144A in which we received net proceeds of
$76.6 million.

Net cash used by operating activities was $36.7 million in 2005, $52.7 million in 2004 and $8.7 million in
2003. For the year ended December 31, 2005, net operating cash was used primarily by our net operating loss,
decreases in accounts payable and payroll liabilities, and increases in accounts receivable and inventory,
partially oÅset by an increase in deferred revenue. For 2004, net operating cash was used primarily by our net
operating loss and an increase in inventory, oÅset in part by increases in deferred revenue and accounts
payable and a decrease in accounts receivable. In 2003 net operating cash was used primarily by increases in
accounts receivable, inventory and prepaid expenses and other assets, which was oÅset in part by an increase in
deferred revenue.

Net cash provided by investing activities was $41.7 million in 2005, while net cash used in investing
activities was $29.9 million in 2004 and $41.2 million in 2003. For the year ended December 31, 2005, net cash
provided by investing activities consisted of the sale of short-term investments, partially oÅset by the
purchases of short-term investments and equipment as well as a decrease in restricted cash. In 2004, net cash
used in investing activities consisted primarily of $12.5 million of capital expenditures, $11.4 million increase
in restricted cash and $6.3 million used for the acquisition of OctigaBay (which consisted of $15.9 million in
cash used in connection with the acquisition netted against $9.6 million in cash we acquired from OctigaBay's
existing business), oÅset by net sales of $317,000 of short-term investments. In 2003 net cash used in investing
activities was primarily for net purchases of short-term investments and equipment.

Net cash used in Ñnancing activities was $137,000 in 2005, while net cash provided by Ñnancing activities
was $84.2 million in 2004 and $65.1 million in 2003. For the year ended December 31, 2005, net cash used in
Ñnancing activities consisted primarily of $755,000 paid for line of credit issuance costs and $731,000 for
payments on capital leases, oÅset by $1.3 million in proceeds from the issuance of common stock through the
employee stock purchase plan and exercise of stock options. The 2004 net cash provided by Ñnancing activities
was primarily related to our Note oÅering under Rule 144A in which we received net proceeds of
$76.6 million. In 2004 we also received approximately $8.3 million through stock option and warrant exercises
as well as through the issuance of common stock in connection with our employee stock purchase plan. The
2003 net cash provided by Ñnancing activities was primarily from our public oÅering, in which we received net
proceeds of $42.5 million, and $27.0 million from stock option and warrant exercises and the issuance of
common stock through the employee stock purchase plan, while we used $4.1 million to pay down a portion of
our debt.

Over the next twelve months, our signiÑcant cash requirements will relate to operational expenses,
consisting primarily of personnel costs, costs of inventory and spare parts, outside engineering expenses,
particularly as we continue development of our Cray XT3 and successor line and internally fund a portion of

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the expenses resulting from the anticipated phase 3 of the Cascade program, interest expense and acquisition
of property and equipment. Our Ñscal year 2006 capital budget for property and equipment is currently
estimated at approximately $10 million. In addition, we lease certain equipment used in our operations under
operating or capital leases in the normal course of business. In the fourth quarter of 2005, we completed
negotiation of changes to our lease for corporate oÇce space, which will lead to a decrease in our future cash
obligations in the amount of approximately $1.8 million over the lease term, which extends into 2008. The
following table summarizes our contractual cash obligations as of December 31, 2005 (in thousands):

Contractual Obligations

Amounts Committed by Year

Total

2006

2007

2008

Development agreements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Capital lease obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Operating leases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$15,170
154
9,807

$13,100
123
3,473

$2,027
31
2,950

43
Ì
2,534

Total contractual cash obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$25,131

$16,696

$5,008

$2,577

2009

$ Ì
Ì
850

$850

We have $80 million of outstanding Convertible Senior Subordinated Notes (""Notes'') which are due in
2024. These Notes bear interest at 3.0% (approximately $2.4 million per year) and holders of these Notes may
require us to purchase these Notes on December 1, 2009. Additionally, we have a two-year revolving line of
credit for up to $30 million, which expires in May 2007. No amounts were outstanding under this line as of
December 31, 2005. As of February 6, 2006, the Company was eligible to borrow $25.8 million against this
line of credit.

In our normal course of operations, we engage in development arrangements under which we hire outside
engineering resources to augment our existing internal staÅ in order to complete research and development
projects, or parts thereof. For the years ended December 31, 2005, 2004 and 2003, we incurred $20.3 million,
$16.8 million and $5.8 million, respectively, for such arrangements.

At any particular time, our cash position is aÅected by the timing of cash receipts for product sales,
maintenance contracts, government funding for research and development activities and our payments for
inventory, resulting in signiÑcant quarter-to-quarter, as well as within a quarter, Öuctuations in our cash
balances. Our principal sources of liquidity are our cash and cash equivalents, operations and credit facility.
We experienced lower than anticipated product sales and delays in the availability of our new products in
2004, which adversely aÅected cash Öows in 2005. We have used signiÑcant working capital in 2005, due to
our operating loss, increased inventory purchases and increased accounts receivable. Cash used in operating
activities during the Ñrst half of 2005 was partially oÅset by improved second-half cash Öow. Assuming
acceptances and payment for large new systems to be sold and beneÑt from our 2004 and 2005 restructurings
and other recent cost reduction eÅorts, we expect our cash Öow to be slightly negative in 2006, although a wide
range of results is possible. Currently, we do not anticipate borrowing from our credit line during 2006,
although it is possible that we may have to do so.

If we were to experience a material shortfall in our plans, we would take all appropriate actions to ensure
the continuing operation of our business and to mitigate any negative impact on our operating results and
available cash resources. The range of actions we could take includes, in the short-term, reductions in
inventory purchases and commitments, seeking Ñnancing from investors, strategic partners and vendors and
other Ñnancial sources and further reducing headcount-related expenses.

We have been focusing on expense controls, negotiating sales contracts with advance partial payments
where possible, implementing tighter purchasing and manufacturing processes and improving working capital
management in order to maintain adequate levels of cash. While we believe these steps will generate suÇcient
cash to fund our operations for at least the next twelve months, we may consider enhancing our cash and
working capital position by raising additional equity or debt capital. There can be no assurance that we would
succeed in these eÅorts or that additional funding would be available. Additionally, the adequacy of our cash
resources is dependent on the amount and timing of government funding as well as our ability to sell our
products, particularly the Cray XT3 and upgraded systems, with adequate margins. Beyond the next twelve

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months, the adequacy of our cash resources will largely depend on our success in re-establishing proÑtable
operations and positive operating cash Öows on a sustained basis. See ""Item 1A. Risk Factors,'' above.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to Ñnancial market risks, including changes in interest rates and equity price Öuctuations.

Interest Rate Risk: We invest our available cash in investment-grade debt instruments of corporate
issuers and debt instruments of the U.S. government and its agencies. We do not have any derivative
instruments in our investment portfolio. We protect and preserve invested funds by limiting default, market
and reinvestment risk. Investments in both Ñxed-rate and Öoating-rate interest earning instruments carry a
degree of interest rate risk. Fixed-rate securities may have their fair market value adversely aÅected due to a
rise in interest rates, while Öoating-rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, our future investment income may fall short of expectations due to changes in
interest rates or we may suÅer losses in principal if forced to sell securities, which have declined in market
value due to changes in interest rates. At December 31, 2005, we did not have any short-term investments.

Foreign Currency Risk: We sell our products primarily in North America, Asia and Europe. As a result,
our Ñnancial results could be aÅected by factors such as changes in foreign currency exchange rates or weak
economic conditions in foreign markets. Our products are generally priced in U.S. dollars, and a strengthening
of the dollar could make our products less competitive in foreign markets. While we commonly sell products
with payments in U.S. dollars, our product sales contracts occasionally call for receipt of cash in foreign
currencies and to the extent we do so, or engage with our foreign subsidiaries in transactions deemed to be
short-term in nature, we are subject to foreign currency exchange risks. In order to limit such risks on large
transactions that may extend over a longer period of time, we may choose to hedge this risk with a forward
exchange contract. Our foreign maintenance contracts are paid in local currencies and provide a natural hedge
against foreign exchange exposure. To the extent that we wish to repatriate any of these funds to the United
States, however, we are subject to foreign exchange risks. As of December 31, 2005, a 10% change in foreign
exchange rates could impact our earnings and cash Öows by approximately $924,000.

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Item 8. Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS*

Consolidated Balance Sheets at December 31, 2004 (Restated) and December 31, 2005 ÏÏÏÏÏÏÏÏÏÏ
Consolidated Statements of Operations for the years ended December 31, 2003, 2004 (Restated)

F-1

and 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

F-2

Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss) for the years

ended December 31, 2003, 2004 (Restated) and 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

F-3

Consolidated Statements of Cash Flows for the three years ended December 31, 2003, 2004

(Restated) and 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
F-4
F-5
Notes to Consolidated Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Reports of Independent Registered Public Accounting Firms ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ F-32

* The Financial Statements are located following page 65.

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QUARTERLY FINANCIAL DATA
(Unaudited, in thousands, except per share data)

The following table presents unaudited quarterly Ñnancial information for the two years ended Decem-
ber 31, 2005, with 2004 results as previously reported and as restated. For additional information, refer to
Note 2 Ì Restatement of Previously Issued Financial Statements of the Notes to Consolidated Financial
Statements. In the opinion of management, this information contains all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation thereof. The operating results for each of the
quarters in the year ended December 31, 2004 have been appropriately restated. Additionally, certain 2004
quarterly reclassiÑcations have been made to conform to 2005 presentation. The operating results are not
necessarily indicative of results for any future periods. Quarter-to-quarter comparisons should not be relied
upon as indicators of future performance.

For the Quarter Ended

3/31

6/30

9/30

12/31

3/31

2004 (As Previously Reported)

2004 (Restated)
9/30

6/30

12/31

Revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$42,135
28,336

$ 21,710
17,066

45,924
52,961

$ 39,415
39,239

$41,781
28,010

$ 21,152
16,552

44,821
51,946

$ 38,095
38,026

Gross margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and development ÏÏÏÏÏÏÏ
Marketing and sales ÏÏÏÏÏÏÏÏÏÏÏÏ
General and administrativeÏÏÏÏÏÏÏ
Restructuring, severance and

impairment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

In-process research and

development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net lossÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net loss per common share, basic

and diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

13,799
9,042
7,646
2,873

4,644
12,393
8,584
4,507

(7,037)
13,344
8,720
4,974

176
15,419
9,998
7,097

13,771
9,368
7,646
2,873

4,600
12,907
8,584
4,507

(7,125)
14,359
8,720
4,974

69
16,632
9,998
7,097

7,129

1,053

7,129

1,053

Ì
(3,843)

43,400
(54,504)

Ì
(110,999)

Ì
(34,677)

Ì
(4,097)

43,400
(54,862)

Ì
(112,402)

Ì
(35,997)

$ (0.05)

(0.64)

(1.27)

(0.40)

$ (0.06)

(0.64)

(1.29)

(0.41)

2005

For the Quarter Ended

3/31

6/30

9/30

12/31

Revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cost of revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 37,634
33,927

$ 53,419
48,741

$ 44,741
36,551

$65,257
49,331

Gross margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Marketing and salesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Restructuring, severance and impairment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
In-process research and development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net loss per common share, basic and diluted ÏÏÏÏÏÏÏÏÏÏÏÏ

3,707
13,032
6,599
4,267
(215)
Ì

4,678
13,427
7,574
4,607
1,947
Ì

8,190
6,472
5,778
3,617
1,201
Ì

15,926
8,780
5,857
3,654
6,817
Ì

(21,035)
(0.24)

(23,796)
(0.27)

(10,250)

(9,227)
(0.12) $ (0.10)

The in-process research and development charge in the 2004 second quarter related to our acquisition of
OctigaBay Systems Corporation. The large net loss in the third quarter of 2004 included the establishment of a
valuation allowance against our deferred tax asset of approximately $59 million.

Since the second half of 2004, we have reviewed our workforce requirements in light of our operating
results and have engaged in workforce reductions, particularly in the third quarter of 2004 and the second and
fourth quarters of 2005. The 2005 fourth quarter also reÖects a $4.9 million charge related to impairment of a
core technology intangible asset.

Our operating results are subject to quarterly Öuctuations as a result of a number of factors. See

""Item 1A. Risk Factors Ì Risk Factors Pertaining to Our Business and Operations.''

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to
be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within
the time periods speciÑed in the SEC's rules and forms, and that such information is accumulated and
communicated to management, as appropriate, to allow timely decisions regarding required disclosure. Our
management, with the participation and supervision of our Chief Executive OÇcer, Chief Financial OÇcer
and Chief Accounting OÇcer/Corporate Controller, evaluated the eÅectiveness of our disclosure controls and
procedures as of the end of the period covered by this report and determined that our disclosure controls and
procedures were eÅective.

Changes in Internal Control over Financial Reporting

As disclosed in our 2004 Annual Report on Form 10-K/A, and in our Quarterly Reports on Form 10-Q
for each of the Ñrst three quarters of 2005, we reported material weaknesses in our internal controls over
Ñnancial reporting as discussed in more detail below.

As of December 31, 2005, we have remediated the previously reported material weaknesses in internal

controls over Ñnancial reporting. The reported material weaknesses and remediation results are as follows:

Control Environment.

In 2004, our control environment did not suÇciently promote eÅective internal
control over Ñnancial reporting throughout our management structure, and this material weakness was a
contributing factor in the development of other material weaknesses described below. Principal contributing
factors included the lack of permanent employees in key Ñnancial reporting positions, resistance to change of
long-held practices developed in an entrepreneurial and trust culture, the lack of a formal program for training
members of our Ñnance and accounting group and a lack of a full evaluation of our Ñnancial system
applications due to incomplete documentation and testing of key controls. Our control environment also
contributed to our inability to fully evaluate our general computer controls, Ñnancial system application
controls and tax controls, as described more fully below.

Remediation:

We have hired permanent employees in key Ñnancial reporting positions including Chief Financial
OÇcer, Chief Accounting OÇcer/Corporate Controller, Director of SEC Reporting, Internal Audit Director
and Sarbanes-Oxley Compliance Executive, all of whom have worked to promote eÅective internal control
over Ñnancial reporting and improve our overall Company culture. We have instituted a training program for
the accounting personnel and have completed a full evaluation of our control environment which included our
general computer controls, Ñnancial system application controls and tax controls.

Risk Assessment.

In 2004, we did not perform a formal entity-level risk assessment to evaluate the
implications of relevant risks on Ñnancial reporting, including the impact of our diversifying business and non-
routine transactions, if any, on our internal control over Ñnancial reporting. Based on the signiÑcance a
suÇcient entity-level risk assessment has on eÅective internal control over Ñnancial reporting, this represented
a design deÑciency and constituted a material weakness.

Remediation:

We have performed a formalized entity level risk assessment using the criteria established by the
Commission of Sponsoring Organizations of the Treadway Commission in ""Internal Control Ì Integrated
Framework'' report. This assessment was considered in the scope of our testing.

Segregation of Duties.

In 2004, we did not segregate duties in several important functions, including:
permitting one person the ability to receive inventory, perform cycle counts and process adjustments, and

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another individual to initiate and authorize the scrapping of obsolete and excess inventory; permitting changes
to inventory quantity information within the Ñnancial application system without appropriate review; providing
users access within our Ñnancial application system to areas outside of their responsibilities; and permitting the
creation, modiÑcation and updating of customer or vendor data without a secondary level of review or
approval.

Remediation:

We implemented changes to the various roles and responsibilities within the accounting department.
These changes addressed each of the above issues to ensure that adequate segregation was achieved or that
enhanced mitigating controls were in place and operating eÅectively. SpeciÑcally, we have added independent
inventory counts and levels of independent review of inventory cycle counts, inventory adjustments,
adjustments for scrapping excess and obsolete inventory, and creation or modiÑcation of customer and vendor
data.

