-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RKk8jNQ+MOLakOj6Dhcwjss1vkRNYsTOfgq9nD+GmuzhcO2Zg5nYdSxy7oOysfEm q+HLRuZUyKd+Ky7EdtYGeg== 0000891020-01-500295.txt : 20020410 0000891020-01-500295.hdr.sgml : 20020410 ACCESSION NUMBER: 0000891020-01-500295 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CRAY INC CENTRAL INDEX KEY: 0000949158 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 930962605 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26820 FILM NUMBER: 1788280 BUSINESS ADDRESS: STREET 1: 411 FIRST AVE SOUTH STREET 2: SUITE 600 CITY: SEATTLE STATE: WA ZIP: 98104-2860 BUSINESS PHONE: 2067012000 MAIL ADDRESS: STREET 1: 411 FIRST AVE SOUTH STREET 2: SUITE 600 CITY: SEATTLE STATE: WA ZIP: 98104-2860 FORMER COMPANY: FORMER CONFORMED NAME: TERA COMPUTER CO \WA\ DATE OF NAME CHANGE: 19950809 10-Q 1 v77177e10-q.txt FORM 10-Q QUARTER ENDED SEPTEMBER 30, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ...... to ...... . Commission file number 0-26820 CRAY INC. (Exact name of registrant as specified in its charter) WASHINGTON 93-0962605 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 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 [X] No [ ] As of November 10, 2001, 42,111,021 shares of the Company's Common Stock, par value $0.01 per share, were outstanding. CRAY INC. AND SUBSIDIARIES TABLE OF CONTENTS
Page No. -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets as of December 31, 2000 And September 30, 2001 3 Condensed Consolidated Statements of Operations for the Three And Nine Months Ended September 30, 2000 and 2001 4 Condensed Consolidated Statement of Shareholders' Equity for the Nine Months Ended September 30, 2001 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2000 and 2001 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk 24 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 24
2 CRAY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
December 31, September 30, 2000 2001 ------------ ------------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 4,626 $ 4,306 Restricted cash 761 459 Accounts receivable 25,159 31,870 Inventory, net 23,637 18,291 Prepaid expenses and other assets 2,835 3,330 --------- --------- Total current assets 57,018 58,256 Property and equipment, net 25,535 26,835 Service spares, net 21,139 13,710 Goodwill and intangible assets, net 29,578 24,370 Other assets 2,923 3,074 --------- --------- TOTAL $ 136,193 $ 126,245 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 16,247 $ 9,386 Accrued payroll and related expenses 12,028 10,655 Accrued loss on purchase commitment 6,006 2,486 Other accrued liabilities 6,574 6,236 Deferred revenue 17,666 14,548 Current portion of warranty reserves 17,996 9,079 Current portion of obligations under capital leases 349 209 Current portion of term loan 2,136 Current portion of notes payable 8,357 274 --------- --------- Total current liabilities 85,223 55,009 Warranty reserves 14,285 9,896 Obligations under capital leases 284 74 Term loan payable 4,471 Notes payable 254 562 Shareholders' equity: Series A Preferred stock, par $.01 - Authorized, 3,125 shares; issued and outstanding, 3,125 shares 25,000 Common stock, par $.01 - Authorized, 100,000 shares; issued and outstanding, 35,250 and 42,104 shares 158,799 171,957 Accumulated deficit (122,524) (140,420) Accumulated other comprehensive loss: Cumulative currency translation adjustment (128) (304) --------- --------- 36,147 56,233 --------- --------- TOTAL $ 136,193 $ 126,245 ========= =========
See accompanying notes 3 CRAY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (in thousands, except per share data)
For the Three Months Ended For the Nine Months Ended September 30, September 30, 2000 2001 2000 2001 --------- --------- --------- --------- Revenue: Product $ 10,404 $ 9,124 $ 37,097 $ 45,333 Service 23,284 20,252 47,608 62,213 --------- --------- --------- --------- Total revenue 33,688 29,376 84,705 107,546 --------- --------- --------- --------- Operating expenses: Cost of product revenue 7,017 5,996 24,259 24,777 Cost of service revenue 11,409 11,116 23,699 29,780 Research and development 13,272 13,211 31,620 40,398 Marketing and sales 4,397 5,276 7,987 14,859 General and administrative 1,645 1,937 4,643 6,320 Restructuring charges 1,284 1,284 Amortization of goodwill and intangible assets 1,675 1,772 3,350 5,318 --------- --------- --------- --------- Total operating expenses 39,415 40,592 95,558 122,736 --------- --------- --------- --------- Loss from operations (5,727) (11,216) (10,853) (15,190) Other income (expense), net 114 1,105 615 (255) Interest income (expense), net (484) (209) (1,203) (1,490) --------- --------- --------- --------- Loss before income taxes (6,097) (10,320) (11,441) (16,935) Provision for income taxes 479 961 --------- --------- --------- --------- Net loss $ (6,097) $ (10,799) $ (11,441) $ (17,896) ========= ========= ========= ========= Net loss per common share, basic and diluted $ (0.18) $ (0.26) $ (0.36) $ (0.45) ========= ========= ========= ========= Weighted average shares outstanding, basic and diluted 33,401 41,529 31,500 40,130 ========= ========= ========= =========
See accompanying notes 4 CRAY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (unaudited) (in thousands)
Preferred Stock Common Stock Accumulated --------------------- -------------------- Other Number of Number of Accumulated Comprehensive Shares Amount Shares Amount Deficit Loss Total ----------- --------- --------- ---------- ----------- ------------- --------- BALANCE, January 1, 2001 35,250 $ 158,799 $ (122,524) $ (128) $ 36,147 Issuance of shares under Employee Stock Purchase Plan 349 644 644 Options issued for debt 225 225 Common stock issued in exchange for notes, net of issuance costs of $821 3,764 6,960 6,960 Common stock issued 1,147 2,500 2,500 Exercise of stock options 8 15 15 Warrants issued for services 26 26 Warrants issued for credit facility 123 123 Other comprehensive loss: Cumulative currency translation adjustment (833) (833) Net income 2,789 2,789 ----------- --------- ------- ---------- ----------- ------- --------- BALANCE, March 31, 2001 40,518 $ 169,292 $ (119,735) $ (961) $ 48,596 Common stock issued 600 930 930 Series A preferred stock issued to NEC 3,125 25,000 25,000 Common stock issued in exchange for notes 320 519 519 Other comprehensive income: Cumulative currency translation adjustment 17 17 Net loss (9,886) (9,886) ----------- --------- ------- ---------- ----------- ------- --------- BALANCE, June 30, 2001 3,125 $ 25,000 41,438 $ 170,741 $ (129,621) $ (944) $ 65,176 Issuance of shares under Employee Stock Purchase Plan 336 533 533 Issuance of shares under Employee 401k Plan 330 683 683 Other comprehensive income: Cumulative currency translation adjustment 640 640 Net loss (10,799) (10,799) ----------- --------- ------- ---------- ----------- ------- --------- BALANCE, September 30, 2001 3,125 $ 25,000 42,104 $ 171,957 $ (140,420) $ (304) $ 56,233 =========== ========= ======= ========== =========== ======= =========
See accompanying notes 5 CRAY INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands)
