UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the quarterly period ended
March 31, 2005

OR

For the transition period from            to

Commission file number 0-26820

411 First Avenue South, Suite 600
Seattle, WA 98104-2860
(206) 701- 2000

(Address of principal executive offices)
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed 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 file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

     As of May 6, 2005, 87,855,365 shares of the Company’s Common Stock, par value $0.01 per share, were outstanding.

TABLE OF CONTENTS

CRAY INC. AND SUBSIDIARIES

TABLE OF CONTENTS

Available Information

     Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and proxy statements filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act are available free of charge at our web site at www.cray.com as soon as reasonably practicable after we file electronically such reports with the SEC.

     Cray is a federally registered trademark of Cray Inc., and Cray X1, Cray X1E, Cray XT3 and Cray XD1 are trademarks of Cray Inc.

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CRAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes

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CRAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes

4

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

See accompanying notes

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CRAY INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes

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CRAY INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Basis of Presentation

     In the opinion of management, the accompanying condensed consolidated balance sheets and related condensed consolidated statements of operations, shareholders’ equity and cash flows have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. All adjustments considered necessary for fair presentation have been included. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

     In December 2004 the Company raised net proceeds of $76.6 million from the sale of convertible senior subordinated notes. During the three months March 31, 2005, the Company incurred a net loss of $21.0 million and used $44.2 million of cash in operating activities. Management expects to use significant working capital, particularly in the first half of 2005, primarily to fund growth in inventory until product shipments are made and acceptances and payments are received. Management’s plans project that the Company’s current cash resources and cash to be generated from operations in 2005 will be adequate for the next twelve months. If the Company were to experience a material shortfall in its plans, however, it would pursue additional initiatives to reduce costs further, including reductions in inventory purchases and commitments, and/or seek additional financing. There can be no assurance the Company will be successful in its efforts to achieve future profitable operations or generate sufficient cash from operations, or obtain additional funding in the event its financial resources became insufficient.

Principles of Consolidation

     The accompanying condensed consolidated financial statements include the accounts of Cray Inc. and its wholly-owned subsidiaries (“the Company”). All material intercompany accounts and transactions have been eliminated.

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 classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. All short-term investments are classified as available for sale and are recorded at fair value, based on quoted market prices; unrealized gains and losses are reflected in other comprehensive income.

Balance Sheet Details

     Net accounts receivable consisted of the following (in thousands):

Inventory consisted of the following (in thousands):

     Finished goods inventory represents inventory located at customer sites pending acceptance.

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     Revenue for the first quarter of 2005 includes $2.0 million from the sale of refurbished inventory recorded at a zero cost basis.

     In November 2004 the Financial Accounting and Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 151, Inventory Costs — an amendment to ARB No. 43, Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage), together referred to as unabsorbed manufacturing overhead, and requires that those items be recognized as current-period charges regardless of whether they meet the criterion set forth in ARB No. 43. This statement also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company adopted SFAS No. 151 effective January 1, 2005. The adoption of SFAS No. 151 did not have a material impact on the Company’s financial position or results of operations.

     Deferred revenue consisted of the following (in thousands):

     As of December 31, 2004, and March 31, 2005, deferred revenue included $23.6 million of deferred product revenue not expected to be realized for at least 12 months. The Company considers this balance to be a current liability as the customer has contractual cancellation rights.

Goodwill

     In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company does not amortize goodwill but instead tests it for impairment at least annually, and between annual tests if indicators of potential impairment exist, using a fair-value based approach. The Company performs its annual impairment test in January of each calendar year. Results of the January 2004 and January 2005 impairment tests did not indicate an impairment loss.

     The following table provides information about activity in goodwill for the period from January 1, 2005, to March 31, 2005 (in thousands):

     In connection with the acquisition of OctigaBay Systems Corporation in April 2004, the Company recognized an inside-basis deferred tax liability in the amount of $2.0 million. As this deferred tax liability reverses, goodwill is also adjusted by the same amount.

Line of Credit

     In December 2004 the Company negotiated a $15.0 million secured credit facility with Wells Fargo Bank which is used only to support outstanding letters of credit. As of December 31, 2004 and March 31, 2005, the Company had $11.4 million of outstanding letters of credit. The Company is required to maintain cash and short-term investment balances at least equal to the outstanding letters of credit. As such, the Company has designated $11.4 million of its cash as restricted cash at December 31, 2004 and March 31, 2005.

Comprehensive Loss

     The components of comprehensive loss are as follows (in thousands):

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Segment Information

     SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments and for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker, or decision-making group, in making decisions on allocating resources and assessing performance. Cray’s chief decision-maker, as defined under SFAS No. 131, is the Chief Executive Officer. As of March 31, 2005, Cray operated in one business segment: global sales and service of high performance computers.

     Product and service revenue from U.S. government agencies and customers primarily serving the U.S. government totaled approximately $20.1 million for the three months ended March 31, 2004, compared to $20.7 million for the three months ended March 31, 2005.

     The Company’s significant operations outside the Americas include sales and service offices in Europe, the Middle East and Africa (“EMEA”) and Japan, Australia, Korea, China and Taiwan (“Asia Pacific”). Intercompany transfers between operating segments and geographic areas are primarily accounted for at prices that approximate arm’s length transactions. Geographic revenue and long-lived assets related to operations were as follows (in thousands):

Earnings Per Share (“EPS”)

     Basic EPS is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted average number of common and common equivalent shares outstanding during the period, which includes the additional dilution related to conversion of stock options and common stock purchase warrants as computed under the treasury stock method. Because outstanding stock options and warrants are antidilutive, their effect has not been included in the calculation of the net loss per share for the three months ended March 31, 2004, and 2005.

     For the three months ended March 31, 2004, common stock equivalents of 19.9 million shares were antidilutive and not included in computing diluted EPS. For the three months ended March 31, 2005, common stock equivalents of 35.6 million shares were antidilutive and not included in computing diluted EPS.

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Restructuring Costs

     The Company did not record or adjust any existing restructuring charges in the three months ended March 31, 2004. During the three months ended March 31, 2005, the Company recorded an adjustment of $236,000 related to the reversal of restructuring charges previously recognized during the second half of 2004 as the Company’s estimate of charges were higher than the actual costs incurred. This credit was offset by additional restructuring charges of approximately $21,000.

     The restructuring liability included within accrued payroll and related expenses on the accompanying condensed consolidated balance sheets as of December 31, 2004, and March 31, 2005, is from restructuring charges recognized during the second half of 2004. The liability activity related to restructuring during the three months ended March 31, 2004, and 2005, was as follows (in thousands):

Taxes

     The Company recorded a tax benefit of $2.2 million for the three months ended March 31, 2004 compared to a tax expense of $120,000 for the three months ended March 31, 2005. The expense recorded for the three months ended March 31, 2005, was related to foreign income taxes payable and state income taxes payable.

Notes Payable

     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 3.00%, 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.

     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 effectively 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 fiscal 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 fiscal quarter, if on each of at least 20 trading days in the period of 30 consecutive trading days ending on the first trading day of the conversion period, the closing sale price of the Company’s common stock exceeds 120% of the conversion price in effect on that 30th trading day of such period. The “mid-point dates” for the fiscal 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, up