Additionally, a complete general computer control review was performed of JD Edwards (the Ñnancial
system of record) which included related access controls and all other programs aÅecting the integrity of
Ñnancial data.

Inadequate StaÇng and Training in Finance and Accounting.

In 2004, we had a lack of resources and
inadequate training within our Ñnance and accounting departments. In the second half of 2004 our corporate
controller was assigned primary responsibility for our Sarbanes-Oxley compliance eÅort and in late 2004 both
our chief Ñnancial oÇcer and Ñnancial reporting manager separately left for other opportunities, stretching our
limited resources even further. Training for our accounting staÅ with respect to generally accepted accounting
principles (""GAAP'') had been ad hoc rather than systematic. As a result of these factors, certain transactions
were not recorded initially in accordance with GAAP, such as a limited number of third-party vendor
contracts, leases and licenses; the capitalization of sales and use taxes on Ñxed assets and the internal labor
component of a Ñnancial application system implementation; and appropriate period-end cut-oÅ for ""FOB
Origin'' inventory received shortly after the end of the period. These deÑciencies represented a design
deÑciency in internal controls which resulted in more than a remote likelihood that a material error would not
have been prevented or detected, and constituted a material weakness.

Remediation:

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We have added staÇng in a number of critical areas over the last year and since our last quarterly
reporting period. Those positions include a permanent Chief Financial OÇcer, Chief Accounting OÇcer/
Corporate Controller; Director of SEC Reporting, Internal Audit Director and Sarbanes-Oxley Compliance
Executive. In addition, the accounting managers and controllers have all received training during the last year.
Training occurred at all appropriate levels and there is a requirement for 16 hours of continued training in
2006 and forward. This training requirement has also been incorporated into employees' performance
evaluations.

Inadequate Oversight of Accounting Transactions.

In 2004, we had insuÇcient processes and personnel
to provide adequate oversight of Ñnancially signiÑcant transactions and determinations by our Ñnance and
accounting personnel in our oÇces outside of headquarters. These deÑciencies represented a design deÑciency
in internal controls which resulted in more than a remote likelihood that a material error would not have been
prevented or detected, and constituted a material weakness.

Remediation:

In addition to the staÇng added that provided additional levels of review, we have added additional
documentation of review of accounting entries and balance sheet reconciliation accounts. This review and
analysis has resulted in management's ability to identify errors and additional required disclosures through the
closing process rather than through external examinations. In addition, management has maintained a
schedule for the year-end closing process which has enhanced the review for completeness.

Inadequate Controls Over Journal Entry Approvals.

In 2004, we did not have appropriate controls
around the process for recording and approving journal entries. We also noted instances where material journal

entries were recorded before subsequently provided supporting documentation was prepared or reviewed by
the accounting department. Instances also occurred in which journal entries were not adequately documented
and reviewed. These deÑciencies represented an operating eÅectiveness deÑciency in internal controls which
resulted in more than a remote likelihood that a material error would not have been prevented or detected, and
constituted a material weakness.

Remediation:

We have implemented procedures requiring completed supporting documentation for all journal entries.
The entries and the supporting documentation are reviewed by someone other than the preparer and checked
for accuracy, completeness, disclosure requirements and appropriateness.

Complex Contract Accounting Procedures.

In 2004, we did not have a consistent process in place to
document the signiÑcant terms of all important product sales contracts and our accounting for these contracts.
We enter into a small number of high dollar amount contracts for our product sales. These contracts often
contain complex terms that impact our recognition and determination of revenue (including customer rights of
return, multiple elements and contingencies that can have a material impact on the recognition or deferral of
revenue) and balance sheet classiÑcation of deferred revenue. In a limited number of cases, we did not
evaluate and document the consideration of such terms, and until late 2004 we did not have a process for
independent review of the accounting treatment and the associated revenue determinations for such contracts.
These deÑciencies represented a design deÑciency in internal controls which resulted in more than a remote
likelihood that a material error would not have been prevented or detected, and constituted a material
weakness.

Remediation:

We performed a fair market analysis for all signiÑcant sales contracts for 2005 which have been reviewed
by the Chief Financial OÇcer or Chief Accounting OÇcer/Corporate Controller. In addition, large contracts
and those with long terms of installation and acceptance are now reviewed by the Chief Financial OÇcer and
Chief Accounting OÇcer/Corporate Controller.

Tax Controls.

In 2004, our processes for preparation and review of tax provisions were documented late
and complete testing was not possible. We were unable to demonstrate through testing that such internal
controls were implemented and operating as expected in 2004. The following deÑciencies noted in our limited
testing of tax controls constituted a material weakness: a failure to maintain eÅective review and controls over
the determination and reporting of the provision for income taxes, particularly the tax eÅect due to analysis of
subsidiary dividends; the tax eÅect of a correction of foreign net operating losses; and adjustments to deferred
taxes. These deÑciencies represented a design deÑciency in internal controls which resulted in more than a
remote likelihood that a material error would not have been prevented or detected, and constituted a material
weakness.

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Remediation:

Procedures were implemented requiring the review of the tax provision and the related tax entries by the
Chief Financial OÇcer and Chief Accounting OÇcer/Corporate Controller where appropriate to determine
the suÇciency of the entries.

In the third and fourth quarters of 2005, we undertook and completed, our testing to validate compliance
with the newly implemented policies, procedures and controls. We have undertaken this testing over these two
quarters in order to be able to demonstrate operating eÅectiveness over a period of time that is suÇcient to
support our conclusions. In reviewing the result from this testing, management has concluded that the internal
controls over Ñnancial reporting have been signiÑcantly improved and that the material weaknesses described
above have been remediated as of December 31, 2005.

Except for the remediations discussed above, there have been no changes in our internal controls over
Ñnancial reporting during the most recently completed Ñscal quarter that have materially aÅected, or are
reasonably likely to materially aÅect our internal controls over Ñnancial reporting.

Management's Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over Ñnancial
reporting as deÑned by Rule 13a-15(f) under the Exchange Act. Internal control over Ñnancial reporting is a
process designed to provide reasonable assurance regarding the reliability of Ñnancial reporting and the
preparation of Ñnancial statements for external purposes in accordance with accounting principles generally
accepted in the United States of America.

Our internal control over Ñnancial reporting includes those policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reÖect our transactions and dispositions
of assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of
Ñnancial statements in accordance with accounting principles generally accepted in the United States of
America, and that our receipts and expenditures are being made only in accordance with authorizations of our
management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our assets that could have a material eÅect on the Ñnancial
statements.

Because of its inherent limitations, internal control over Ñnancial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of eÅectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

Our management conducted an evaluation of the eÅectiveness of our internal control over Ñnancial
reporting based on the framework in ""Internal Control Ì Integrated Framework'' issued by the Committee of
Sponsoring Organizations of the Treadway Commission (""COSO''). Based on this evaluation under the
framework in ""Internal Control Ì Integrated Framework,'' our management concluded that our internal
control over Ñnancial reporting was eÅective as of December 31, 2005.

Management's assessment of the eÅectiveness of our internal controls over Ñnancial reporting as of
December 31, 2005 has been audited by Peterson Sullivan PLLC, an independent registered public
accounting Ñrm, as stated in their report which is included below.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING

To the Board of Directors and Shareholders
Cray Inc.

We have audited management's assessment, included in the accompanying Management's Report on
Internal Control over Financial Reporting, that Cray Inc. and subsidiaries (""the Company'') maintained
eÅective internal control over Ñnancial reporting as of December 31, 2005, based on criteria established in
Internal Control Ì Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company's management is responsible for maintaining eÅective
internal control over Ñnancial reporting and for its assessment of the eÅectiveness of internal control over
Ñnancial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on
the eÅectiveness of the Company's internal control over Ñnancial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether eÅective internal control over Ñnancial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over Ñnancial reporting, evaluating
management's assessment, testing and evaluating the design and operating eÅectiveness of internal control,
and performing such other procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.

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A company's internal control over Ñnancial reporting is a process designed to provide reasonable
assurance regarding the reliability of Ñnancial reporting and the preparation of Ñnancial statements for external
purposes in accordance with accounting principles generally accepted in the United States of America. A
company's internal control over Ñnancial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly reÖect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of Ñnancial statements in accordance with accounting principles generally
accepted in the United States of America, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material eÅect on the Ñnancial statements.

In our opinion, management's assessment that the Company maintained eÅective internal control over
Ñnancial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria
established in Internal Control Ì Integrated Framework issued by the Committee of Sponsoring Organiza-
tions of the Treadway Commission (COSO). Also in our opinion, the Company maintained, in all material
respects, eÅective internal control over Ñnancial reporting as of December 31, 2005, based on criteria
established in Internal Control Ì Integrated Framework issued by the Committee of Sponsoring Organiza-
tions of the Treadway Commission (COSO).

We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheet of Cray Inc. and subsidiaries as of December 31, 2005,
and the related consolidated statements of operations, shareholders' equity and comprehensive income (loss),
and cash Öows for the year then ended, and our report dated March 15, 2006, expressed an unqualiÑed
opinion.

/s/ PETERSON SULLIVAN PLLC

Seattle, Washington
March 15, 2006

Item 9B. Other Information

None.

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PART III

Certain information required by Part III is omitted from this Report as we will Ñle a deÑnitive proxy
statement for the Annual Meeting of Shareholders to be held on June 6, 2006, pursuant to Regulation 14A
(the ""Proxy Statement'') not later than 120 days after the end of the Ñscal year covered by this Report, and
certain information included in the Proxy Statement is incorporated herein by reference. Only those sections
of the Proxy Statement which speciÑcally address the items set forth herein are incorporated by reference.

Item 10. Directors and Executive OÇcers of the Company

Information with respect to our directors may be found in the section titled ""Corporate Governance Ì
The Board of Directors'' and in the section titled ""Discussion of Proposals Recommended by the Board Ì
Proposal 1: To Elect Eight Directors For One-Year Terms'' in our Proxy Statement. Such information is
incorporated herein by reference. Information with respect to executive oÇcers may be found beginning on
page 32 above, under the caption ""Executive OÇcers of the Company.'' Information with respect to
compliance with Section 16(a) of the Exchange Act by the persons subject thereto may be found under the
section titled ""Our Common Stock Ownership Ì Section 16(a) BeneÑcial Ownership Reporting Compli-
ance'' in the Proxy Statement and is incorporated herein by reference.

Our Board of Directors has adopted a Code of Business Conduct applicable to all of our directors, oÇcers
and employees. The Code of Business Conduct, our Corporate Governance Guidelines, charters for each of
our Board committees and other governance documents may be found on our website: www.cray.com under
""Investors Ì Corporate Governance.''

Item 11. Executive Compensation

The information in the Proxy Statement set forth in the section titled ""Corporate Governance Ì The
Board of Directors'' under the captions ""The Committees of the Board'' and ""How We Compensate
Directors,'' in the section titled ""Corporate Governance Ì The Executive OÇcers,'' in the section titled
""Corporate Governance Ì Report on Executive Compensation for 2005 by the Compensation Committee''
and in the section titled ""Stock Performance Graph'' is incorporated herein by reference.

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Item 12. Security Ownership of Certain BeneÑcial Owners and Management and Related Shareholder

Matters

The information in the Proxy Statement set forth in the section ""Our Common Stock Ownership'' and in
the subpart ""Corporate Governance Ì The Executive OÇcers Ì How We Compensate Executive OÇcers Ì
Equity Compensation Plan Information'' is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

The information in the Proxy Statement set forth in the section titled ""Corporate Governance'' under the
caption ""The Executive OÇcers Ì Management Agreements and Policies'' and in the section titled
""Corporate Governance Ì Legal Proceedings and IndemniÑcation'' is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

The information set forth in the section titled ""Independent Registered Public Accounting Firms'' under
the caption ""Information Regarding Our Independent Public Accountants'' in the Proxy Statement is
incorporated herein by reference.

Item 15. Exhibits and Financial Statement Schedules

(a)(1) Financial Statements

PART IV

Consolidated Balance Sheets at December 31, 2004 (Restated) and December 31, 2005

Consolidated Statements of Operations for the years ended December 31, 2003, 2004 (Restated) and

2005

Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss) for the years ended

December 31, 2003, 2004 (Restated) and 2005

Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 (Restated) and

2005

Notes to Consolidated Financial Statements

Reports of Independent Registered Public Accounting Firms

(a)(2) Financial Statement Schedules

Schedule II Ì Valuation and Qualifying Accounts Ì The Ñnancial statement schedule for the years
ended December 31, 2005, 2004, and 2003 should be read in conjunction with the consolidated Ñnancial
statements of Cray Inc. Ñled as part of this Annual Report on Form 10-K.

Schedules other than that listed above have been omitted since they are either not required, not
applicable, or because the information required is included in the consolidated Ñnancial statements or the
notes thereto.

(a)(3) Exhibits

The Exhibits listed in the Exhibit Index, which appears immediately following the signature page and
certiÑcations and is incorporated herein by reference, are Ñled as part of this Annual Report on Form 10-K.

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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Seattle, State of Washington, on April 20, 2006.

SIGNATURES

CRAY INC.

/s/ PETER J. UNGARO

Peter J. Ungaro
Chief Executive OÇcer and President

Each of the undersigned hereby constitutes and appoints Peter J. Ungaro, Brian C. Henry and Kenneth
W. Johnson and each of them, the undersigned's true and lawful attorney-in-fact and agent, with full power of
substitution, for the undersigned and in his or her name, place and stead, in any and all capacities, to sign any
or all amendments to this Annual Report on Form 10-K and any other instruments or documents that said
attorneys-in-fact and agents may deem necessary or advisable, to enable Cray Inc. to comply with the
Securities Exchange Act of 1934 and any requirements of the Securities and Exchange Commission in respect
thereof, and to Ñle the same, with all exhibits thereto, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents and each of them full power and authority to do and perform each and
every act and thing requisite and necessary to be done, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and conÑrming all that each such attorney-in-fact and agent, or
his substitute, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below

by the following persons on behalf of Company and in the capacities indicated on April 20, 2006.

Signature

Title

By /s/ PETER J. UNGARO

Chief Executive OÇcer, President and Director

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Peter J. Ungaro

By /s/ BRIAN C. HENRY

Brian C. Henry

By /s/ KENNETH D. ROSELLI

Kenneth D. Roselli

By /s/

JOHN B. JONES, JR.
John B. Jones, Jr.

By /s/ KENNETH W. KENNEDY, JR.

Kenneth W. Kennedy, Jr.