For the Nine Months Ended September 30, ------------------------------- 2000 2001 -------------- --------------- Operating activities Net loss $ (11,441) $ (17,896) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 10,195 10,455 Imputed interest expense 1,203 Amortization of goodwill and intangible assets 3,350 5,318 Beneficial conversion feature of notes payable 28 747 Non-cash warrant and option expense 328 374 Cash provided (used) by changes in operating assets and liabilities: Accounts receivable (17,951) (6,840) Inventory 5,558 10,265 Other assets (1,067) (756) Accounts payable 3,422 (6,861) Other accrued liabilities 7,945 (4,679) Accrued payroll and related expenses 5,376 (1,373) Warranty reserve (9,023) (13,306) Deferred revenue (3,118) -------------- --------------- Net cash used by operating activities (2,077) (27,670) Investing activities Purchases of spares (1,527) Cash used for acquisition (39,784) Purchases of property and equipment (4,168) (7,133) -------------- --------------- Net cash used by investing activities (43,952) (8,660) Financing activities Restricted cash 275 302 Related party (receivable)/payments (16) 129 Proceeds from term loan 7,500 Sale of common stock 25,386 5,305 Proceeds from line of credit 4,500 Proceeds from sale of preferred stock 25,000 Proceeds from exercise of warrants 8,868 Principal payments on notes (215) (1,700) Capital leases, net (442) (350) -------------- --------------- Net cash provided by financing activities 38,356 36,186 -------------- --------------- Effect of foreign exchange rate changes on cash and cash equivalents (176) Net decrease in cash and cash equivalents (7,673) (320) Cash and cash equivalents Beginning of period 10,069 4,626 -------------- --------------- End of period $ 2,396 $ 4,306 ============== =============== Supplemental disclosure of cash flow information: Cash paid for interest $ 198 $ 796 Non-cash investing and financing activities Inventory reclassed to fixed assets 4,633 Inventory reclassed to service spares 4,919 Fixed asset additions through notes payable 585 Note payable converted to common stock 8,300 Warranty reserve reclassed to service spares 1,901 Common stock issued for acquisition of assets 6,700
See accompanying notes 6 CRAY INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 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 footnotes 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/A for the fiscal year ended December 31, 2000. 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. ACQUISITION On April 1, 2000, the Company acquired certain assets of the Cray Research business unit operations from Silicon Graphics, Inc., and changed its name from Tera Computer Company to Cray Inc. With this acquisition, the Company changed from a development stage company with 125 employees (almost all located in Seattle, Washington), limited revenue and one product under development, to a company with nearly 900 employees located in over 20 countries, ongoing sales of supercomputer systems with several products under development, major manufacturing operations, an established service organization and substantial inventory. For these reasons, period to period comparisons that include periods prior to April 1, 2000, are not indicative of future results. 7 INVENTORY Inventory consisted of the following (in thousands):
December 31, September 30, 2000 2001 ------------ ------------- Components and subassemblies $ 14,884 $ 12,207 Work in process 10,148 7,565 Finished goods 936 942 Reserve for excess and obsolete (2,331) (2,423) -------- -------- $ 23,637 $ 18,291 ======== ========
COMPREHENSIVE LOSS The components of comprehensive loss are as follows:
Three months Nine months ended September 30, ended September 30, 2000 2001 2000 2001 ----------- --------- --------- --------- Net loss $ 6,097 $ 10,799 $ 11,441 $ 17,896 Foreign currency translation adjustment 640 (176) ----------- --------- --------- --------- Comprehensive loss $ 6,097 $ 10,159 $ 11,441 $ 18,072 =========== ========= ========= =========
SEGMENT INFORMATION Revenue from U.S. government agencies or commercial customers primarily serving the U.S. government totaled approximately $16.9 million and $53.8 million for the three and nine months ended September 30, 2001. The Company's significant operations outside the United States include sales and service offices in Europe, the Middle East and Africa (EMEA), Japan, and Asia Pacific (Australia, Korea, China and Taiwan). Intercompany transfers between operating segments and geographic areas are primarily accounted for at prices that approximate arm's length transactions. 8 Geographic revenue and long-lived assets related to operations were as follows (in thousands):
United Asia Three months ended September 30, 2001: States EMEA Japan Pacific Total ------- ------- ------- ------- ------- Product revenue $ 8,403 $ 38 $ 427 $ 256 $ 9,124 ======= ======= ======= ======= ======= Service revenue $12,837 $ 5,772 $ 1,278 $ 365 $20,252 ======= ======= ======= ======= ======= Nine months ended September 30, 2001: Product revenue $41,160 $ 3,490 $ 427 $ 256 $45,333 ======= ======= ======= ======= ======= Service revenue $40,212 $16,383 $ 4,033 $ 1,585 $62,213 ======= ======= ======= ======= ======= As of September 30, 2001: Long lived assets $61,963 $ 2,593 $ 2,371 $ 1,062 $67,989 ======= ======= ======= ======= =======
United Asia Three months ended September 30, 2000: States EMEA Japan Pacific Total ------- ------- ------- ------- ------- Product revenue $ 9,516 $ 888 $10,404 ======= ======= ======= ======= ======= Service revenue $15,536 $ 4,046 $ 2,534 $ 1,168 $23,284 ======= ======= ======= ======= ======= Nine months ended September 30, 2000: Product revenue $35,506 $ 1,471 $ 120 $37,097 ======= ======= ======= ======= ======= Service revenue $39,860 $ 4,046 $ 2,534 $ 1,168 $47,608 ======= ======= ======= ======= ======= As of September 30, 2000: Long lived assets $84,187 $ 319 $ 475 $ 154 $85,135 ======= ======= ======= ======= =======
NET LOSS PER SHARE Net loss per share is computed on the basis of the weighted average number of common shares outstanding. Because outstanding stock options, warrants and other common stock equivalent shares are antidilutive, their effect has not been included in the calculation of the net loss per share. RECLASSIFICATIONS Certain prior-year amounts have been reclassified to conform with the current-year presentation. 9 RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized, but are reviewed annually for impairment or more frequently if impairment indicators arise. Separable intangible assets that have finite lives will continue to be amortized over their useful lives. The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS No. 142 effective January 1, 2002. The Company is currently evaluating the effects that adoption of the provisions of SFAS No. 142 will have on its results of operations and financial position. As of September 30, 2001, the Company had goodwill and intangible assets, net of accumulated amortization, of approximately $24.4 million, which would be subject to the transitional provisions of SFAS No. 142. Amortization expense was $1.8 million and $5.3 million for the three and nine months ended September 30, 2001. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. This statement establishes accounting standards for recognition and measurement of a liability for an asset retirement obligation and the associated asset retirement cost. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of SFAS No. 143 to have a material effect on its financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Assets to Be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. It retains the fundamental provisions of SFAS No. 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001, with earlier application encouraged. The Company has not yet determined the impact of adopting SFAS No. 144 on its financial position or results of operations SUBSEQUENT EVENT On November 6, 2001, the Company raised $8.0 million from institutional investors in the form of convertible subordinated debentures and common stock purchase warrants. The debentures are convertible into common stock at $2.35 per share. During each three month period after February 6, 2002, up to 25% of principal amount of the debentures are also convertible on a cumulative basis at an alternate conversion price equal to 94% of the average of the seven lowest volume weighted average trading prices of the common stock during the 20 business days preceding each conversion. The debentures bear interest at the rate of 5% per year, payable semiannually in stock or cash at the 10 Company's option, and mature in three years, if not converted earlier. The Company may redeem the debentures at any time at 105% of the principal amount for the first six months and 110% of the principal amount after six months. The warrants cover 316,206 shares of common stock, are exercisable in cash only at $4.42 per share, and expire in three years. The Company has agreed to file a registration statement for the resale of the common shares issuable under the debentures and warrants. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS The information set forth in this Item 2 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, as amended, and is subject to the safe harbor created by those sections. Factors that realistically could cause results to differ materially from those projected in the forward-looking statements are set forth under "Factors That Could Affect Future Results" beginning on page 16. The following discussion should also be read in conjunction with the Financial Statements and Notes thereto. OVERVIEW We design, develop, market and service high-performance computer systems, commonly known as supercomputers. We presently market three computer systems, the Cray SV1ex(TM) system, the Cray T3E(TM) system, and on an exclusive basis in North America the NEC SX-6 system which we have renamed under the Cray brand as the Cray SX-6 system. We also provide maintenance services to the world-wide installed base of these and earlier models of Cray computers and to the NEC systems installed in North America. We are developing memory enhancements to the Cray SV1ex system, and we are developing two new computer systems, the Cray MTA-2(TM), based on our multithreaded architecture system, and the Cray SV2(TM), which will combine the traditional performance strengths of our vector systems and the scalability strengths of our T3E system. We are refocusing our plans for the Cray SuperCluster(R), a highly parallel system utilizing commercial off the shelf components, to support higher potential value-added professional services for our customers. We have experienced net losses in each year of our operations. We incurred net losses of approximately $25.4 million in 2000, $34.5 million in 1999 and $19.8 million in 1998. For the nine months ended September 30, 2001 we had a net loss of $17.9 million. We recognize revenue from sales of our computer systems upon acceptance by the customer, although depending on sales contract terms, revenue may be recognized when title passes upon shipment or may be delayed until funding is certain. We recognize service revenue from the maintenance of our computer systems ratably over the term of each maintenance agreement. Factors that should be considered in evaluating our business, operations and prospects and that could affect our future results and financial condition are set forth below, beginning on page 16. - ------------- Cray and SuperCluster are federally registered trademarks of Cray Inc., and Cray T90, Cray T3E, Cray SV1, Cray SV1ex, Cray SV2, Cray MTA, and Cray MTA-2 are trademarks of Cray Inc. 11 RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001 With our acquisition of the Cray Research business unit from Silicon Graphics, Inc. ("SGI"), on April 1, 2000, period-to-period comparisons of our operating results that include periods prior to April 1, 2000, are not indicative of results for any future period. PRODUCT REVENUE. For the third quarter of fiscal 2001, product revenue decreased from $10.4 million to $9.1 million, compared to the third quarter of fiscal 2000. Third quarter 2001 revenue were adversely impacted by the delay in completing memory enhancements to the SV1ex system. We expect our product revenue to vary quarterly; in the last twelve months, our quarterly product revenue have ranged from $8.6 million to $27.6 million. See "Factors That Could Affect Our Future Results - Our Quarterly Performance May Vary Significantly and Could Cause Our Stock Price To Be Volatile." For the first nine months of fiscal 2001, product revenue increased to $45.3 million from $37.1 million, over the corresponding period of fiscal 2000. The increase is primarily due to the acquisition of the Cray Research business unit on April 1, 2000. Product revenue represented 31% and 42% of total revenue for the three months and nine months ended September 30, 2001, respectively. SERVICE REVENUE. Service revenue was $20.3 million and $62.2 for the three and nine months ended September 30, 2001, compared to $23.3 million and $47.6 million for the respective 2000 periods. 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, and are renewable upon expiration at the customer's election. The overall increase in service revenue for the nine months ended September 30, 2001, over the corresponding period in 2000 is due to the acquisition of the Cray product line and related service business. We expect service revenue to decline gradually over the next year or so as older systems are withdrawn from service and then to stabilize as our new systems are placed in service. Service revenue represented 69% and 58% of total revenue for the three months and nine months ended September 30, 2001, respectively. OPERATING EXPENSES. Our cost of product revenue was 66% and 55% of product revenue for the three months and nine months ended September 30, 2001, compared to 67% and 65% for the corresponding 2000 periods. Cost of product revenue was consistent for the third quarter of 2001 compared to the third quarter of 2000 primarily due to lower margin T3E product sales and lower volumes. Our cost of product revenue is expected to decrease as a percentage of product revenue in the fourth quarter of 2001 and the first half of 2002 as we enter into sales of our SV1ex product line, sell our T3E systems and build sales volume. Cost of product revenue was $6.0 million and $24.8 million for the three and nine months ended September 30, 2001, compared to $7.0 million and $24.3 million for the respective 2000 periods. Cost of service revenue was $11.1 million and $29.8 million for the three and nine months ended September 30, 2001, after utilization of $2.5 million and $11.3 million of warranty reserves for the 12 three and nine months