By /s/ STEPHEN C. KIELY

Stephen C. Kiely

By /s/ FRANK L. LEDERMAN

Frank L. Lederman

By /s/ SALLY G. NARODICK

Sally G. Narodick

Principal Financial OÇcer

Principal Accounting OÇcer

Director

Signature

By /s/ DANIEL C. REGIS

Daniel C. Regis

By /s/ STEPHEN C. RICHARDS

Stephen C. Richards

Title

Director

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Exhibit
Number

3.1
3.2
4.1
4.2
4.3

4.4
10.1
10.2
10.3
10.4
10.5
10.6

10.7
10.8
10.9

EXHIBIT INDEX

Description

Restated Articles of Incorporation(1)
Amended and Restated Bylaws(9)
Form of Common Stock Purchase Warrants due August 30, 2006(16)
Form of Common Stock Purchase Warrants due June 21, 2009(17)
Indenture dated as of December 6, 2004, by and between the Company and The Bank of New York
Trust Company, N.A. as Trustee(14)
Common Stock Purchase Warrant due May 30, 2009(23)
2000 Non-Executive Employee Stock Option Plan(5)
2001 Employee Stock Purchase Plan(13)*
2003 Stock Option Plan(2)*
2004 Long-Term Equity Compensation Plan(15)*
Cray Canada Inc. Amended and Restated Key Employee Stock Option Plan(21)
Form of Management Continuation Agreement between the Company and its Executive OÇcers
and certain other Employees(10)*
Executive Severance Policy, as amended(24)*
Lease Agreement between Merrill Place, LLC and the Company, dated November 21, 1997(6)
FAB I Building Lease Agreement between Union Semiconductor Technology Corporation and the
Company, dated as of June 1, 2000(7)

10.10 Amendment No. 1 to the FAB Building Lease Agreement between Union Semiconductor

10.11

Technology Corporation and the Company, dated as of August 19, 2002(3)
Conference Center Lease Agreement between Union Semiconductor Technology Corporation and
the Company, dated as of June 1, 2000(7)

10.12 Amendment No. 1 to the Conference Center Lease Agreement between Union Semiconductor

Technology Corporation and the Company dated as of August 19, 2002(3)

10.13 Mendota Heights OÇce Lease Agreement between the Teachers' Retirement System of the State

10.14

10.15

10.16

10.17

10.18

10.19

10.20

10.21

of Illinois and the Company, dated as of August 10, 2000(7)
First Amendment to the Mendota Heights OÇce Lease Agreement between the Teachers'
Retirement System of the State of Illinois and the Company, dated as of January 17, 2003(3)
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(22)
Credit Agreement between Wells Fargo Bank, N.A. and the Company, dated April 10, 2003, and
Related Revolving Line of Credit Note(8)
First Amendment to Credit Agreement between Wells Fargo Bank, N.A. and the Company, dated
March 5, 2004(22)
Second Amendment to Credit Agreement between Wells Fargo Bank, N.A. and the Company,
dated June 7, 2004(22)
Third Amendment to Credit Agreement between Wells Fargo Bank, N.A. and the Company, dated
November 29, 2004(22)
Fourth Amendment to Credit Agreement between Wells Fargo Bank, N.A. and the Company,
dated December 15, 2004(22)
Securities Account Control Agreement, with Addendum, by and among Wells Fargo Bank, N.A.
and the Company, dated as of December 15, 2004(22)

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Exhibit
Number

10.22

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

Description

10.23 Distribution Agreement between NEC Corporation and the Company, dated as of February 28,

10.24

2001(12)°
Sales and Marketing Services Agreement among NEC Corporation, HNSX Supercomputers, Inc.
and Cray Inc., dated as of February 28, 2001(12)°

10.25 Maintenance Agreement between NEC Corporation and the Company, dated as of February 28,

2001(12)°

10.26 Amendment to Maintenance Agreement between NEC Corporation and the Company, dated

10.27

June 9, 2003(11)°
Letter from NEC Corporation notifying the Company that its distribution rights in North America
will be non-exclusive, dated April 24, 2003(11)

10.28 Arrangement Agreement, dated as of February 25, 2004, by and among the Company, 3084317

10.29

Nova Scotia Limited and OctigaBay Systems Corporation(18)
Purchase Agreement, dated December 1, 2004, by and between the Company and Bear, Stearns &
Co. Inc. as Initial Purchaser(14)

10.30 Registration Rights Agreement dated December 6, 2004, by and between the Company and Bear,

10.31
10.32
10.33
10.34
10.35
10.36

Stearns & Co. Inc., as Initial Purchaser(14)
2005 Executive Bonus Plan*(20)
Form of OÇcer Non-QualiÑed Stock Option Agreement*(22)
Form of OÇcer Incentive Stock Option Agreement*(22)
Form of Director Stock Option Agreement*(22)
Form of Director Stock Option, immediate vesting*(22)
Fourth Amendment to the Lease between Merrill Place LLC and the Company, dated as of
October 31, 2005(25)
Letter Agreement between the Company and Peter J. Ungaro, eÅective March 7, 2005*(19)

10.37
10.38 OÅer Letter between the Company and Margaret A. Williams, dated April 14, 2005*(26)
10.39 OÅer Letter between the Company and Brian C. Henry, dated May 16, 2005*(27)
10.40

Senior Secured Credit Agreement among the Company, Cray Federal Inc. and Wells Fargo
Foothill, Inc., dated May 31, 2005(23)

10.41 Amendment No. 1 to the Senior Secured Credit Agreement among the Company, Cray Federal

Inc. and Wells Fargo Foothill, Inc., dated November 9, 2005(28)
Form of Restricted Stock Agreement(29)

10.42
10.43 Retention Agreement between the Company and Peter J. Ungaro, dated December 20, 2005*(29)
10.44 Retention Agreement between the Company and Brian C. Henry, dated December 20, 2005*(29)
10.45 Retention Agreement between the Company and Margaret A. Williams, dated December 20,

21.1
23.1
23.2
24.1
31.1
31.2
32.1

2005*(29)
Subsidiaries of the Company
Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
Consent of Peterson Sullivan PLLC, Independent Registered Public Accounting Firm
Power of Attorney (included on the signature page of this report)
Rule 13a-14(a)/15d-14(a) CertiÑcation of Mr. Ungaro, Chief Executive OÇcer
Rule 13a-14(a)/15d-14(a) CertiÑcation of Mr. Henry, Chief Financial OÇcer
CertiÑcation pursuant to 18 U.S.C. Section 1350 by the Chief Executive OÇcer and the Chief
Financial OÇcer

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* Management contract or compensatory plan or arrangement.

° Subject to conÑdential treatment. The omitted conÑdential information has been Ñled with the

Securities and Exchange Commission.

(1) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on May 14, 2004.

(2) Incorporated by reference to the Company's deÑnitive Proxy Statement for the 2003 Annual Meeting,

as Ñled with the Commission on March 31, 2003.

(3) Incorporated by reference to the Company's Annual Report on Form 10-K, as Ñled with the

Commission for the Ñscal year ended December 31, 2002.

(4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q, as Ñled 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 Ñled with the Commission on March 30, 2001.

(6) Incorporated by reference to the Company's Annual Report on Form 10-K, as Ñled with the

Commission for the Ñscal year ended December 31, 1997.

(7) Incorporated by reference to the Company's Annual Report on Form 10-K, as Ñled with the

Commission for the Ñscal year ended December 31, 2000.

(8) Incorporated by reference to the Company's Quarterly Report on Form 10-Q, as Ñled with the

Commission on May 15, 2003.

(9) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on February 21, 2006.

(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q, as Ñled with the

Commission on May 17, 1999.

(11) Incorporated by reference to the Company's Quarterly Report on Form 10-Q, as Ñled with the

Commission on August 14, 2003.

(12) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on May 14, 2001.

(13) Incorporated by reference to the Company's Registration Statement on Form S-8 (SEC

No. 333-70238), Ñled on September 26, 2001.

(14) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on December 7, 2004.

(15) Incorporated by reference to the Company's deÑnitive Proxy Statement for the 2004 Annual Meeting,

as Ñled with the Commission on March 24, 2004.

(16) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on September 4, 2002.

(17) Incorporated by reference to the Company's Registration Statement on Form S-3 (SEC

No. 333-57972), as Ñled with the Commission on March 30, 2001.

(18) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on April 2, 2004.

(19) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on March 8, 2005.

(20) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on March 25, 2005.

(21) Incorporated by reference to the Company's Registration Statement on Form S-8 (SEC

No. 333-114243), Ñled on April 6, 2004.

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(22) Incorporated by reference to the Company's Annual Report on Form 10-K, as Ñled with the

Commission for the Ñscal year ended December 31, 2004.

(23) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on June 1, 2005.

(24) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on August 10, 2005.

(25) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on November 15, 2005.

(26) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on May 9, 2005.

(27) Incorporated by reference to the Company's Quarterly Report on Form 10-Q, as Ñled with the

Commission on November 9, 2005.

(28) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on November 16, 2005.

(29) Incorporated by reference to the Company's Current Report on Form 8-K, as Ñled with the Commission

on December 22, 2005.

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CRAY INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

ASSETS

Current assets:

Cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Restricted cashÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Short-term investments, available-for-sale ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accounts receivable, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
InventoryÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Prepaid expenses and other current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Total current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Property and equipment, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Service inventory, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Goodwill ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Deferred tax asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Intangible assets, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other non-current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

December 31, 2004
(Restated-See Note 2)

December 31,
2005

41,732
11,437
34,253
33,185
71,521
5,613
197,741
36,875
3,590
55,644
Ì
7,294
9,360

46,026
Ì
Ì
55,064
67,712
2,909
171,711
31,292
3,285
56,839
575
1,113
8,190

TOTAL ASSETS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 310,504

$ 273,005

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:

Accounts payableÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accrued payroll and related expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other accrued liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Deferred revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Total current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Long-term deferred tax liability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Long-term deferred revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other non-current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Convertible notes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
TOTAL LIABILITIES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Commitments and Contingencies (Note 12)
Shareholders' equity:

Preferred Stock Ì Authorized and undesignated, 5,000,000 shares;

no shares issued or outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Common Stock and additional paid-in capital, par value $.01 per

share Ì Authorized, 150,000,000 shares; issued and outstanding,
87,348,641 and 90,973,506 shares, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Exchangeable shares, no par value Ì Unlimited shares authorized;

570,963 and 78,840 shares outstanding, respectively ÏÏÏÏÏÏÏÏÏÏÏÏÏ
Deferred compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accumulated other comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accumulated deÑcitÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
TOTAL SHAREHOLDERS' EQUITY ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

23,875
14,970
8,726
56,554
104,125
1,538
1,027
1,849
80,000
188,539

14,911
12,145
10,702
81,749
119,507
Ì
5,234
2,317
80,000
207,058

413,911

422,691

4,173
(4,220)
4,560
(296,459)
121,965

576
(2,811)
6,258
(360,767)
65,947

TOTAL LIABILITIES AND SHAREHOLDERS'

EQUITY ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 310,504

$ 273,005

See accompanying notes

F-1

F
n
a
n
c
a
s

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

Years Ended December 31,
2004
(Restated-See Note 2)

2005

2003

Revenue:

Product ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Service ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$175,004
61,958

Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

236,962

Operating expenses:

Cost of product revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cost of service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Marketing and sales ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Restructuring, severance and impairment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
In-process research and development charge ÏÏÏÏÏÏÏÏÏÏÏÏ

97,354
40,780
37,762
27,038
10,908
4,019
Ì

Total operating expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

217,861

95,901
49,948

145,849

104,196
30,338
53,266
34,948
19,451
8,182
43,400

293,781

$152,098
48,953

201,051

139,518
29,032
41,711
25,808
16,145
9,750
Ì

261,964

Income (loss) from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

19,101

(147,932)

(60,913)

Other income (expense), net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Interest income (expense), netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

1,496
444

Income (loss) before income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Income tax expense (beneÑt) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

21,041
(42,207)

(699)
365

(148,266)
59,092

(1,421)
(3,462)

(65,796)
(1,488)

Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 63,248

$(207,358)

$(64,308)

Basic net income (loss) per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Diluted net income (loss) per common share ÏÏÏÏÏÏÏÏÏÏÏÏÏ

0.94

0.81

(2.49)

(0.73)

Weighted average shares outstanding Ì basic ÏÏÏÏÏÏÏÏÏÏÏÏÏ

67,098

Weighted average shares outstanding Ì diluted ÏÏÏÏÏÏÏÏÏÏÏÏ

77,861

83,387

88,499

See accompanying notes

F-2

s
a
c
n
a
n
F

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(In thousands)

Common Stock
and Additional
Paid In Capital
Number
of Shares Amount of Shares Amount Compensation

Exchangeable
Shares

Deferred

Number

Ì 3,158

24,207

1,190
31,219

1,682
(4,269)

11,185
(31,219)

(14,599)
Ì

BALANCE, December 31, 2002 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Common stock issued, less issuance costs of $3,165
Exercise of underwriter over-allotment option ÏÏÏÏÏ
Common stock issued in conversion of Series A

Preferred stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Issuance of shares under Company 401(k) Plan

matchÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Issuance of shares under Employee Stock Purchase
Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Exercise of stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Exercise of warrants, less issuance costs of $397 ÏÏÏ
Issuance of restricted stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Compensation expense on restricted stockÏÏÏÏÏÏÏÏÏ
Tax beneÑt on non-qualiÑed stock options ÏÏÏÏÏÏÏÏ
Other comprehensive income:

Unrealized gain on available-for-sale investments
Currency translation adjustment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
BALANCE, December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Common stock issued in acquisition of OctigaBayÏÏ
Exchangeable shares issued in acquisition of

OctigaBay ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Deferred compensation related to acquisition of

OctigaBay ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Exchangeable shares converted into common shares
Acquisition-related stock-based compensation

expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Fair value of OctigaBay options acquired ÏÏÏÏÏÏÏÏÏ
Issuance of shares under Employee Stock Purchase
Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Exercise of stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Issuance of shares under Company 401(k) Plan

matchÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Exercise of warrants, less issuance costs of $191 ÏÏÏ
Common stock issued for bonus ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Compensation expense on restricted stockÏÏÏÏÏÏÏÏÏ
Compensation expense on modiÑcation of stock

options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Compensation expense on stock options issued to

contractors ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Other comprehensive income:

Exchangeable shares converted into common shares
Issuance of shares under Employee Stock Purchase
Plan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Exercise of stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Issuance of shares under Company 401(k) Plan

matchÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Warrants issued in connection with Ñnancing ÏÏÏÏÏÏ
Restricted shares issued for compensationÏÏÏÏÏÏÏÏÏ
Amortization of deferred compensation ÏÏÏÏÏÏÏÏÏÏÏ
Reversal of deferred compensation for stock options
due to employee terminations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Common shares issued in exchange for lease

amendment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Other comprehensive income:

ReclassiÑcation adjustment for available-for-sale

realized losses included in net loss ÏÏÏÏÏÏÏÏÏÏÏ
Currency translation adjustment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
BALANCE, December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

56,250
7,355
1,125

$211,255
42,500
6,559

3,269

24,946

243
2,752
1,722
20
Ì
Ì

Ì
Ì
Ì
72,812

7,382

179
4,269

Ì
Ì

404
876

94
1,279
54
Ì

492

802
89

207
Ì
1,965
Ì

550

1,646
12,019
6,665
180
Ì
6,326

Ì
Ì
Ì
312,646

56,756

Ì
2,579

1,796
2,841

645
3,634
374
Ì

196

1,211
138

770
219
2,881
Ì

(116)

Ì $
Ì
Ì

Ì
Ì
Ì
Ì
Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì
Ì
Ì
Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì
Ì
571

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì
Ì
4,173

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì
Ì
79

Unrealized loss on available-for-sale investments
Currency translation adjustment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net loss (Restated-See Note 2)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
BALANCE, December 31, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Ì
Ì
Ì
87,349

Ì
Ì
Ì
413,911

3,597

(492)

(3,597)

Accumulated
Other
Comprehensive
Income
(Loss)

Accumulated
DeÑcit

Total

Comprehensive
Income
(Loss)

$ (291)
Ì
Ì

$(152,349) $

Ì
Ì

Ì
Ì
Ì
Ì
Ì
Ì

9
(525)
Ì
(807)

Ì
Ì
63,248
(89,101)

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì

Ì
Ì
Ì
Ì

58,615
42,500
6,559

24,946

550

1,646
12,019
6,665
Ì
75
6,326

9
(525)
63,248
222,633

56,756

24,207

(2,224)
Ì

11,134
2,579

1,796
2,841

645
3,634
374
105

196

Ì
Ì
Ì

Ì
Ì
Ì
Ì
Ì
Ì

Ì
(525)
63,248
62,723

Ì
Ì

Ì
Ì
Ì
Ì

(33)
5,400
Ì
4,560

Ì
Ì
(207,358)
(296,459)

(33)
4,645
(207,358)
121,965

(33)
5,400
(207,358)
$(201,991)

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì

Ì
Ì
Ì
Ì

Ì $

1,211
138

770
219
Ì
4,106

Ì
Ì

Ì
Ì
Ì
Ì

Ì
Ì
Ì

Ì
Ì
Ì
(180)
75
Ì

Ì
Ì
Ì
(105)

11,134
Ì

Ì
Ì

Ì
Ì
Ì
105

Ì
(755)
Ì
(4,220)

Ì
Ì

Ì
Ì
(2,881)
4,106

116

Ì
Ì
Ì
90,974

Ì
Ì
Ì
$422,691

Ì
Ì
Ì
576

Ì
68
Ì
$ (2,811)

24
1,674
Ì
$6,258

Ì
Ì
(64,308)
$(360,767) $

24
1,742
(64,308)
65,947

24
1,674
(64,308)
$ (62,610)

F
n
a
n
c
a
s

See accompanying notes

F-3

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

Years Ended December 31,
2004
(Restated-See Note 2)

2005

2003

$ 63,248

$(207,358)

$(64,308)

Operating activities:
Net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Stock-based compensation expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
In-process research and development charge ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Inventory write-down ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Impairment of core technology intangible asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Tax beneÑt on stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Amortization of issuance costs, convertible notes payable and line of credit ÏÏÏÏÏ
Deferred income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Cash provided by (used in) changes in operating assets and liabilities, net of the

eÅects of the OctigaBay acquisition:
Accounts receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Prepaid expenses and other assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Service inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accounts payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accrued payroll and related expenses and other accrued liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other non-current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Deferred revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net cash used in operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Investing activities:

Sales/maturities of short-term investmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Purchases of short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Acquisition of OctigaBay, net of cash acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
(Increase) decrease in restricted cash ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Purchases of property and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net cash provided by (used in) investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Financing activities:

Sale of common stock, net of issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Proceeds from issuance of common stock through employee stock purchase plan
Proceeds from exercise of options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Proceeds from exercise of warrants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Proceeds from issuance of convertible notes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Convertible notes payable and line of credit issuance costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Principal payments on debtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Principal payments on capital leases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net cash provided by (used in) Ñnancing activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

EÅect of foreign exchange rate changes on cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏ
Net increase in cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cash and cash equivalents

15,860
75
Ì
Ì
Ì
6,326
Ì

(48,996)
231

(18,553)
(27,084)
(11,893)
(180)
(678)
(1,897)

Ì
14,828
(8,713)

14,563
(49,133)
Ì
Ì
(6,599)
(41,169)

49,059
1,646
12,094
6,665
Ì
Ì

(4,144)
(241)

65,079

660
15,857

Beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
End of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

23,916
$ 39,773

Supplemental disclosure of cash Öow information:

Cash paid for interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cash paid for income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

213
2,741

Non-cash investing and Ñnancing activities:

Inventory transfers to Ñxed assets and service inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Preferred stock converted to common stock ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Shares issued in acquisition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Warrants issued in connection with line of credit arrangement ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

8,095
24,946
Ì
Ì

See accompanying notes

F-4

s
a
c
n
a
n
F

17,179
11,844
43,400
8,513
Ì
Ì
Ì
59,188
Ì

15,471
(47,443)
11,555
(58)
9,609
1,061
Ì
24,383
(52,656)

68,635
(68,318)
(6,270)
(11,437)
(12,518)
(29,908)

Ì
1,796
2,841
3,634
80,000
(3,376)
Ì
(742)

84,153

370
1,959

39,773
41,732

153
590

11,281
Ì
83,542
Ì

19,578
4,106
Ì
5,751
4,912
Ì
1,008
(2,260)
80

(21,623)
(10,628)
3,908
141
(8,422)
833
473
29,746
(36,705)

44,437
(10,161)
Ì
11,437
(3,982)
41,731

Ì
1,211
138
Ì
Ì
(755)
Ì
(731)
(137)

(595)
4,294

41,732
$ 46,026

2,972
312

8,703
Ì
Ì
219

CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 DESCRIPTION OF BUSINESS

Cray Inc. (""Cray'' or the ""Company'') designs, develops, manufactures, markets and services high
performance computer systems, commonly known as supercomputers. These systems provide capability and
capacity far beyond typical server-based computer systems and address challenging scientiÑc and engineering
computing problems for government, industry and academia. The Company has transitioned from oÅering a
single principal product in 2003, the Cray X1 system which incorporates both vector and massively parallel
technologies, to oÅering three principal products in 2005 Ì the Cray X1E system, an upgrade to the Cray X1
system with increased processor speed and capability; the Cray XT3 system, a massively parallel high-
bandwidth system using standard commodity processors; and the Cray XD1 system, a balanced high-
bandwidth system employing standard commodity processors targeted for the mid-range market.

In 2005, the Company incurred a net loss of $64.3 million and used $36.7 million in cash for operating
activities. Management's plans project that the Company's current cash resources and cash to be generated
from operations in 2006 will be adequate to meet the Company's liquidity needs for at least the next twelve
months. These plans assume sales, shipment acceptance and subsequent collections from several large
customers, as well as cash receipts on new bookings. Should acceptances and payments be delayed
signiÑcantly, the Company could face a signiÑcant liquidity challenge which would require it to pursue
additional initiatives to reduce costs and/or to seek additional Ñnancing. There can be no assurance that the
Company will be successful in its eÅorts to achieve future proÑtable operations or generate suÇcient cash
from operations, or obtain additional funding in the event that its Ñnancial resources become insuÇcient.

NOTE 2 RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

Subsequent to the issuance of the December 31, 2004 consolidated Ñnancial statements, the Company
determined that certain research and development costs were incorrectly charged to one of its product
development contracts in 2004. The contract is accounted for under the percentage of completion method of
accounting. The error resulted in revenue being recognized prematurely on the contract. Accordingly, the
accompanying 2004 Ñnancial statements have been restated from the amounts previously reported to correct
this error. Additionally, the Company has reclassiÑed the cash Öow impact of changes in restricted cash from
Ñnancing activities to investing activities.

F-5

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

A summary of the signiÑcant eÅects of the restatement is as follows (in thousands, except per share

data):

Year Ended December 31, 2004:
Product revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Total revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Cost of product revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and development (a) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net loss ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Basic and diluted net loss per common share ÏÏÏÏÏÏÏÏÏÏÏÏ

Consolidated Statement of Operations

As Previously
Reported

As Restated

Change

$
99,236
$ 149,184
$ 107,264
$
50,198
$(204,023)
(2.45)
$

$
95,901
$ 145,849
$ 104,196
$
53,266
$(207,358)
(2.49)
$

$(3,335)
$(3,335)
$(3,068)
$ 3,068
$(3,335)
$ (0.04)

Consolidated Balance Sheet

As Previously
Reported

As Restated

Change

As of December 31, 2004:
Current deferred revenue (b) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accumulated deÑcit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$
53,219
$(293,124)

$
56,554
$(296,459)

$ 3,335
$(3,335)

Notes:

(a) Previously reported amount was increased by $5,068 to conform to 2005 Ñnancial statement

presentation. Amount was reclassiÑed from Acquisition-related Compensation Expense.

(b) Previously reported amount was decreased by $1,027 to conform to 2005 Ñnancial statement

presentation. Amount was reclassiÑed to Long-term Deferred Revenue.

NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Principles

The consolidated Ñnancial statements and accompanying notes are prepared in accordance with

accounting principles generally accepted in the United States of America.

Principles of Consolidation

The consolidated Ñnancial statements include the accounts of the Company and its wholly-owned

subsidiaries. Intercompany balances and transactions have been eliminated.

ReclassiÑcations

Certain prior year amounts have been reclassiÑed to conform with the current year presentation. There

has been no impact on previously reported net income (loss) or shareholders' equity.

Use of Estimates

Preparation of Ñnancial statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions that aÅect the amounts
reported in the consolidated Ñnancial statements and accompanying notes. These estimates are based on
management's best knowledge of current events and actions the Company may undertake in the future.
Estimates are used in accounting for, among other items, fair value allocation used in revenue recognition,
percentage of completion accounting, determination of inventory lower of cost or market, useful lives for

F-6

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

depreciation and amortization, future cash Öows associated with impairment testing for goodwill and long-
lived assets, as well as any fair value assessment, restructuring costs, deferred income tax assets, potential
income tax assessments and contingencies. Actual results could diÅer from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid Ñnancial instruments that are readily convertible to
cash and have original maturities of three months or less at the time of acquisition. The Company maintains
cash and cash equivalent balances with Ñnancial institutions that exceed federally insured limits. The
Company has not experienced any losses related to these balances, and management believes its credit risk to
be minimal. The Company had no pledges nor any restrictions on any of its cash balances at December 31,
2005, except as described in Note 14 Ì Convertible Notes Payable and Lines of Credit. At December 31,
2004, $11.4 million of the Company's cash balance was restricted for outstanding letters of credit (see
Note 14 Ì Convertible Notes Payable and Lines of Credit).

Short-term Investments

Short-term investments generally mature between three months and two years from the purchase date.
Investments with maturities beyond one year may be classiÑed as short-term based on their highly liquid
nature and because such marketable securities are readily convertible into cash which could be used in current
operations. All short-term investments are classiÑed as available-for-sale and are recorded at fair value, based
on quoted market prices; unrealized gains and losses are reÖected in other comprehensive income. The
Company held no short-term investments as of December 31, 2005. The Company had no pledges nor any
restrictions on its short-term investment balance as of December 31, 2004.

Concentration of Credit Risk

The Company currently derives the majority of revenue from sales of products and services to
U.S. government agencies or commercial customers primarily serving the U.S. government. See Note 17 Ì
Segment Information for additional information. Given the type of customers, the Company does not believe
its accounts receivable represent signiÑcant credit risk.

As of December 31, 2005 and 2004, accounts receivable included $8.8 million and $15.1 million,
respectively, due from Sandia National Laboratories on the Red Storm project. Of this amount, $8.3 million
and $5.5 million, respectively, was unbilled, based upon a milestone billing arrangement with this customer.

Accounts Receivable

Accounts receivable are stated at principal amounts and are primarily comprised of amounts contractu-
ally due from customers for products and services and amounts due from government funded research and
development projects. The Company provides for an allowance for doubtful accounts based on an evaluation
of customer account balances past due ninety days from the date of invoicing. In determining whether to
record an allowance for a speciÑc customer, the Company considers a number of factors, including prior
payment history and Ñnancial information for the customer. The Company had no pledges nor any restrictions
on its accounts receivable balances in 2005 or 2004, except as described in Note 14 Ì Convertible
Notes Payable and Lines of Credit.

Fair Values of Financial Instruments

The Company generally has the following Ñnancial instruments: cash and cash equivalents, short-term
investments, accounts receivable, accounts payable, accrued liabilities and convertible notes payable. The
carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities

F-7

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

approximate their fair value based on the short-term nature of these Ñnancial instruments. The fair value of
convertible notes payable is based on quoted market prices. The Company's convertible notes payable are
traded in a market with low liquidity and are therefore subject to price volatility. As of December 31, 2005, the
fair value of these convertible notes payable was approximately $44.0 million compared to their carrying value
of $80.0 million. As of December 31, 2004, the fair value of the convertible notes payable approximated their
carrying value. Short-term investments are recorded at their fair value.

Inventories

Inventories are valued at cost (on a Ñrst-in, Ñrst-out basis) which is not in excess of estimated current
market prices. The Company regularly evaluates the technological usefulness and anticipated future demand
for various inventory components and the expected use of the inventory. When it is determined that these
components do not function as intended, or quantities on hand are in excess of estimated requirements, the
costs associated with these components are charged to expense. The Company has no pledges nor any
restrictions on any inventory balances at December 31, 2005 or 2004, except as described in Note 14 Ì
Convertible Notes Payable and Lines of Credit.

In connection with certain of its sales agreements, the Company may receive used equipment from a
customer. This inventory generally will be recorded at no value based on the expectation that the Company
will not be able to resell or otherwise use the equipment. In the event that the Company has a speciÑc
contractual plan for resale at the date the inventory is acquired, the inventory is recorded at its estimated fair
value.

Property and Equipment, net

Property and equipment are recorded at cost less accumulated depreciation and amortization. Deprecia-
tion is calculated on a straight-line basis over the estimated useful lives of the related assets, ranging from
18 months to seven years for furniture, Ñxtures and computer equipment, and eight to 25 years for buildings
and land improvements. Equipment under capital lease is amortized over the lesser of the lease term or its
estimated useful life. Leasehold improvements are amortized over the lesser of their estimated useful lives or
the term of the lease. The cost of software obtained or inventory transferred for internal use is capitalized and
depreciated over their estimated useful lives, generally four years. The Company had no pledges nor any
restrictions on any of its net property and equipment balance at December 31, 2005 or 2004, except as
described in Note 14 Ì Convertible Notes Payable and Lines of Credit.

In accordance with Statement of Position (""SOP'') 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, the Company has capitalized certain costs associated with the
implementation of software developed for internal use. Costs capitalized primarily consist of employee salaries
and beneÑts allocated to the implementation project. The Company capitalized no costs in 2005 and
approximately $0.8 million, and $1.1 million of costs associated with computer software developed for internal
use during the years ended December 31, 2004, and 2003, respectively.

Service Inventory

Service inventory is valued at the lower of cost or estimated market and represents inventory used to
support service and maintenance agreements with customers. As inventory is utilized, replaced items are
returned and are either repaired or scrapped. Costs incurred to repair inventory to a usable state are charged to
expense as incurred. Service inventory is recorded at cost and is amortized over the estimated service life of
the related product platform (generally four years). The Company has no pledges nor any restrictions on any
service inventory balances at December 31, 2005 or 2004, except as described in Note 14 Ì Convertible
Notes Payable and Lines of Credit.

F-8

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Goodwill and Other Intangible Assets

In accordance with Statement of Financial Accounting Standards (""SFAS'') No. 142, Goodwill and
Other Intangible Assets, the Company tests goodwill for impairment on an annual basis as of January 1, and
between annual tests if indicators of potential impairment exist, using a fair-value based approach. The
Company currently has one operating segment and reporting unit. As such, the Company evaluates
impairment based on certain external factors, such as its market capitalization. No impairment of goodwill has
been identiÑed during any of the periods presented.

The Company capitalizes certain external legal costs incurred for patent Ñlings. The Company begins
amortization of these costs as each patent is awarded. Patents are amortized over their estimated useful lives
(generally Ñve years). The Company performs periodic review of its capitalized patent costs to ensure that the
patents have continuing value to the Company. As of both December 31, 2005 and 2004, the Company had a
balance of $1.1 million of net capitalized patent costs.

Impairment of Long-Lived Assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
management tests long-lived assets to be held and used for recoverability whenever events or changes in
circumstances indicate that their carrying amount may not be recoverable. As part of the 2004 OctigaBay
Systems Corporation acquisition, the Company assigned $6.7 million of value to core technology. In
December 2005 the Company announced plans to further integrate its technology platforms, and combine the
Cray XD1 and the Cray XT3 products into a uniÑed product oÅering. The expected undiscounted cash Öows
from the product using the core technology were not suÇcient to recover the carrying value of the asset. The
Company performed a fair value assessment similar to the original valuation and determined the asset had no
continuing value. The Company wrote oÅ the unamortized balance of its core technology intangible asset of
$4.9 million which is included in ""Restructuring, Severance and Impairment'' in the accompanying 2005
Consolidated Statements of Operations. No impairment of intangible assets was recorded during 2004 or 2003.

Revenue Recognition

The Company recognizes revenue when it is realized or realizable and earned. In accordance with the
Securities and Exchange Commission StaÅ Accounting Bulletin (""SAB'') No. 104, Revenue Recognition in
Financial Statements, the Company considers revenue realized or realizable and earned when it has persuasive
evidence of an arrangement, the product has been shipped or the services have been provided to the customer,
title and risk of loss for products has passed to the customer, the sales price is Ñxed or determinable, no
signiÑcant unfulÑlled Company obligations exist, and collectibility is reasonably assured. In addition to the
aforementioned general policy, the following are the speciÑc revenue recognition policies for each major
category of revenue and for multiple-element arrangements.