ended September 30, 2001, compared to cost of service revenue of $11.4 million and $23.7 million for the respective 2000 periods. Cost of service revenue represented 55% and 48% of service revenue for the three months and nine months ended September 30, 2001, respectively. We expect our cost of service revenue, after application of warranty reserves, to increase in the fourth quarter of 2001 and in 2002 due to expected reduced application of the warranty reserves, reduced service revenue and slower reductions in service expense. Research and development expenses reflect our costs associated with the enhancements to the SV1 and T3E systems and the development of the MTA-2(TM) and SV2 systems, including related software development. These costs also include personnel expenses, allocated overhead and operating expenses, software, materials and engineering expenses, including payments to third parties. These costs are offset in part by governmental development funding. Net research and development expenses were $13.2 million and $40.4 million for the three and nine months ended September 30, 2001, compared to $11.4 million and $23.7 million for the respective 2000 periods. Government developmental funding was $3.2 million and $9.7 million for the three and nine months ended September 30, 2001, compared to $2.9 and $6.4 million for the respective 2000 periods. Net research and development expenditures represented 45% and 38% of total revenue for the three months and nine months ended September 30, 2001, respectively. We expect third party payments for non-recurring engineering expenses to decrease as we complete the development of the MTA-2 and SV-2 systems. Changes in research and development expenses primarily will depend on changes in engineering personnel and the level of governmental funding. Over time, with receipt of increased revenue from products currently under development, increased government funding and/or reductions in engineering expenses, we expect research and development expenses to decrease as a percentage of overall revenue. Marketing and sales expenses were $5.3 million and $14.9 million for the three and nine months ended September 30, 2001, compared to $4.4 million and $8.0 million for the respective 2000 periods. The increase over the 2000 periods was primarily due to increased staffing and infrastructure following the April 1, 2000 acquisition of the Cray Research business unit. We expect quarterly marketing and sales expenses to decrease somewhat in the fourth quarter of 2001 and in 2002. General and administrative expenses were $1.9 million and $6.3 million for the three and nine months ended September 30, 2001, compared to $1.6 million and $4.6 million for the respective 2000 periods. The increase over the 2000 periods was primarily due to increased staffing and infrastructure following the April 1, 2000 acquisition of the Cray Research business unit. We expect quarterly general and administrative expenses to increase slightly in the fourth quarter of 2001 and in 2002 as we complete our staffing. Restructuring charges were $1.3 million for the three and nine months ended September 30, 2001 compared to none for the respective 2000 periods. These charges are primarily for severance expenses related to the termination of approximately 50 employees in the third quarter of 2001. We incurred amortization expense of $1.8 million and $5.3 million for the three and nine months ended September 30, 2001, compared to $1.7 million and $3.4 million for the respective 2000 periods. Amortization expense relates to the goodwill and intangible assets from the acquisition of the Cray Research business unit on April 1, 2000. 13 OTHER INCOME (EXPENSE). Other income (expense) was $1.1 million and ($255,000) for the three and nine months ended September 30, 2001, compared to other income of $114,000 and $615,000 for the respective 2000 periods. The increase in other income and expense in both periods consisted primarily of realized gains and losses from the effects of foreign currency exchange rates. INTEREST INCOME (EXPENSE), NET. Interest income was $28,000 and $96,000 for the three and nine months ended September 30, 2001, compared to $63,000 and $664,000 for the respective 2000 periods. The decrease in both 2001 periods was due to lower average cash balances in 2001. Interest expense was $237,000 and $1.6 million for the three and nine months ended September 30, 2001, compared to $547,000 and $1.9 million for the respective 2000 periods. Interest expense for the third quarter of 2001 primarily related to equipment leases and our term loan. The third quarter of 2000 expense included a non-cash imputed interest charge of $484,000 relating to the acquisition note payable to SGI. The results for the 2001 nine months include a first quarter non-cash charge of $747,000 associated with the value of the conversion feature of certain investor promissory notes, and a $225,000 non-cash charge for the value of options issued in conjunction with certain investor promissory notes. The results for the 2000 nine months include $1.2 million relating to the acquisition note payable to SGI. We expect to incur additional non-cash interest charges associated with the financing completed in November 2001. TAXES. We made a provision of $479,000 and $961,000 for income taxes in foreign countries for the three and nine months ended September 30, 2001, respectively. NET LOSS. We had a net loss of $10.8 million for the third quarter of 2001 compared to a net loss of $6.1 million for the 2000 third quarter, primarily due to a decrease of $4.3 million in aggregate product and service revenue in the 2001 third quarter compared to the third quarter of 2000 and a $1.3 million restructuring charge recorded in the third quarter of 2001. To become profitable we need to increase our product revenue from the enhancements to our current products, our products under development and the Cray SX-6, and reduce our overall level of research and development expenses. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and accounts receivable totaled $36.6 million at September 30, 2001, compared to $30.5 million at December 31, 2000. Over that period, cash decreased slightly from $4.6 million to $4.3 million, while restricted cash balances, which serve as collateral for capital equipment loans and leases, decreased from $761,000 to $459,000. Net cash used by operating activities was $27.7 million for the nine months ended September 30, 2001, compared to $2.1 million used in the nine months ended September 30, 2000. For the nine months ended September 30, 2001, net operating cash was used primarily by decreases in our accounts payable, accrued liabilities, accrued payroll, and deferred revenue, and increases in our net loss and receivables, offset in part by depreciation and amortization expenses and reductions in inventory. Net cash used by investing activities was $8.7 million for the nine months ended September 30, 2001, compared to $44.0 million for the corresponding 2000 period. Net cash used by investing 14 activities for the 2001 period consisted primarily of $5.1 million spent on additional property, plant and equipment used primarily for computers and electronic test equipment, computer software and furniture and fixtures, $2.0 million for software license fees and $1.5 million for service spares. The significant cash used in the 2000 period was primarily for the Cray Research acquisition. Net cash provided by financing activities was $36.2 million for the nine months ended September 30, 2001, compared to $38.4 million for the nine months ended September 30, 2000. For the nine months ended September 30, 2001, we raised $3.4 million through the sale of common stock to two institutional investors, and raised $25 million through the sale of preferred stock to NEC. We also secured a $15 million credit facility of which we used $6.6 million as of September 30, 2001. Over the next twelve months our significant cash requirements will relate to operational expenses, primarily for personnel, inventory and third-party engineering services, and acquisition of capital goods. These expenses include our commitments to acquire components and manufacturing and engineering services. We expect that anticipated product sales, maintenance services and government funding of research and development expenses over the next twelve months, coupled with limitations on operating expenses and capital expenditures, will generate overall positive cash flow. At any particular time, given the high average selling price of our products, our cash position is affected by the timing of payment of product sales, receipt of prepaid maintenance revenue and receipt of government funding for research and development activities. In addition, delays in the completion of the SV1ex system, the development of the MTA-2 system, and in the availability of the SX-6 system for delivery in North America, all planned for the next three to six months, or delays in the SV2 development program, may require additional capital earlier than planned. While we believe our cash resources will be adequate for the next twelve months, we may need to raise additional equity and/or debt capital if we experience lower than anticipated product sales due to delays in product availability and general economic conditions or if we do not receive sufficient governmental support for our products and research activities. In addition we may raise additional funds to enhance our working capital position. Financings may not be available to us when needed or, if available, may not be available on satisfactory terms and may be dilutive to our shareholders. 15 FACTORS THAT COULD AFFECT FUTURE RESULTS The following factors should be considered in evaluating our business, operations and prospects and may affect our future results and financial condition. LACK OF CUSTOMER ORDERS FOR OUR EXISTING SV1 AND T3E PRODUCTS AND OUR INABILITY TO SELL OUR PRODUCTS AT EXPECTED PRICES WOULD LIMIT OUR REVENUE AND OUR ABILITY TO BE PROFITABLE. We will depend on sales of our current products, the Cray SV1ex series and T3E systems, for significant product revenue in the fourth quarter of 2001 and the first half of 2002. To obtain these sales, we need to complete the development of the SV1ex system, which has been significantly delayed, and to assure our customers of product performance and our ability to service these products. Most of our potential customers already own or lease very high-performance computer systems. Some of our competitors may offer trade-in allowances or substantial discounts to potential customers, and we may not be able to match these sales incentives. We may be required to provide discounts to make sales or to provide lease financing for our products, which would result in a deferral of our receipt of cash for these systems. These developments would limit our revenue and resources and would reduce our ability to be profitable. OUR INABILITY TO OVERCOME THE TECHNICAL CHALLENGES OF COMPLETING THE DEVELOPMENT OF OUR SYSTEMS COULD CAUSE OUR BUSINESS TO FAIL. We expect that our success in 2002 and following years depends upon completing the development of the SV1ex, the MTA-2 and the SV2 systems. These development efforts are lengthy and technically challenging processes, and require a significant investment of capital, engineering and other resources. Delays in completing the design of the hardware components or software of these systems or in integrating the full systems would make it difficult for us to develop and market these systems. We are dependent on our vendors to manufacture components for our systems, and few companies can meet our design requirements. If our vendors are unable to manufacture our components to our design specifications on a timely basis, the completion of our products will be delayed. During the development process we have had, and in the future we may have, to redesign components because of previously unforeseen design flaws. We also may find flaws in our system software which require correction. Redesign work may be costly and cause delays in the development of these systems, and could make it more difficult for these systems to be successful as commercial products. LACK OF SALES OF THE SX-6 SYSTEM COULD DECREASE OUR REVENUE AND DELAY PROFITABILITY. We anticipate significant sales of the NEC SX-6 and successor systems in North America under the Cray brand in 2002 and beyond. These sales would be adversely affected if NEC does not complete timely the development of the SX-6 system, make it available for benchmarking or does not deliver timely the SX-6 system for sale in the North American market, currently scheduled for the second quarter of 2002, or if NEC does not develop a follow-on product to the SX-6. Supercomputers from Japan have not been available for sale in the United States since 1997, and there may be reluctance among traditional customers, such as governmental agencies and research organizations and industrial users, to purchase supercomputers from non-U.S. sources. In addition, we must appropriately place the SX-6 system within our own product line to avoid customer and market confusion. Competing successfully with NEC with respect to sales of the SX-6 system outside of North America will be difficult. 16 GENERAL ECONOMIC AND MARKET CONDITIONS COULD DECREASE OUR REVENUE, INCREASE OUR NEED FOR CASH AND DELAY PROFITABILITY. While most of our business is related to the government sector, which is relatively immune to short-term economic cycles, a slow-down in the overall U.S. and global economy and resultant decreases in capital expenditures likely would affect sales to our industrial customers. Cancellations or delays in purchases would decrease our revenue, increase our need for working capital and delay profitability. LACK OF GOVERNMENT SUPPORT FOR SUPERCOMPUTER SYSTEMS WOULD INCREASE OUR CAPITAL REQUIREMENTS AND DECREASE OUR ABILITY TO CONDUCT RESEARCH AND DEVELOPMENT. We have targeted U.S. and foreign government agencies and research laboratories as important sales prospects for all of our products. A few of these agencies fund a portion of our development efforts. The U.S. government historically has facilitated the development of, and has constituted a market for, new and enhanced very high-performance computer systems. Congressional action with respect to the 2002 budget has been delayed due to the events of September 11, 2001, and other events in Washington, D.C. The failure of U.S. and foreign government agencies to continue to fund these development efforts, due to lack of funding, change of priorities or for any other reason, or continued delays in funding, would cause us to increase our need for capital and reduce our research and development expenditures. IF THE U.S. GOVERNMENT PURCHASES FEWER SUPERCOMPUTERS, OUR REVENUE WOULD BE REDUCED. Historically, sales to the U.S. government have been a significant market for supercomputers. In the nine months ended September 30, 2001, approximately 50% of our revenue were derived from sales to various agencies and departments of the U.S. government. Sales to the U.S. government may be affected by factors outside our control, such as changes in procurement policies and budget considerations. If the U.S. government were to stop or reduce its use and purchases of supercomputers, our revenue would be reduced. PROPOSALS AND PURCHASES BASED ON THEORETICAL PEAK PERFORMANCE REDUCE OUR ABILITY TO MARKET OUR SYSTEMS. Our high-performance systems are designed to provide high actual sustained performance on difficult computational problems. Many of our competitors offer systems with higher theoretical peak performance numbers, although their actual sustained performance frequently is a small fraction of their theoretical peak performance. Nevertheless, many requests for proposals, primarily from governmental agencies in the U.S. and elsewhere, have criteria based on theoretical peak performance. Until these criteria are changed, we are foreclosed from bidding or proposing our systems on such proposals, which will limit our revenue potential. OUR RELIANCE ON THIRD-PARTY SUPPLIERS POSES SIGNIFICANT 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, flex circuits and power supplies, on a sole or limited source basis to third-party suppliers. We also use a contract manufacturer to assemble our SV1 and T3E components, and plan to do so for our MTA-2 and SV-2 systems also. We are exposed to substantial risks because of our reliance on these and other limited or sole source suppliers. For example: - if a reduction or interruption of supply of our components occurred, it could take us a 17 considerable period of time to identify and qualify alternative suppliers to redesign our products as necessary and to begin manufacture of the redesigned components; - if we were ever unable to locate a supplier for a component, we would be unable to assemble and deliver our products; - one or more suppliers may make strategic changes in their product lines, which may result in the delay or suspension of manufacture of our components or systems; and - some of our key suppliers are small companies with limited financial and other resources, and consequently may be more likely to experience financial difficulties than larger, well-established companies. We have experienced delays in obtaining circuit boards, integrated circuits and flex circuits on a timely basis from our suppliers, which have resulted in delays in the development of our products. ADDITIONAL FINANCINGS MAY BE DILUTIVE TO EXISTING SHAREHOLDERS. Over the next twelve months our significant cash requirements relate to operational expenses, primarily for personnel, inventory and third-party engineering services, and acquisition of capital goods. We expect to have positive cash flow from our anticipated product sales, maintenance services and government funding of research and development expenses over the next twelve months. We secured a $15 million credit facility in March 2001, we completed the NEC distribution agreement in the second quarter of 2001 at which time NEC invested $25 million in us, and we received $8 million in the November 2001 financing. At any particular time, given the high average selling price of our products, our cash position is impacted by the timing of particular product sales, receipt of prepaid maintenance and receipt of government funding of research and development activities. Delays in the completion of the SV1ex system, the development of the MTA-2 system, and in the availability of the SX-6 system for delivery in North America, all planned for the next three to six months, or delays in the SV2 development program, may require additional capital earlier than planned. While we believe our cash resources will be adequate for the next twelve months, we may need to raise additional equity and/or debt capital if we experience lower than anticipated product sales due to delays in product availability, general economic conditions and/or failure to receive sufficient governmental support for our products and research activities. In addition we may raise additional funds to enhance our working capital position. Financings may not be available to us when needed or, if available, may not be available on satisfactory terms and may be dilutive to our shareholders. FAILURE TO OBTAIN RENEWAL OF SERVICE CONTRACTS WILL REDUCE OUR REVENUE AND EARNINGS. 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. Over the past year, we have been performing maintenance services under existing Silicon Graphics maintenance contracts as a sub-contractor to Silicon Graphics; we have been successful in having almost all of these contracts assigned to us. As these contracts expire, however, we need to sell new maintenance service contracts to these customers. Revenue from service contracts have declined from approximately $125 million in 1999 to approximately $95 million in 2000 and are expected to further decline until new products are designed and sold. If customers do not renew their maintenance service contracts with us, our revenue and earnings will be reduced. 18 THE ABSENCE OF THIRD-PARTY APPLICATION SOFTWARE COULD MAKE IT MORE DIFFICULT FOR US TO SELL OUR SYSTEMS TO COMMERCIAL CUSTOMERS. To make sales in the automotive, aerospace, chemistry and other engineering and commercial markets, we must be able to attract independent software vendors to port their software application programs so that they will run on our systems. The relatively low volume of supercomputer sales makes it difficult for us to attract these vendors. We also modify and rewrite third-party software applications to run on our systems and so facilitate the expansion of our potential markets. There can be no assurance that we will be able to induce independent software vendors to rewrite their applications, or that we will successfully rewrite third-party applications for use on our systems. FAILURE TO OBTAIN CREDIT FACILITIES MAY RESTRICT OUR OPERATIONS. While we have obtained a $15 million secured credit facility based on domestic accounts receivables and maintenance revenue, we are seeking additional credit facilities of up to approximately $4 million, such as bank lines of credit, vendor credit and capitalized equipment lease lines. The absence of a consistent record of revenue and earnings makes obtaining such facilities more difficult; if we obtain such facilities, they may have high interest rates, contain restrictions on our operations and require security. Failure to obtain such credit facilities may limit our planned operations and our ability to acquire needed infrastructure and other capital items would reduce or eliminate our cash reserves and increase our need for capital. OUR QUARTERLY PERFORMANCE MAY VARY SIGNIFICANTLY AND COULD CAUSE OUR STOCK PRICE TO BE VOLATILE. One or a few system sales may account for a substantial percentage of our quarterly and annual revenue. This is due to the high