Products: The Company recognizes revenue from its product lines, as follows:

‚ Cray X1/X1E and Cray XT3 Product Lines: The Company recognizes revenue from product sales
upon customer acceptance of the system, when there are no signiÑcant unfulÑlled Company obligations
stipulated by the contract that aÅect the customer's Ñnal acceptance, the price is 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
signiÑcant unfulÑlled Company obligations stipulated by the contract, the price is 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 unfulÑlled obligations.

F-9

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Revenue from contracts that require the Company to design, develop, manufacture or modify complex
information technology systems to a customer's speciÑcations, is recognized using the percentage of
completion method for long-term development projects under AICPA Statement of Position 81-1, Accounting
for Performance of Construction-Type and Certain Production-Type Contracts. Percentage of completion is
measured based on the ratio of costs incurred to date compared to the total estimated costs. Total estimated
costs are based on several factors, including estimated labor hours to complete certain tasks and the estimated
cost of purchased components or services. Estimates may need to be adjusted from quarter to quarter, which
would impact revenue and margins on a cumulative basis. To the extent the estimate of total costs to complete
the contract indicates a loss, such amount is recognized in full at that time. On a regular basis, the Company
updates its estimates of total costs; changes to the estimate may result in a charge or beneÑt to operations.

In 2004, the Company concluded that its Red Storm contract would result in an estimated loss of
$7.6 million. This amount was charged to cost of product revenue. During 2005, the Company increased the
estimate of the loss on the contract by $7.7 million (cumulative loss of $15.3 million) due to additional
hardware to be delivered to satisfy contractual and performance issues. This amount was also charged to cost
of product revenue. As of December 31, 2005 and 2004, the balance in the Red Storm loss contract accrual
was $5.7 million and $3.1 million, respectively, and is included in ""Other Accrued Liabilities'' on the
accompanying Consolidated Balance Sheets.

Services: Revenue for the maintenance of computers is recognized ratably over the term of the
maintenance contract. Maintenance contracts that are paid in advance are recorded as deferred revenue. The
Company considers Ñscal funding clauses as contingencies for the recognition of revenue until the funding is
assured. High performance computing service revenue is recognized as the services are rendered.

Multiple-Element Arrangements. The Company commonly enters into transactions that include multi-
ple-element arrangements, which may include any combination of hardware, maintenance, and other services.
In accordance with Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables, when some elements are delivered prior to others in an arrangement and all of the following
criteria are met, revenue for the delivered element is recognized upon delivery and acceptance of such item:

‚ 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.

If all of the criteria are not met, revenue is deferred until delivery of the last element as the elements
would not be considered a separate unit of accounting and revenue would be recognized as described above,
under our product line or service revenue recognition policies. The Company considers the maintenance period
to commence upon installation and acceptance of the product, which may include a warranty period and
accordingly allocates a portion of the sales price as a separate deliverable which is recognized as service
revenue over the entire service period.

Foreign Currency Translation

The functional currency of the Company's foreign subsidiaries is the local currency. Assets and liabilities
of foreign subsidiaries are translated into U.S. dollars at year-end exchange rates, and revenue and expenses
are translated at average rates prevailing during the year. Translation adjustments are included in accumulated
other comprehensive income (loss), a separate component of shareholders' equity. Transaction gains and
losses arising from transactions denominated in a currency other than the functional currency of the entity
involved are included in the Consolidated Statements of Operations. Aggregate transaction gains and losses

F-10

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

included in net income or loss in 2005, 2004 and 2003 was a loss of $1.4 million, a loss of $361,000, and a gain
of $1.6 million, respectively.

Research and Development

Research and development costs include costs incurred in the development and production of the
Company's hardware and software, costs incurred to enhance and support existing software features and
expenses related to future product development. Research and development costs are expensed as incurred,
and may be oÅset in part by government funding for certain development and services. Contract engineering
costs are expensed as incurred over the term of the development period. SFAS No. 86, Accounting for the
Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, requires the capitalization of certain
software product costs after technological feasibility of the software is established. Due to the relatively short
period between the technological feasibility of a product and completion of product development, and the
insigniÑcance of related costs incurred during this period, no software development costs have been
capitalized.

The Company classiÑes amounts to be received from funded research and development projects as either
revenue or a reduction to research and development expense based on the speciÑc facts and circumstances of
the contractual arrangement, considering total costs expected to be incurred compared to total expected
funding and the nature of the research and development contractual arrangement. In the event that a
particular arrangement is determined to represent revenue, the corresponding research and development costs
are classiÑed as cost of revenue.

Income Taxes

The Company accounts for income taxes under SFAS No. 109, Accounting for Income Taxes. Deferred
tax assets and liabilities are determined based on temporary diÅerences between Ñnancial reporting and tax
bases of assets and liabilities, operating loss and tax credit carryforwards, and are measured using the enacted
tax rates and laws that will be in eÅect when the diÅerences are expected to be recovered or settled.
Realization of certain deferred tax assets is dependent upon generating suÇcient taxable income in the
appropriate jurisdiction. The Company records a valuation allowance to reduce deferred tax assets to amounts
that are more likely than not to be realized. The initial recording and any subsequent changes to valuation
allowance are based on a number of factors (positive and negative evidence), as required by SFAS No. 109.
The Company considers its actual historical results to have stronger weight than other more subjective
indicators when considering whether to establish or reduce a valuation allowance.

Stock-Based Compensation

The Company accounts for its stock-based compensation plans under the intrinsic value method, which
follows the recognition and measurement principles of Accounting Principles Board (""APB'') Opinion
No. 25, Accounting for Stock Issued to Employees. In accordance with APB Opinion No. 25, the Company
does not record any expense when stock options are granted to employees and are priced at the fair market
value of the Company's stock at the date of grant.

F-11

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

To estimate compensation expense which would be recognized under SFAS No. 123, Accounting for
Stock-based Compensation, the Company uses the modiÑed Black-Scholes fair value option-pricing model
with the following weighted-average assumptions for options granted during the years ended December 31:

2003

2004

2005

Risk-free interest rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Expected dividend yield ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
VolatilityÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Expected life ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Weighted average Black-Scholes value of options grantedÏÏÏÏ

4.3%
0%
84%
7.1 years
$8.43

4.2%
0%
82%
6.9 years
$3.75

4.1%
0%
85%
4.6 years
$1.36

The weighted average Black-Scholes value of shares granted under the employee stock purchase plans
during 2005 and 2004 was $0.46 and $1.30, respectively. Fair values were estimated as of the dates of purchase
using the Black-Scholes fair value model with the following assumptions for 2005 and 2004: expected volatility
of 72% and 83%, respectively; risk-free interest rate of 3.5% and 1.5%, respectively; an expected term of
3 months for both years; and no dividend yield in either year.

If compensation cost for the Company's stock option plans and its stock purchase plan had been
determined based on the fair value at the grant dates for awards under those plans in accordance with a fair
value based method of SFAS No. 123, the Company's net income (loss) and net income (loss) per common
share for the years ended December 31 would have been the pro forma amounts indicated below (in
thousands). For purposes of this pro forma disclosure, the value of the options is amortized ratably to expense
over the options' vesting periods. Because the estimated value is determined as of the date of grant, the actual
value ultimately realized by the employee may be signiÑcantly diÅerent.

Net income (loss), as reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Add:

Stock-based employee compensation included in reported

2003

2004
(Restated)

2005

$ 63,248

$(207,358)

$(64,308)

net income (loss), net of related tax eÅects ÏÏÏÏÏÏÏÏÏÏ

11,844

4,106

Less:

Amortized stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax eÅectsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(10,207)

(19,423)

(30,524)

Pro forma net income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 53,116

$(214,937)

$(90,726)

Amortization of pro forma stock-based employee compensation expense increased signiÑcantly in 2005
due to the actions taken to accelerate vesting described in Note 15 Ì Shareholders' Equity, Stock Option
Plans.

F-12

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Pro forma basic and diluted net income (loss) per common share for the years ended December 31 are as

follows:

Basic:

2003

2004
(Restated)

2005

As reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$0.94
$0.79

$(2.49)
$(2.58)

$(0.73)
$(1.03)

Diluted:

$0.81
$0.68

$(2.49)
$(2.58)

$(0.73)
$(1.03)

Shipping and Handling Costs

Costs related to shipping and handling are included in ""Cost of Product Revenue'' and ""Cost of Service

Revenue'' on the accompanying Consolidated Statements of Operations.

Advertising Costs

Marketing and sales expenses in the accompanying Consolidated Statements of Operations include
advertising expenses of $747,000, $683,000 and $392,000 in 2005, 2004 and 2003, respectively. The Company
incurs advertising costs for representation at certain trade shows, promotional events, sales lead generation, as
well as design and printing costs for promotional materials. The Company expenses all advertising costs as
incurred.

Earnings (Loss) Per Share (""EPS'')

Basic EPS is computed by dividing net income available to common shareholders by the weighted
average number of common shares, including exchangeable shares but excluding unvested restricted stock,
outstanding during the period. Diluted EPS is computed by dividing net income available to common
shareholders by the weighted average number of common and potential common shares outstanding during
the period, which includes the additional dilution related to conversion of stock options, unvested restricted
stock and common stock purchase warrants as computed under the treasury stock method and the common
shares issuable upon conversion of the outstanding convertible notes. For the years ended December 31, 2005
and 2004, outstanding stock options, unvested restricted stock, warrants, and shares issuable upon conversion
of the convertible notes are antidilutive because of net losses, and as such, their eÅect has not been included in
the calculation of basic or diluted net loss per share.

The following table presents the amounts used in computing the weighted average number of shares of

potentially dilutive common stock (in thousands):

Weighted average number of shares used in basic EPSÏÏÏÏÏÏÏÏÏÏÏÏ
EÅect of dilutive securities:

Years Ended December 31,
2005
2004
2003

67,098

83,387

88,499

Stock options and warrants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

10,763

Weighted average number of common shares and potentially dilutive
common stock used in diluted EPS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

77,861

83,387

88,499

Potentially dilutive securities excluded from computations because

they are antidilutive ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

8,654

36,300

48,392

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss), a component of shareholders' equity, consisted of the

following at December 31 (in thousands):

2003

2004

2005

Accumulated unrealized gain (loss) on available-for-sale investments
Accumulated currency translation adjustment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

9
(816)

$ (24)
4,584

$ Ì
6,258

Accumulated other comprehensive income (loss) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$(807)

$4,560

$6,258

Recent Accounting Pronouncements

As of December 31, 2005, the Company accounted for stock-based compensation awards using the
intrinsic value measurement provisions of APB No. 25. Accordingly, no compensation expense is recorded for
stock options granted with exercise prices greater than or equal to the fair value of the underlying common
stock at the date of grant. On December 16, 2004, the Financial Accounting Standards Board (the ""FASB'')
issued SFAS No. 123 (revised 2004), Share-Based Payment (""SFAS No. 123(R)'') and in March 2005, the
SEC issued SAB No. 107 relating to the adoption of SFAS No. 123(R). SFAS No. 123(R) eliminates the
alternative of applying the intrinsic value measurement provisions of APB No. 25 to stock compensation
awards. Rather, SFAS No. 123(R) requires enterprises to measure the cost of services received in exchange
for an award of equity instruments based on the fair value of the award at the date of grant.

The Company adopted SFAS No. 123(R) eÅective January 1, 2006, using the ModiÑed Prospective
Application Method and the Black-Scholes fair value option-pricing model. Under this method,
SFAS No. 123(R) is applied to new awards and to awards modiÑed, repurchased, or cancelled after the
eÅective date. Additionally, compensation cost for the portion of awards for which the requisite service has not
been rendered (such as unvested options) that are outstanding as of the date of adoption will be recognized as
the remaining requisite services are rendered. The compensation cost relating to unvested awards at the date of
adoption was based on the fair value at the date of grant of those awards as calculated for pro forma
disclosures under SFAS No. 123, Stock-Based Compensation.

The Company expects that the adoption of SFAS No. 123(R) will impact its Ñnancial results in the
future. As of December 31, 2005, the Company has unamortized stock-based compensation expense of
$3.0 million, of which $1.9 million is expected to be expensed in 2006. However, this amount does not reÖect
any expense associated with equity awards that are expected to be granted to employees in 2006. Management
is currently reviewing its alternatives for granting equity-based awards and, while the Company expects to
continue granting equity-based awards to its employees, the type and amount of award is still under
consideration. Accordingly, the overall eÅect of adopting this new standard on the Ñnancial results for 2006
has not yet been quantiÑed. The actual eÅects of adopting SFAS No. 123(R) will be dependent on numerous
factors including, but not limited to, the number of options granted in the future, the assumed and actual
award forfeiture rate, and the accounting policies adopted concerning the method of recognizing the fair value
of awards over the requisite service period.

In March 2005 the FASB issued FASB Interpretation (""FIN'') 47, Accounting for Conditional Asset
Retirement Obligations. This clariÑes the term ""conditional asset retirement obligation'' as used in
SFAS No. 143, Accounting for Asset Retirement Obligations, and provides guidance to ensure consistency in
recording legal obligations associated with long-lived tangible asset retirements. The adoption of FIN 47 did
not have a material eÅect on the Company's Ñnancial position, cash Öows or results of operations.

In May 2005 the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement
of Accounting Principles Board Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting

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Changes in Interim Financial Statements (""SFAS No. 154''). SFAS No. 154 changes the requirements for,
the accounting for, and reporting of, a change in accounting principle. Previously, voluntary changes in
accounting principles were generally required to be recognized by way of a cumulative eÅect adjustment
within net income during the period of the change. SFAS No. 154 requires retrospective application to prior
periods' Ñnancial statements, unless it is impracticable to determine either the period-speciÑc eÅects or the
cumulative eÅect of the change. SFAS No. 154 is eÅective for accounting changes made in Ñscal years
beginning after December 15, 2005; however, the statement does not change the transition provisions of any
existing accounting pronouncements.

In June 2005, the FASB issued StaÅ Position No. FAS 143-1, Accounting for Electronic Equipment
Waste Obligations Pursuant to a European Union Directive, (""FSP No. 143-1''). The European Union issued
a directive to its member states to adopt legislation regulating the collection, treatment, recovery and disposal
of electrical and electronic waste equipment. The directive distinguished between ""new waste'' and ""historical
waste.'' FSP No. 143-1 provides guidance concerning the accounting for historical waste and states that the
obligation associated with historical waste qualiÑes as an asset retirement obligation to be accounted for in
accordance with SFAS No. 143, Accounting for Asset Retirement Obligations, and FIN No. 47, Accounting
for Conditional Asset Retirement Obligations. The Company has certain of its components that must comply
with this new directive but at this time cannot quantify the impact to its Ñnancial results, as many of the
European Union member states have not Ñnalized legislation.

In November 2005 the FASB issued StaÅ Position No. FAS 115-1 and FAS 124-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, (""FSP No. 115-1''). FSP
No. 115-1 provides accounting guidance for identifying and recognizing other-than-temporary impairments of
debt and equity securities, as well as cost method investments in addition to disclosure requirements. FSP
No. 115-1 is eÅective for reporting periods beginning after December 15, 2005, and earlier application is
permitted. This new pronouncement will be eÅective in 2006 and the Company does not believe that adoption
of FSP No. 115-1 will have a material eÅect on its Ñnancial position, cash Öows or results of operations.

NOTE 4 SHORT-TERM INVESTMENTS

As of December 31, 2005, the Company held no short-term investments. As of December 31, 2004, the

Company's short-term investments consisted of the following (in thousands):

Amortized
Cost
Basis

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Commercial paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
U.S. government and agency securitiesÏÏÏÏÏÏÏÏÏÏ
Asset-backed securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Corporate notes and bonds ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 1,294
18,026
2,515
12,442

Total short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$34,277

Ì
$ 3
Ì
Ì

$ 3

Ì
$ (9)
(2)
(16)

$(27)

Fair Value

$ 1,294
18,020
2,513
12,426

$34,253

Any realized gains (losses) for the years ended December 31, 2005, 2004 and 2003 were not signiÑcant.

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NOTE 5 ACCOUNTS RECEIVABLE, NET

A summary of accounts receivable is as follows (in thousands):

December 31,

2004

2005

Trade accounts receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Unbilled receivablesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Government funding pass-through ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Advance billings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$23,737
6,770
4,015
102

$14,547
12,340
8,476
19,894

Allowance for doubtful accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

34,624
(1,439)

55,257

(193)

Accounts receivable, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$33,185

$55,064

Unbilled receivables represent amounts where the Company has recognized revenue in advance of the
contractual billing terms. The increase in the balance at December 31, 2005, is due to revenue recognized
based on percentage of completion accounting for the Red Storm contract in excess of contractual billing
milestones and a receivable with non-standard payment terms. Advance billings represent billings made based
on contractual terms for which no revenue is recognized. The increase in the advanced billings balance as of
December 31, 2005 is due to billings made to two customers; in one case based on a milestone agreement with
a U.S. government customer and in another case for maintenance services that will not be performed until
2006 and 2007.

The Company makes estimates of allowances for potential future uncollectible amounts related to current
period revenue of products and services. The allowance for doubtful accounts is an estimate that considers
actual facts and circumstances of individual customers and other debtors, such as Ñnancial condition and
historical payment trends. Management evaluates the adequacy of the allowance utilizing a combination of
speciÑc identiÑcation of potentially problematic accounts and identiÑcation of accounts that have exceeded
payment terms.

The decrease in the allowance for doubtful accounts during 2005 was related to management's decision to
write oÅ certain aged receivables that had previously been fully provided for in the allowance for doubtful
accounts.

NOTE 6

INVENTORY

A summary of inventory is as follows (in thousands):

December 31,

2004

2005

Components and subassemblies ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Work in process ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Finished goods ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$24,615
19,541
27,365

$10,706
8,314
48,692

$71,521

$67,712

At December 31, 2005 and 2004, all Ñnished goods inventory was located at customer sites pending
acceptance. At December 31, 2005 and 2004, $33.2 million and $13.8 million, respectively, was related to a
single customer. Revenue for 2005, 2004, and 2003 includes $2.1 million, $498,000, and $316,000, respec-
tively, from the sale of refurbished inventory recorded at a zero cost basis. In 2005, the amount consisted
mainly of the sale of a refurbished Cray T3E supercomputer, one of the Company's legacy systems.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

During 2005, the Company wrote oÅ $5.8 million of inventory, primarily related to the Cray X1E and
Cray XD1 product lines. During 2004, the Company wrote oÅ $8.5 million of inventory, primarily related to
the Cray X1 product line.

NOTE 7 PROPERTY AND EQUIPMENT, NET

A summary of property and equipment is as follows (in thousands):

December 31,

2004

2005

Land ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
BuildingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Furniture and equipmentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Computer equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Leasehold improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

131
9,590
8,971
66,305
3,854

131
9,638
14,161
70,704
3,046

Accumulated depreciation and amortizationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

88,851
(51,976)

97,680
(66,388)

Property and equipment, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 36,875

$ 31,292

Depreciation expense for 2005, 2004 and 2003 was $17.9 million, $15.7 million, and $15.8 million,

respectively.

NOTE 8 SERVICE INVENTORY, NET

A summary of service inventory is as follows (in thousands):

Service inventory ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accumulated depreciationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 29,899
(26,309)

$ 26,201
(22,916)

Service inventory, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

3,590

3,285

December 31,

2004

2005

NOTE 9 GOODWILL AND INTANGIBLE ASSETS

On April 1, 2004, the Company completed its acquisition of OctigaBay Systems Corporation. As part of
the acquisition, the Company recorded $38.8 million of goodwill. The following table provides information
about activity in goodwill for the years ended December 31, 2005 and 2004, respectively (in thousands):

2004

2005

Goodwill, at January 1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Acquisition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Foreign currency translation adjustments and otherÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$13,344
38,836
3,464

$55,644
Ì
1,195

Goodwill, at December 31 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$55,644

$56,839

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Intangible assets are as follows (in thousands):

Core technology acquired in OctigaBay acquisition, net of accumulated

amortization of $503,000 and $0 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Capitalized patent costs, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$6,197
1,097

$ Ì
1,113

Intangible assets, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$7,294

$1,113

Amortization expense for 2005, 2004 and 2003 was $1.6 million, $1.5 million, and $85,000, respectively.

December 31,

2004

2005

NOTE 10 DEFERRED REVENUE

Deferred revenue consisted of the following (in thousands):

Deferred product revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Deferred service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other deferred revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

December 31,

2004
(Restated)

$36,824
20,636
121

2005

$58,593
28,390
Ì

Total deferred revenueÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Less long-term deferred revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

57,581
(1,027)

86,983
(5,234)

Deferred revenue in current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$56,554

$81,749

As of December 31, 2005 and 2004, deferred revenue included $43.5 million and $23.6 million,
respectively, of deferred product revenue from a single customer. The Company expects to recognize this
amount as revenue in the latter part of 2006, upon fulÑllment of its contractual obligations.

NOTE 11 RESTRUCTURING AND SEVERANCE CHARGES

During 2005, the Company recognized restructuring charges of $4.8 million, which is included in
""Restructuring, Severance and Impairment'' on the accompanying Consolidated Statements of Operations,
net of adjustments for previously accrued amounts, mainly related to severance expenses for a worldwide
reduction in work force which was announced on June 27, 2005, and aÅected employees in operations, sales
and marketing. The restructuring charge was also increased for a December 12, 2005 announcement of a plan
to reduce full-time staÅ by another 65 employees, principally based in the Company's Burnaby, British
Columbia, Canada facility, based upon Company plans to increase research and development eÇciencies,
lower costs and integrate technology platforms, with the remainder occurring in Europe. The $4.8 million
charge does not include $4.9 million of core technology impairment charges, as described in Note 3 Ì
Summary of SigniÑcant Accounting Policies, Impairment of Long-Lived Assets.

During 2004, the Company recognized restructuring costs of $8.2 million in ""Restructuring, Severance
and Impairment'' on the accompanying Consolidated Statements of Operations, including a $196,000
compensation charge related to the modiÑcation of stock options for certain individuals aÅected by the
restructuring. The $196,000 charge was recorded directly to common stock. Substantially all of the
restructuring costs represent severance expenses for 131 terminated employees.

During 2003, the Company recorded a restructuring charge of $3.3 million in ""Restructuring, Severance
and Impairment'' on the accompanying Consolidated Statements of Operations relating to the termination of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

approximately 27 employees. The $3.3 million charge did not include $721,000 of multithreaded architecture
impairment charges.

Activity related to the Company's restructuring liability, included in ""Accrued Payroll and Related
Expenses'' on the accompanying Consolidated Balance Sheets, during the years ended December 31 is as
follows (in thousands):

2003

2004

2005

Balance, January 1 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Additional restructuring charge ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Payments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Adjustments to previously accrued amounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Foreign currency translation adjustmentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

866
3,298
(1,097)
Ì
2

$ 3,069
8,077
(6,420)
(91)
55

Total restructuring and severance liability, December 31ÏÏÏÏÏÏÏÏ
Less long-term restructuring and severance liability ÏÏÏÏÏÏÏÏÏÏ

3,069
Ì

4,690
Ì

$ 4,690
5,092
(5,724)
(255)
(221)

3,582
(362)

Current restructuring and severance liability ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 3,069

$ 4,690

$ 3,220

NOTE 12 COMMITMENTS AND CONTINGENCIES

The Company leases certain property and equipment under capital leases pursuant to master equipment
lease agreements and has non-cancelable operating leases for facilities. Under the master equipment lease
agreements, the Company had Ñxed asset balances of $7.5 million and $9.2 million as of December 31, 2005
and 2004, respectively, net of accumulated amortization of $5.4 million and $4.2 million, respectively.

The Company has recorded rent expense under leases for buildings or oÇce space accounted for as

operating leases in 2005, 2004 and 2003 of $4.1 million, $4.2 million, and $3.9 million, respectively.

As of December 31, 2005, the Company had no commitments past 2009, except for principal and interest
due on its convertible notes payable described in Note 14 Ì Convertible Notes Payable and Lines of Credit.
Minimum contractual commitments as of December 31, 2005, were as follows (in thousands):

Capital
leases

Operating
leases

Development
agreements

2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$128
31
Ì
Ì

Minimum contractual commitmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

159

$3,473
2,950
2,534
850

$9,807

$13,100
2,027
43
Ì

$15,170

Less amount representing interestÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(5)

Recorded capital lease obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$154

In its normal course of operations, the Company engages in development arrangements under which it
hires outside engineering resources to augment its existing internal staÅ in order to complete research and
development projects, or parts thereof. For the years ended December 31, 2005, 2004 and 2003, the Company
incurred $20.3 million, $16.8 million and $5.8 million, respectively, for such arrangements.

In October 2005, the Company renegotiated one of its facility leases to consolidate its Öoor space in its
headquarters in Seattle, Washington. The Company issued 70,000 shares of common stock to the landlord,
Merrill Place, LLC, for release from certain of its operating lease obligations. The Company charged $80,000,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

representing the fair value of the shares issued, to ""Restructuring, Severance and Impairment'' on the
accompanying Consolidated Statements of Operations for this issuance and related release from future
obligations.

Litigation

Beginning on May 25, 2005, the Company and certain current and former oÇcers were served with six
securities class action complaints Ñled in the U.S. District Court for the Western District of Washington. On
October 19, 2005, the Court ordered the consolidation of these cases into a single action, and on November 15,
2005, the plaintiÅs Ñled an amended consolidated complaint. PlaintiÅs seek to represent a class of purchasers
of the Company's securities from October 23, 2002, through May 9, 2005. The consolidated complaint alleges
federal securities law violations in connection with the issuance of various reports, press releases and
statements in investor telephone conference calls, and seeks unspeciÑed damages, interest, attorneys' fees,
costs and other relief. On December 19, 2005, the Company and the individual defendants moved to dismiss
the consolidated complaint, which motion is pending before the Court.

On June 3 and June 17, 2005, two shareholder derivative complaints were Ñled in the U.S. District Court
for the Western District of Washington against members of the Company's Board of Directors and certain
current and former oÇcers. The derivative plaintiÅs purport to act on the Company's behalf and assert
allegations substantially similar to those asserted in the putative class action complaints, as well as allegations
of breach of Ñduciary duty, abuse of control, gross mismanagement, waste of corporate assets, and unjust
enrichment. The complaints seek to recover on the Company's behalf unspeciÑed damages and seek attorney's
fees, costs and other relief. On August 29, 2005, the Court ordered the consolidation of these two cases into a
single action, and in October 2005 the Company was served with an amended derivative complaint containing
substantially identical allegations as in the earlier complaints. On November 18, 2005, the Company and the
individual defendants moved to dismiss the consolidated derivative complaint, which motions are pending
before the Court.

On January 9, 2006, the Company was served in two additional shareholder derivative complaints Ñled in
the Superior Court of the State of Washington for King County against members of the Company's Board of
Directors and certain current and former oÇcers and former directors. The derivative plaintiÅs purport to act
on the Company's behalf and assert allegations substantially similar to those asserted in the consolidated
derivative case previously Ñled in the U.S. District Court for the Western District of Washington. The
complaints seek to recover on the Company's behalf unspeciÑed damages and seek attorneys' fees, costs and
other relief. On February 15, 2006, the two state court derivative actions were consolidated by order of the
Court.

The Company is indemnifying its current and former oÇcers and directors named in each of the
foregoing actions, subject to an undertaking by each of them to repay the advanced fees and costs if it is
ultimately determined that he or she is not entitled to such indemniÑcation.

Other

From time to time the Company is subject to various other legal proceedings that arise in the ordinary
course of business or are not material to the Company's business. Additionally, the Company is subject to
income taxes in the U.S. and several foreign jurisdictions and, in the ordinary course of business, there are
transactions and calculations where the ultimate tax determination is uncertain. Although the Company
cannot predict the outcomes of these matters with certainty, the Company's management does not believe that
the disposition of these ordinary course matters will have a material adverse eÅect on the Company's Ñnancial
position, results of operations or cash Öows. Because the Company is not at this time able to determine the
probability of outcome or any estimable losses, no amounts have been accrued for potential settlements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

NOTE 13

INCOME TAXES

Under SFAS No. 109, Accounting for Income Taxes, income taxes are recognized for the amount of
taxes payable for the current year and for the impact of deferred tax assets and liabilities, which represent
consequences of events that have been recognized diÅerently in the Ñnancial statements under GAAP than for
tax purposes. As of December 31, 2005, the Company had federal net operating loss carryforwards of
approximately $288 million and gross federal research and experimentation tax credit carryforwards of
approximately $12.4 million. The net operating loss carryforwards will expire from 2010 through 2025, if not
utilized, and research and development tax credits will expire from 2006 through 2025, if not utilized.

Income (loss) before provision for income taxes consists of the following (in thousands):

Year Ended December 31,
2004
(Restated)

2003

2005

United StatesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
International ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 31,202
(10,161)

$ (92,654)
(55,612)

$(63,304)
(2,492)

Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 21,041

$(148,266)

$(65,796)

The provision (beneÑt) for income taxes related to operations consists of the following (in thousands):

Year Ended December 31,
2004
(Restated)

2003

2005

Current provision (beneÑt):

Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
State ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Foreign ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Total current provision ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

134
(44)
294

384

$ Ì $ Ì
128
644

Ì
581

581

772

Deferred provision (beneÑt):

(42,012)
(482)
(97)

61,906
(3,466)
71

Ì
Ì
(2,260)

Total deferred provision (beneÑt)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(42,591)

58,511

(2,260)

Total provision (beneÑt) for income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$(42,207)

$59,092

$(1,488)

F-21

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

The following table reconciles the federal statutory income tax rate to the Company's eÅective tax rate:

Federal statutory income tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
State taxes, net of federal eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Impact of change in state rateÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Foreign taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
In-process research and development write-oÅ ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Permanent diÅerences ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Foreign tax credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and development tax credit ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
EÅect of change in valuation allowance on deferred tax assets

2003

35.0%
2.2
(1.4)
(5.2)
Ì
Ì
Ì
(5.3)
1.2
(227.1)

2004
(Restated)

(35.0)%
(2.4)
Ì
(0.3)
10.6
3.9
(0.3)
(1.0)
(0.1)
64.5

EÅective income tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(200.6)%

39.9%

2005

(35.0)%
(3.1)
Ì
1.0
Ì
1.5
Ì
(2.1)
(0.4)
35.8

(2.3)%

Deferred income taxes reÖect the net tax eÅects of temporary diÅerences between the tax bases of assets
and liabilities and the corresponding Ñnancial statement amounts, operating loss, and tax credit carryforwards.
SigniÑcant components of the Company's deferred income tax assets and liabilities are as follows (in
thousands):

December 31,

2004
(Restated)

2005

Assets
Current:

InventoryÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accrued compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Deferred service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

2,714
2,731
1,452

Gross current deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Valuation allowanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

6,897
(6,848)

Net current deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Long-Term:

Property and equipment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Research and experimentation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net operating loss carryforwards ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Accrued restructuring charge ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

1,724
6,681
88,826
801
568

2,840
1,876
684

5,400
(5,377)

709
12,447
115,110
764
576

Gross long-term deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Valuation allowanceÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

98,600
(97,931)

129,606
(129,031)

Net long-term deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

Total net deferred tax assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

669

718

575

598

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

December 31,

2004
(Restated)

2005

Liabilities
Current:

Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(173)

Long-Term:

Core technology intangible asset ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(2,028)
(179)

Gross long-term deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(2,207)

Total deferred tax liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(2,380)

Net deferred tax asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ (1,662)

Net current deferred tax asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net non-current deferred tax asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

(124)
(1,538)

Net deferred tax asset (liability) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ (1,662)

Ì
Ì

598

23
575

598

The 2004 net current deferred tax liability of $124,000 is included in ""Other Accrued Liabilities'' on the
accompanying Consolidated Balance Sheets, while the 2005 net current deferred tax asset of $23,000 is
included in ""Prepaid Expenses and Other Current Assets'' of the same statement.