average sales price of our products, particularly the Cray T3E system, and the expected high average sales prices for our MTA-2, SX-6 and SV2 systems, and the timing of purchase orders and product acceptances. Because a number of our prospective customers receive funding from the U.S. or foreign governments, the timing of orders from such customers may be subject to the appropriation and funding schedules of the relevant government agencies. The timing of orders and shipments also could be affected by other events outside our control, such as: - changes in levels of customer capital spending; - the introduction or announcement of competitive products; - the availability of components; - timing of the receipt of necessary export licenses; or - currency fluctuations and international conflicts or economic crises. Because of these factors, revenue, net income or loss and cash flow are likely to fluctuate significantly from quarter to quarter. THE COST OF SERVICE OF THE T90 INSTALLED BASE WILL REDUCE OUR EARNINGS. Some of the components in the T90 vector computers sold by Silicon Graphics before our acquisition of the operations of Cray Research have an unusually high failure rate. The cost of servicing the T90 19 computers exceeds the related service revenue. We are continuing to take action that commenced before the acquisition to address this problem, and have recorded a warranty reserve, with a balance of $19.0 million as of September 30, 2001, to provide for anticipated future losses on the T90 maintenance service contracts. OUR UNCERTAIN PROSPECTS FOR EARNINGS COULD CAUSE OUR STOCK PRICE TO DECLINE. While we have had a substantial increase in revenue with the acquisition of the business operations of Cray Research and have had two profitable quarters since that acquisition, whether we will achieve earnings on a consistent basis will depend on a number of factors, including: - our ability to market and sell the T3E and SX-6 systems, and complete the development of the SV1ex, MTA-2 and SV2 systems; - the level of revenue in any given period; - the cost of servicing the T90 installed base; - the terms and conditions of sale or lease for our products; and - our expense levels, particularly for research and development and manufacturing and service costs. IF WE CANNOT ATTRACT, RETAIN AND MOTIVATE KEY PERSONNEL, WE MAY BE UNABLE TO IMPLEMENT EFFECTIVELY OUR BUSINESS PLAN. Our success also depends in large part upon our ability to attract, retain and motivate highly skilled management, technical and marketing and sales personnel. Competition for highly skilled management, technical, marketing and sales personnel is intense, and we may not be successful in attracting and retaining such personnel. We have no employment contracts with any of our employees. A SUBSTANTIAL NUMBER OF OUR SHARES ARE ELIGIBLE FOR FUTURE SALE AND COULD DEPRESS MARKET PRICES OF OUR STOCK AND HINDER OUR ABILITY TO OBTAIN ADDITIONAL FINANCING. Sale of a substantial number of our shares of common stock in the public market or the prospect of sales could cause the market price of our common stock to decline. As of September 30, 2001, we had outstanding: - 42,103,680 shares of common stock; - 3,125,000 shares of Series A preferred stock convertible into 3,125,000 shares of common stock; - warrants to purchase 14,901,096 shares of common stock; - stock options to purchase an aggregate of 10,243,128 shares of common stock, of which 4,595,471 options were then exercisable. Almost all of our outstanding shares of common stock may be sold without substantial restrictions. All of the shares purchased under the warrants and exercisable options are available for sale in the public market, subject in some cases to volume and other limitations. The shares of common stock 20 underlying the Series A preferred stock are not available for public sale until May 2003. Sales in the public market of substantial amounts of our common stock, including sales of common stock issuable upon the exercise of warrants and options, could depress prevailing market prices for the common stock. Even the perception that sales could occur may impact market prices. The existence of outstanding warrants and options may prove to be a hindrance to our future equity financings. Further, the holders of the warrants and options may exercise them 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. 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 has delayed the shipment of our products. Delay or denial in the granting of any required licenses could make it more difficult to make sales to foreign customers, eliminating an important source of potential revenue. OUR STOCK PRICE MAY BE VOLATILE. The trading price of our common stock is subject to significant fluctuations in response to: - changes in analysts' estimates; - our future capital raising activities; - announcements of technological innovations by us or our competitors; and general conditions in our industry. The stock market has been and is subject to price and volume fluctuations that particularly affect the market prices for small capitalization, high technology companies like ourselves. IF WE ARE NOT ABLE TO KEEP UP WITH RAPID TECHNOLOGICAL CHANGE, OUR PRODUCTS WILL NOT BE COMPETITIVE. Our market is characterized by rapidly changing technology, accelerated product obsolescence and continuously evolving industry standards. Our success will depend upon our ability to enhance our current products, to complete development of the MTA-2 and the SV2 systems, to sell the SX-6 system, and to develop successor systems in the future. We will need to introduce new products and features in a timely manner to meet evolving customer requirements. We may not succeed in these efforts. Even if we succeed, products or technologies developed by others may render our products or technologies noncompetitive or obsolete. If we incur delays in developing our products or if such products do not gain broad market acceptance or become obsolete, our ability to develop and market our products will be reduced. 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 offered by our competitors, and we may not compete successfully over time against new entrants or innovative competitors at the lower end of the market. Periodic announcements by our competitors of new high-performance computer systems and price 21 adjustments may reduce customer demand for our products. Our competitors are established companies that are well known in the high-performance computer market, including IBM, Sun Microsystems, Compaq Computer, Hewlett-Packard, Silicon Graphics, NEC Corporation (outside of North America), Fujitsu and Hitachi. Each of these competitors has broader product lines and substantially greater research, engineering, manufacturing, marketing and financial resources than we do. We also compete with new entrants capitalizing on developments in parallel processing and increased computer performance through networking and clustering systems. Currently, these products are limited in applicability and scalability and can be difficult to program. A breakthrough in architecture or software technology could make parallel systems more attractive to potential customers. Such a breakthrough would impair our ability to sell our products and reduce our revenue. 