In September 2004, as a result of substantial losses during the year and based on revised projections
indicating continued challenging operating results, the Company established the valuation allowance of
$58.9 million. In the fourth quarter of 2003, management determined that, based on its most recent operating
performance and its expected future performance, the Company was more likely than not able to utilize
certain of its U.S.-based deferred tax assets and therefore reduced the valuation allowance by approximately
$58.0 million. A summary of the changes to the valuation allowance on deferred tax assets for the years ended
December 31, 2005, 2004 and 2003 was an increase of $29.6 million, an increase of $96.7 million, and a
decrease of $58.0 million, respectively.

Undistributed earnings of the Company's foreign subsidiaries are considered to be permanently rein-
vested; accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon
repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to both
U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the
various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is
not practicable due to the complexities associated with this hypothetical calculation.

NOTE 14 CONVERTIBLE NOTES PAYABLE AND LINES OF CREDIT

In December 2004 the Company issued $80 million aggregate principal amount of 3.0% Convertible
Senior Subordinated Notes due 2024 (""Notes'') in a private placement pursuant to Rule 144A under the
Securities Act of 1933, as amended. These unsecured Notes bear interest at an annual rate of 3.0%, payable
semiannually on June 1 and December 1 of each year through the maturity date of December 1, 2024.

The Notes are convertible, under certain circumstances, into the Company's common stock at an initial
conversion rate of 207.2002 shares of common stock per $1,000 principal amount of Notes, which is equivalent
to an initial conversion price of approximately $4.83 per share of common stock (subject to adjustment in
certain events). Upon conversion of the Notes, in lieu of delivering common stock, the Company may, at its
discretion, deliver cash or a combination of cash and common stock.

F-23

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

The Notes are general unsecured senior subordinated obligations, ranking junior in right of payment to
the Company's existing and future senior indebtedness, equally in right of payment with the Company's
existing and future indebtedness or other obligations that are not, by their terms, either senior or subordinated
to the Notes and senior in right of payment to the Company's future indebtedness that, by its terms, is
subordinated to the Notes. In addition, the Notes are eÅectively subordinated to any of the Company's
existing and future secured indebtedness to the extent of the assets securing such indebtedness and structurally
subordinated to the claims of all creditors of the Company's subsidiaries.

Holders may convert the Notes during a conversion period beginning with the mid-point date in a Ñscal
quarter to, but not including, the mid-point date (or, if that day is not a trading day, then the next trading day)
in the immediately following Ñscal quarter, if on each of at least 20 trading days in the period of 30 consecutive
trading days ending on the Ñrst trading day of the conversion period, the closing sale price of the Company's
common stock exceeds 120% of the conversion price in eÅect on that 30th trading day of such period. The
""mid-point dates'' for the Ñscal quarters are February 15, May 15, August 15 and November 15. Holders may
also convert the Notes if the Company has called the Notes for redemption or, during prescribed periods, upon
the occurrence of speciÑed corporate transactions or a fundamental change, in each case as described in the
indenture governing the Notes. As of December 31, 2004 and 2005, none of the conditions for conversion of
the Notes were satisÑed.

The Company may, at its option, redeem all or a portion of the Notes for cash at any time on or after
December 1, 2007, and prior to December 1, 2009, at a redemption price of 100% of the principal amount of
the Notes plus accrued and unpaid interest plus a make whole premium of $150.00 per $1,000 principal
amount of Notes, less the amount of any interest actually paid or accrued and unpaid on the Notes prior to the
redemption date, if the closing sale price of the Company's common stock exceeds 150% of the conversion
price for at least 20 trading days in the 30-trading day period ending on the trading day prior to the date of
mailing of the redemption notice. On or after December 1, 2009, the Company may redeem for cash all or a
portion of the Notes at a redemption price of 100% of the principal amount of the Notes plus accrued and
unpaid interest. Holders may require the Company to purchase all or a part of their Notes for cash at a
purchase price of 100% of the principal amount of the Notes plus accrued and unpaid interest on December 1,
2009, 2014, and 2019, or upon the occurrence of certain events provided in the indenture governing the Notes.

In connection with the issuance of the Notes, the Company incurred $3.4 million of issuance costs, which
primarily consisted of investment banker fees, legal and other professional fees. These costs are being
amortized using the eÅective interest method to interest expense over the Ñve-year period from December
2004 through November 2009. A total of $676,000 was amortized into interest expense during 2005. The
unamortized balance of these costs of $2.7 million as of December 31, 2005, is included in ""Other Non-
current Assets'' on the accompanying Consolidated Balance Sheets.

Lines of Credit

On May 31, 2005, the Company entered into a Senior Secured Credit Agreement with Wells Fargo
Foothill, Inc. (""the Credit Agreement''), providing for a two-year revolving line of credit for up to
$30.0 million. The credit line replaces the Company's previous line of credit with Wells Fargo Bank, N.A. The
Credit Agreement provides support for the Company's existing letters of credit while permitting the Company
to use previously restricted cash of $11.4 million and permitting additional cash advances, subject to a
borrowing base composed of (a) up to $20.0 million based on 100% of the Company's maintenance service
revenue for the trailing six-month period and (b) up to $10.0 million based on 85% of eligible accounts
receivable, as deÑned in the Credit Agreement, subject to other limitations provided in the Credit Agreement.
As of December 31, 2005, the Company was eligible to use all $30.0 million of the credit line, which was
reduced by the amount of outstanding letters of credit at that date, or $11.3 million, to arrive at the calculated
borrowing base as of that date of approximately $18.7 million. As of February 1, 2006, outstanding letters of

F-24

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

credit were reduced from $11.3 million to $1.4 million, eÅectively increasing the calculated borrowing base to
$28.6 million; as of February 6, 2006, the calculated borrowing base was reduced by another $2.8 million to
$25.8 million as the credit line was used to support a forward currency contract on a speciÑc sales contract.
See Note 20 Ì Subsequent Events, below. The Credit Agreement provides for interest on a performance-
based formula, contains covenants to maintain or achieve certain Ñnancial performance standards and is
collateralized by all of the Company's assets and pledges of the stock of its subsidiaries.

As of December 31, 2005, the Company had met all but one of its covenants on the credit line, and
received a waiver from Wells Fargo Foothill, Inc. for the applicable covenant. The Company also renegotiated
this covenant for the remainder of the agreement, which reduces the risk of future violation of this same
covenant. In connection with the initiation of the line of credit, the Company was obligated to pay a closing fee
of 2.5% of the maximum amount of the credit line, or $750,000, and other fees and costs customary for such
transactions. Half of the closing fee was paid at closing and half is payable one year from closing. These costs
have been capitalized and are being amortized over the two-year life of the Credit Agreement. The
indebtedness under the Credit Agreement constitutes senior indebtedness under the indenture governing the
Company's outstanding convertible senior subordinated notes issued in December 2004. As of December 31,
2005, the Company had not drawn upon the credit facility.

In connection with the Credit Agreement, the Company issued the lender a four-year warrant to
purchase 200,000 shares of its common stock, with an exercise price of $1.65 per share, the closing price of its
common stock on the date the warrant was issued. Using the Black-Scholes pricing model, the fair value of
the warrant was estimated at $219,000 and is also being amortized over the two-year life of the Credit
Agreement, along with the fees described above. A total of $1.3 million in fees was capitalized in connection
with the line of credit which has been recorded in ""Other Non-current Assets'' on the accompanying
Consolidated Balance Sheets. As of December 31, 2005, $962,000 is the unamortized balance, with $332,000
included in interest expense during 2005.

The Company's $25.0 million revolving line of credit with Wells Fargo Bank, N.A. expired on April 29,
2004. Subsequent to April 29, 2004, the Company was granted extensions of the line of credit through
December 1, 2004, with no material changes to the terms and conditions. Subsequent to December 1, 2004,
the Company negotiated a $15.0 million secured credit facility with Wells Fargo Bank, N.A. which was used
only to support outstanding letters of credit. At December 31, 2004, the Company had $11.4 million of
outstanding letters of credit. The Company was required to maintain cash and short-term investment balances
at least equal to the outstanding letters of credit. As such, the Company designated $11.4 million of its cash as
restricted cash at December 31, 2004.

NOTE 15 SHAREHOLDERS' EQUITY

Common Stock:

In the Ñrst quarter of 2003, the Company completed a public oÅering of
8,480,000 shares of newly issued common stock, and an additional 145,000 shares of common stock from
certain selling shareholders, at a public oÅering price of $6.20 per share. The Company received from the
oÅering, after underwriting discount and selling expenses, net proceeds of $49.1 million. The Company used
the net proceeds for general corporate purposes.

On April 1, 2004, the Company issued 7,560,885 shares of its common stock and 4,840,421 exchangeable
shares in connection with the acquisition of OctigaBay Systems Corporation. See Note 18 Ì OctigaBay
Acquisition.

Exchangeable Shares: Shares of exchangeable stock were issued by one of the Company's Nova Scotia
subsidiaries in connection with the April 2004 acquisition of OctigaBay Systems Corporation (""OctigaBay'').
Exchangeable stock is, as nearly as practicable, the economic equivalent of the Company's common stock.
Through the provisions of the exchangeable stock and related acquisition documents, holders of the

F-25

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

exchangeable stock have the right to exchange such stock for the Company's common stock on a one-for-one
basis. Holders also have the right to receive the same dividends and distributions paid on the Company's
common stock and the right to participate in certain liquidation events on a pro rata basis with holders of the
Company's common stock. Holders of exchangeable stock do not have the right to vote, however, as holders of
the Company's common stock. All remaining shares of exchangeable stock outstanding on December 31,
2005, were exchanged for an equivalent number of shares of the Company's common stock in January 2006.

Preferred Stock: The Company has 5,000,000 shares of undesignated preferred stock authorized, and

no shares of preferred stock outstanding.

Shareholder Warrants: At December 31, 2005, the Company had outstanding and exercisable warrants

to purchase an aggregate of 5,634,049 shares of common stock, as follows:

Shares of
Common Stock

Exercise Price
per share

Expiration
Date of Warrants

524
294,117
200,000
5,139,408

5,634,049

$6.00
$4.50
$1.65
$2.53

May 21, 2006
September 3, 2006
May 30, 2009
June 21, 2009

Restricted Stock:

In the fourth quarter of 2005, the Company issued an aggregate of 1,965,000 shares
of restricted stock to certain executives and management employees from the Company's 2004 Long Term
Equity Compensation Plan. These shares will become fully vested on June 30, 2007. The Company has
recorded a deferred compensation charge of $2.8 million for the issuance of these shares, and will recognize
compensation expense ratably over the 18-month vesting period. The Company recorded $70,000 for
amortization of deferred compensation on these shares in December 2005.

Stock Option Plans: As of December 31, 2005, the Company had Ñve active stock option plans that
provide for option grants to employees, directors and others. Options granted to employees under the
Company's option plans generally vest over four years or as otherwise determined by the plan administrator;
however, options granted during 2005 were generally granted with full vesting on or before December 31,
2005, in order to avoid additional expense related to the options under the implementation of
SFAS No. 123(R). Options to purchase shares expire no later than ten years after the date of grant.

On December 20, 2005, the Company announced a stock option repricing for certain outstanding options
as of that date, the purpose of which was to reduce the number of new options needed for grant at the same
time, since the Company had a limited number of shares available for such grant. A total of 1,274,260 options
with original exercise prices from $3.63 to $8.53 per share were repriced to an exercise price of $1.49 per share,
all of which were fully vested at the time of repricing. Per the requirements of FIN No. 44, Accounting for
Certain Transactions Involving Stock Compensation, the stock option modiÑcation resulted in variable stock
option accounting from the date of repricing until the end of the year; however, because the closing price of
the Company's common stock on December 31, 2005, was less than the re-grant price, no compensation
expense was recorded.

Twice during 2005, the Board of Directors approved the acceleration of the vesting of all unvested
outstanding stock options previously granted to employees and executive oÇcers under the Company's stock
option plans which exceeded certain exercise price thresholds. In March 2005 the threshold for accelerated
vesting was all options with a per share exercise price of $2.36 or higher (the market price of the Company's
common stock on the date of the change), while in May 2005 the threshold was all options with a per share
exercise price of $1.47 or greater (the market price of the Company's common stock on the date of the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

change). This acceleration resulted in options to acquire approximately 4.6 million shares of the Company's
common stock becoming immediately exercisable. Options granted to consultants and to non-employee
directors were not accelerated. All other terms and conditions applicable to outstanding stock option grants,
including the exercise prices and numbers of shares subject to the accelerated options, were unchanged. The
acceleration resulted in a charge to income of approximately $1.1 million related to the deferred compensation
of previously unvested options granted as part of the OctigaBay acquisition in April 2004. The acceleration
eliminates future compensation expense that the Company would have recognized in its statement of
operations with respect to these options upon the adoption of SFAS No. 123(R) on January 1, 2006, which
requires expensing of stock options over the service period in which they vest.

In connection with a restructuring plan announced in June 2005, the Company amended the stock option
grants for certain terminated employees to extend the exercise period of vested stock options, which is
normally three months from the date of termination. No compensation expense was recorded as the fair
market value of the Company's stock (the closing market price of the Company's stock on the date of the
change) was less than the respective stock option exercise prices.

A summary of the Company's stock option activity and related information follows:

Outstanding Options

Exercisable Options

Options
Outstanding

Weighted
Average
Exercise
Price

Options
Exercisable

Weighted
Average
Exercise
Price

Balance, January 1, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

13,380,602

$4.52

6,811,975

$5.36

Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
ExercisedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Canceled ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

1,637,465
(2,759,187)
(118,748)

Balance, December 31, 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

12,140,132

4,019,830
(875,856)
(999,715)

Balance, December 31, 2004 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

14,284,391

5,114,270

(89,180)
(1,308,901)

Balance, December 31, 2005(a) ÏÏÏÏÏÏÏÏÏÏÏÏÏ

18,000,580

Available for grant at December 31, 2005 ÏÏÏÏÏ

733,419

9.63
4.37
4.07

5.23

4.59
3.23
5.52

5.16

2.14
1.56
4.15

4.14

7,380,453

$5.14

8,857,598

$5.01

17,982,045

$4.14

(a) The weighted average exercise price of outstanding options at December 31, 2005 includes the impact of

the 2005 repricing of 1,274,260 options, as described above.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Outstanding and exercisable options by price range as of December 31, 2005, are as follows:

Outstanding Options

Exercisable Options

Range of Exercise
Prices Per Share

$ 0.26 Ó $ 1.00
$ 1.01 Ó $ 2.00
$ 2.01 Ó $ 3.00
$ 3.01 Ó $ 4.00
$ 4.01 Ó $ 6.00
$ 6.01 Ó $ 8.00
$ 8.01 Ó $11.00
$11.01 Ó $13.69

Number
Outstanding

386,452
4,281,445
3,318,953
3,912,043
1,566,132
2,904,209
1,050,426
580,920

$ 0.26 Ó $13.69

18,000,580

Weighted
Average
Remaining
Life (Years)

9.4
7.7
5.9
5.2
2.2
3.3
4.8
7.1

5.5

Weighted
Average
Exercise
Price

$ 0.92
$ 1.55
$ 2.54
$ 3.71
$ 5.16
$ 7.10
$ 8.90
$11.18

$ 4.14

Number
Exercisable

386,452
4,281,445
3,318,953
3,911,661
1,559,960
2,892,542
1,050,426
580,606

17,982,045

Weighted
Average
Exercise
Price

$ 0.92
$ 1.55
$ 2.54
$ 3.71
$ 5.16
$ 7.10
$ 8.90
$11.18

$ 4.14

In accordance with FIN 44, the unamortized intrinsic value of unvested options assumed in the April
2004 acquisition of OctigaBay is included in deferred compensation. The Company measured this intrinsic
value based on the number of options granted and the diÅerence between the converted exercise price of the
options and the fair value of the underlying common stock-based on the quoted price of the Company's
common stock at the date the options were assumed. The deferred compensation has been amortized over the
requisite service periods. Allocation of this acquisition-related deferred compensation expense to the operating
categories for years ended December 31 is as follows (in thousands):

2003

2004

2005

Research and development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Sales and marketing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Total acquisition-related compensation expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ Ì $ 5,068
2,837
3,229
$ Ì $11,134

Ì
Ì

$3,444
579
13
$4,036

Employee Stock Purchase Plan:

In 2001, the Company established an Employee Stock Purchase Plan
(""2001 ESPP''), which received shareholder approval in May 2002. The maximum number of shares of the
Company's common stock that employees could acquire under the 2001 ESPP is 4,000,000 shares. Eligible
employees are permitted to acquire shares of the Company's common stock through payroll deductions not
exceeding 15% of base wages. The purchase price per share under the 2001 ESPP was the lower of (a) 85% of the
fair market value of the Company's common stock at the beginning of each three month offering period, or (b) the
fair market value of the common stock at the end of each three month offering period. As of December 31, 2005
and 2004, 1,850,131 and 1,048,889 shares, respectively, had been issued under the 2001 ESPP.

As of the purchase period that began on December 16, 2005, the Company has amended the purchase
price per share in order to avoid additional expense that would otherwise be recorded under the SFAS 123(R)
rules. For purchase periods commencing on or after that date, the purchase price per share under the 2001
ESPP will be 95% of the closing market price on the fourth business day after the end of each oÅering period.

NOTE 16 BENEFIT PLANS

401(k) Plan

The Company has a retirement plan covering substantially all U.S. employees that provides for voluntary
salary deferral contributions on a pre-tax basis in accordance with Section 401(k) of the Internal Revenue

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

Code of 1986, as amended. Prior to 2005, the Company matched 25% of employee contributions each
calendar year, comprised of a 12.5% match of employee contributions in cash 45 days after each quarter and a
12.5% match determined annually by the Board of Directors and payable in cash or common stock of the
Company. The Company eliminated its matching obligation as of June 30, 2005. The Company's 2005, 2004,
and 2003 matching contribution expenses were $795,000, $1.6 million, and $1.3 million, respectively.

NOTE 17 SEGMENT INFORMATION

SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information (""SFAS 131''),
establishes standards for reporting information about operating segments and for related disclosures about
products, services and geographic areas. Operating segments are identiÑed as components of an enterprise
about which separate discrete Ñnancial information is available for evaluation by the chief operating decision-
maker, or decision-making group, in making decisions regarding allocation of resources and assessing
performance. Cray's chief decision-maker, as deÑned under SFAS 131, is the Chief Executive OÇcer. During
2003, 2004, and 2005, Cray had one operating segment.

Product and service revenue and long-lived assets classiÑed by major geographic areas are as follows (in

thousands):

United States

Other
Countries

Total

For the year ended December 31, 2003:
Product revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$155,941

Service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 38,117

Long-lived assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 44,348

$19,063

$175,004

$23,841

$ 61,958

$ 3,875

$ 48,223

United States

Canada

Other
Countries

Total

For the year ended December 31, 2004 (Restated):
Product revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 86,067

352

$ 9,482

$ 95,901

Service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 34,800

$ 1,297

$13,851

$ 49,948

Long-lived assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 54,306

$51,792

$ 5,338

$111,436

For the year ended December 31, 2005:
Product revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$104,274

213

$47,611

$152,098

Service revenue ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 33,377

$ 1,542

$14,034

$ 48,953

Long-lived assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 50,410

$44,311

$ 5,944

$100,665

Revenue attributed to foreign countries are derived from sales to external customers. Revenue derived
from U.S. government agencies or commercial customers primarily serving the U.S. government, and
therefore under their control, totaled approximately $111.2 million, $107.8 million, and $175.4 million in 2005,
2004 and 2003, respectively. In 2005 and 2003, one customer, Oak Ridge National Laboratory, contributed
approximately 18% and 11% of total revenue, respectively. In 2004, one customer, Sandia National
Laboratories, accounted for 27% of total revenue.

NOTE 18 OCTIGABAY ACQUISITION

On April 1, 2004, the Company completed the acquisition of OctigaBay, a privately-held company
located in Burnaby, British Columbia. The acquisition was accounted for as a purchase, pursuant to the

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

requirements of SFAS No. 141, Business Combinations. The Company paid $14,925,000 in cash and issued
7,560,885 shares of Cray common stock and 4,840,421 exchangeable shares. The Company also assumed
outstanding OctigaBay stock options exercisable for 740,722 shares of Cray common stock. Of the total shares
issued and reserved, 1,861,000 shares were not included in the purchase price calculation because they
represented repurchaseable shares that were earned over the repurchase period. OctigaBay was a development
stage company and was in the process of developing an innovative high-performance computing system. The
fair value of the in-process research and development (""IPR&D'') and the core technology was estimated
using the income approach, which reÖects the net present value of the projected cash Öows expected to be
generated by the products incorporating the in-process technology. The discount rate applicable to the cash
Öows of the products reÖected the estimated stage of completion and other risks inherent in the project. The
discount rate used in the valuation of IPR&D was 24.5%. The fair value of IPR&D was estimated to be
$43.4 million with an estimated cost to complete of $8.0 million. The in-process technology was substantially
completed in 2004. The IPR&D fair value was expensed in April 2004. The purchased intangibles consisted of
core technology and were to be amortized over Ñve years. However, as described above, the Company wrote
oÅ the unamortized balance of the core technology intangible asset late in 2005, after performing an
impairment analysis as required by SFAS No. 144. The allocation of the purchase price was as follows (in
thousands):

Fair value of net tangible assets acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Core technology ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
In-process research and development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
GoodwillÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net assets acquiredÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$10,521
6,700
43,400
38,836
$99,457

The Company recorded deferred compensation of $12.4 million resulting from retention agreements with
key OctigaBay personnel and $2.2 million from existing stock options assumed in the OctigaBay acquisition.
The retention agreements expired in November 2005, although the retention agreements for three employees
were terminated at the end of 2004, and the related deferred compensation of approximately $4.7 million was
immediately recognized. The assumed stock options were accelerated in 2005 with the rest of the applicable
groups of stock options, as described in Note 15 Ì Shareholders' Equity, and resulted in a charge to income of
approximately $1.1 million related to the deferred compensation of previously unvested options granted as part
of the OctigaBay acquisition.

NOTE 19

INTEREST INCOME (EXPENSE)

The detail of interest income (expense) for the years ended December 31, 2005, 2004 and 2003 is as

follows (in thousands):

2003

2004

2005

Interest income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ
Net interest income (expense) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$657
(213)
$444

$666
(301)
$365

741
$
(4,203)
$(3,462)

Interest income is earned by the Company on overnight balances, which are invested in short-term debt

securities.

Interest expense in 2005 consists of $2.4 million for interest on the $80 million Notes, $1.0 million of
amortization of all associated fees capitalized for attainment of the line of credit and issuance of the Notes,
and $765,000 in interest and fees on the line of credit with Wells Fargo Foothill, Inc.

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)

NOTE 20 SUBSEQUENT EVENTS

On February 6, 2006, the Company entered into a forward contract for 14,994,000 (British pound
sterling) as a cash Öow hedge on the foreign currency exposure related to a sales contract denominated in
British pound sterling. This sales contract is expected to be billed in milestones based on the Company
meeting contractual and product delivery commitments. The forward contract matures in April 2006 and the
Company plans to rollover the forward contract for amounts yet to be collected until the underlying
transactions (milestone cash payment from the customer) have been completed, which is expected to be
December 2006. The Company has an approved hedging policy which requires speciÑc designation of
transactions to be hedged. This forward contract was designated as a cash Öow hedge on the speciÑc sales
contract. As a result of entering into the forward contract, the availability under the line of credit with Wells
Fargo Foothill, Inc. was reduced by $2.8 million.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
Cray Inc.

We have audited the accompanying consolidated balance sheet of Cray Inc. and subsidiaries as of
December 31, 2005, and the related consolidated statements of operations, shareholders' equity and
comprehensive income (loss), and cash Öows for the year then ended. These Ñnancial statements are the
responsibility of the company's management. Our responsibility is to express an opinion on these Ñnancial
statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the Ñnancial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements. An
audit also includes assessing the accounting principles used and signiÑcant estimates made by management, as
well as evaluating the overall Ñnancial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.

In our opinion, the consolidated Ñnancial statements referred to above present fairly, in all material
respects, the Ñnancial position of Cray Inc. and subsidiaries as of December 31, 2005, and the results of their
operations and their cash Öows for the year ended December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America.

Our audit was conducted for the purpose of forming an opinion on the 2005 basic consolidated Ñnancial
statements taken as a whole. The Ñnancial statement schedule listed in the index at Item 15(a)(2) is
presented for purposes of additional analysis and is not a required part of the basic consolidated Ñnancial
statements. This schedule, for one year ended December 31, 2005, has been subjected to the auditing
procedures applied in the audit of the 2005 basic consolidated Ñnancial statements and, in our opinion, is fairly
stated in all material respects in relation to the 2005 basic consolidated Ñnancial statements taken as a whole.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the eÅectiveness of Cray Inc. and subsidiaries' internal control over Ñnancial reporting
as of December 31, 2005, based on criteria established in Internal Control Ì Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated
March 15, 2006, expressed an unqualiÑed opinion on management's assessment of the eÅectiveness of internal
control over Ñnancial reporting and an unqualiÑed opinion on the eÅectiveness of internal control over Ñnancial
reporting.

/s/ PETERSON SULLIVAN PLLC

Seattle, Washington
March 15, 2006

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Cray Inc.
Seattle, Washington

We have audited the accompanying consolidated balance sheet of Cray Inc. and subsidiaries (the
""Company'') as of December 31, 2004, and the related consolidated statements of operations, shareholders'
equity and comprehensive income (loss), and cash Öows for each of the two years in the period ended
December 31, 2004. Our audits also included the Ñnancial statement schedule for each of the two years in the
period ended December 31, 2004, listed in the Index at Item 15. These Ñnancial statements and Ñnancial
statement schedule are the responsibility of the Company's management. Our responsibility is to express an
opinion on these Ñnancial statements and Ñnancial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the Ñnancial statements are free of material misstatement. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements,
assessing the accounting principles used and signiÑcant estimates made by management, as well as evaluating
the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, such consolidated Ñnancial statements present fairly, in all material respects, the Ñnancial
position of Cray Inc. and subsidiaries at December 31, 2004 and 2003, and the results of their operations and
their cash Öows for the years then ended, in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such Ñnancial statement schedule, when considered in relation
to the basic consolidated Ñnancial statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.

As discussed in Note 2, the accompanying Ñnancial statements as of and for the year ended Decem-

ber 31, 2004, have been restated.

Seattle, Washington
March 31, 2005
(April 20, 2006 as to the eÅects of the restatement discussed in Note 2)

/s/ DELOITTE & TOUCHE LLP

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Schedule II Ì Valuation and Qualifying Accounts
December 31, 2005

Description

Balance at
Beginning
of Period

Additions
Charged
to Expense

Deductions

Balance at
End of
Period

Year ended December 31, 2003:
Allowance for doubtful accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$1,098

Warranty accrual ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$5,599

Year ended December 31, 2004:
Allowance for doubtful accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$1,125

Warranty accrual ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ 655

Year ended December 31, 2005:
Allowance for doubtful accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$1,439

Warranty accrual ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ

$ Ì

$113

$380

$373

$ Ì

$165

$ Ì

(86)(1)

$1,125

$(5,324)(2)

$ 655

(59)(1)

$1,439

$ (655)(2)

$ Ì

$(1,411)(1)

$ 193

$ Ì (2)

$ Ì

(1) Represents uncollectible accounts written oÅ, net of recoveries.

(2) Represents warranty work performed on the T90 product line, and related reduction of the warranty

accrual.

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CRAY ANNUAL MEETING
JUNE 6, 2006 Ì 10:00 A.M.
411 First Avenue South
Seattle, WA 98104-2860

CORPORATE HEADQUARTERS
Cray Inc.
411 First Avenue South
Suite 600
Seattle, WA 98104-2860
206-701-2000
206-701-2500 fax

OTHER PRINCIPAL OFFICES
1050 Lowater Road
Chippewa Falls, WI 54729-0080

1340 Mendota Heights Road
Mendota Heights, MN 55120-1128

INTERNET
E-Mail
info@cray.com

Website
www.cray.com

LEGAL COUNSEL
Stoel Rives LLP
Seattle, WA

INDEPENDENT PUBLIC
ACCOUNTANTS
Peterson Sullivan PLLC
Seattle, WA

STOCK MARKET INFORMATION
Cray Inc. common stock is traded
on NASDAQ National Market
System under the symbol CRAY.

EQUAL OPPORTUNITY
Cray is an equal opportunity
employer.

Investor Information

BOARD OF DIRECTORS
Stephen C. Kiely
Chairman, Cray Inc.
Chairman, Stratus
Technologies Inc.

John B. Jones, Jr.
Private Investor

Kenneth W. Kennedy, Jr.
John and Ann Doerr
University Professor of
Computational Engineering,
Rice University

Frank L. Lederman
Private Investor

Sally G. Narodick
Private Investor

Daniel C. Regis
Managing Director
Digital Partners

Stephen C. Richards
Private Investor

Peter J. Ungaro
President
and Chief Executive OÇcer
Cray Inc.

EXECUTIVE OFFICERS
Peter J. Ungaro
President
and Chief Executive OÇcer

Brian C. Henry
Executive Vice President
and Chief Financial OÇcer

Christopher Jehn
Vice President

Kenneth W. Johnson
Senior Vice President,
General Counsel
and Corporate Secretary

Steven L. Scott
Senior Vice President
and Chief Technology
OÇcer

Jan C. Silverman
Senior Vice President

Margaret A. Williams
Senior Vice President

SHAREHOLDER SERVICES
Mellon Investor Services LLC, our
transfer agent and registrar, can
help you with a variety of
shareholder-related services
including:

‚ Change of address
‚ Lost stock certiÑcates
‚ Transfer of stock to another

person

‚ Additional administrative

services

‚ Account consolidation
Mellon Investor Services LLC
Shareholder Relations
P. O. Box 3315
South Hackensack, NJ 07606

85 Challenger Road
RidgeÑeld Park, NJ 07660
www.melloninvestor.com/isd
Telephone: 800-522-6645
TDD for Hearing Impaired:
800-231-5469
Foreign Shareholders:
201-329-8660
TDD Foreign Shareholders:
201-329-8354

AVAILABLE INFORMATION
Our Annual Report on Form 10-K,
our other SEC reports and filings,
our Code of Business Conduct,
Corporate Governance Principles,
the charters of our Board
committees and other governance
documents and information are
available on our website,
www.cray.com, under ""Investors.''
You may also obtain a copy of our
Form 10-K filed with the SEC and
other company information,
without charge, by writing or
calling:
Cray Inc.
Investor Relations
411 First Avenue S., Suite 600
Seattle, WA 98104-2860
Telephone: 866-729-2729
Shareholders of record who receive
more than one copy of this annual
report can contact our transfer
agent and arrange to have their
accounts consolidated.
Shareholders who own Cray stock
through a brokerage account can
contact their broker to request
consolidation of their accounts.

2005 Annual Report Notice of 2006 Annual Meeting and Proxy StatementCray Inc. 411 First Avenue S., Suite 600 Seattle, WA 98104-2860 USA