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, non-disclosure 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 efforts 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. Although we are not a party to any present litigation disputing proprietary rights, third parties may assert intellectual property claims against us in the future. Such claims, if proved, could require us to pay substantial damages or redesign our existing products. Even meritless claims would require management attention and would cause us to incur significant expense to defend. 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 efforts may not be successful. OUR ABILITY TO BUILD SOME PRODUCTS IS LIMITED BY OUR AGREEMENT WITH SILICON GRAPHICS, WHICH MAY LIMIT OUR ABILITY TO COMPETE WITH SILICON GRAPHICS AND OTHER COMPANIES. The technology agreement through which we acquired and licensed patent, know-how and other intellectual property rights from Silicon Graphics contains restrictions on our ability to develop some products, including specified successors to the T3E system, and restrictions on the use of other technology, such as SGI's IRIX operating system in the SV2. IT MAY BECOME MORE DIFFICULT TO SELL OUR STOCK IN THE PUBLIC MARKET. Our common stock is listed for quotation on the Nasdaq National Market. To keep our listing on this market, Cray must meet Nasdaq's listing maintenance standards. If the bid price of our common stock falls below $1.00 for an extended period, or we are unable to continue to meet Nasdaq's listing maintenance standards for any other reason, our common stock could be delisted from the Nasdaq National Market. If our common stock were delisted, we likely would seek to list the common stock on 22 the Nasdaq SmallCap Market, the American Stock Exchange or on a regional stock exchange. Listing on such other market or exchange could reduce the liquidity for our common stock. If our common stock were not listed on the SmallCap Market or an exchange, trading of our common stock would be conducted in the over-the-counter market on an electronic bulletin board established for unlisted securities or directly through market makers in our common stock. If our common stock were to trade in the over-the-counter market, an investor would find it more difficult to dispose of, or to obtain accurate quotations for the price of, the common stock. A delisting from the Nasdaq National Market and failure to obtain listing on such other market or exchange would subject our securities to so-called penny stock rules that impose additional sales practice and market-making requirements on broker-dealers who sell or make a market in such securities. Consequently, removal from the Nasdaq National Market and failure to obtain listing on another market or exchange could affect the ability or willingness of broker-dealers to sell or make a market in our common stock and the ability of purchasers of our common stock to sell their securities in the secondary market. In addition, if the market price of our common stock falls below $5.00 per share, we may become subject to penny stock rules even if our common stock is still listed on the Nasdaq National Market. While the penny stock rules should not affect the quotation of our common stock on the Nasdaq National Market, these rules may further limit the market liquidity of our common stock and the ability of investors to sell our common stock in the secondary market. PROVISIONS IN OUR AGREEMENT WITH SILICON GRAPHICS MAKE IT MORE DIFFICULT FOR SPECIFIED COMPANIES TO ACQUIRE US. The terms of our purchase of the assets of Cray Research contain provisions restricting our ability to transfer the assets of Cray Research. Sales of these assets to Hewlett-Packard, Sun Microsystems, IBM, Compaq Computer, NEC or Gores Technology Group, or their affiliates, are prohibited until the earlier of March 31, 2003, or if Silicon Graphics were sold. PROVISIONS OF OUR ARTICLES AND BYLAWS COULD MAKE A PROPOSED ACQUISITION THAT IS NOT APPROVED BY OUR MANAGEMENT MORE DIFFICULT. Provisions of our restated articles of incorporation and restated bylaws could make it more difficult 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: - a staggered board of directors, so that only three or four of ten directors are elected each year; - removal of a director only in limited circumstances and only upon the affirmative vote of not less than two-thirds of the shares entitled to vote to elect directors; - the issuance of 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 affirmative vote of not less 23 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 defined as directors who have either served as a director since August 31, 1995 or were nominated to be a director by the continuing directors; - special voting requirements for mergers and other business combinations, unless the proposed transaction was approved by a majority of continuing directors; - special procedures must be followed to bring matters before our shareholders at our annual shareholders' meeting; and - special procedures must be followed in order for nominating members for election to our board of directors. WE DO NOT ANTICIPATE DECLARING ANY DIVIDENDS. We have never paid any dividends on our common stock and we intend to continue our policy of retaining any earnings to finance the development and expansion of our business. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For the quarter ended September 30, 2001, substantially all of our cash equivalents and marketable securities are held in money market funds or commercial paper of less than 90 days that is held to maturity. Accordingly, we believe that the market risk arising from our holdings of these financial instruments is minimal. We sell our products primarily in North America, Asia and Europe. As a result, our financial results could be affected 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 payment in foreign currencies and to the extent we do so, we are subject to foreign currency exchange risks. We plan on using forward currency contracts to minimize these risks. Our foreign maintenance contracts are paid in local currencies and provide a natural hedge against local expenses. To the extent that we wish to repatriate any of these funds to the United States, however, we are subject to foreign exchange risks. We do not hold any derivative instruments and have not engaged in hedging transactions. PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None 24 (b) Reports on Form 8-K A report on Form 8-K for an event of October 1, 2001, was filed on October 10, 2001, reporting the appointment of Michael P. Haydock as President and Chief Executive Officer of the Company under Item 5, "Other Events." A report on Form 8-K/A for an event of December 15, 2000, was filed on July 27, 2001 to amend a report on Form 8-K filed on January 4, 2001, reporting our promissory notes with two institutional investors under Item 5, "Other Events." ITEMS 1, 2, 3, 4 AND 5 OF PART II ARE NOT APPLICABLE AND HAVE BEEN OMITTED. SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CRAY INC. November 14, 2001 By: /s/ MICHAEL P. HAYDOCK Michael P. Haydock President and Chief Executive Officer /s/ KENNETH W. JOHNSON Kenneth W. Johnson Chief Financial Officer /s/ DOUGLAS C. RALPHS Douglas C. Ralphs Chief Accounting Officer 25 -----END PRIVACY-ENHANCED MESSAGE-----