Edgar Filing: CRAY INC

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 1

FORM 10-K/A
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

[ ] 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, WASHINGTON 98104-2860
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (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

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 past 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 [ ]

Indicate by check mark if disclosure of delinquent filers 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 definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.

The aggregate market value of the Common Stock held by non-affiliates of
the Registrant as of March 19, 2001 was approximately $65,600,000, based upon
the last sale price of $1.78 reported for such date on the Nasdaq National
Market System.

As of March 19, 2001, there were 39,375,541 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
May 16, 2001, are incorporated by reference into Part III.

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CRAY INC.

FORM 10-K/A
FOR FISCAL YEAR ENDED DECEMBER 31, 2000

INDEX

PAGE
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PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
Item E.O. Executive Officers of the Company........................... 17

PART II
Item 5. Market for the Company's Common Equity and Related
Stockholder Matters......................................... 19
Item 6. Selected Financial Data..................................... 20
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of Operations....................................... 20
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 24
Item 8. Financial Statements and Supplementary Data................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure........................................ 26

PART III
Item 10. Directors and Executive Officers of the Company............. 27
Item 11. Executive Compensation...................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 27
Item 13. Certain Relationships and Related Transactions.............. 27

PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 27

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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements that
involve risks and uncertainties, as well as assumptions that, if they never
materialize or prove incorrect, could cause our results to differ 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,
revenues, or other financial 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.

The risks, uncertainties and assumptions referred to above include the
timely development, production and acceptance of products and services and their
features; the level of governmental support for supercomputers; our dependency
on third-party suppliers to build and deliver necessary components; our need for
additional credit and financial facilities; the challenge of managing asset
levels, including inventory; the difficulty of keeping expense growth at modest
levels while increasing revenue; our ability to retain and motivate key
employees; and other risks that are described from time to time in our
Securities and Exchange Commission reports, including but not limited to the
items discussed in "Factors That Could Affect Future Results" set forth in
"Business" in Item 1 below in this report, and in subsequently filed reports. We
assume no obligation to update these forward-looking statements.

GENERAL

PART I

ITEM 1. BUSINESS

INTRODUCTION

We design, build, sell and service high performance computer systems,
commonly known as supercomputers. We have leading edge technology, multiple
product platforms, nearly 900 employees, a substantial worldwide installed base
of computers, major manufacturing and service capabilities and extensive global
customer relationships. We believe that our current products and those under
development represent the future of supercomputing.

We were incorporated under the laws of the State of Washington in December
1987. Our corporate headquarters offices are located at 411 First Avenue South,
Suite 600, Seattle, Washington, 98104-2860, and our telephone number is (206)
701-2000.

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Cray, Cray-1, SuperCluster, UNICOS and UNICOS/mk are federally registered
trademarks of Cray Inc., and Cray C90, Cray J90,
Cray T90, Cray T3E, Cray SV1, Cray SV1ex, Cray SV2, Cray MTA, Cray MTA-2 and
Cray MTX are trademarks of Cray Inc. Other
trademarks used in this Annual Report on Form 10-K are the property of their
respective owners.

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CRAY ACQUISITION

As briefly described earlier under "General," we acquired the operating
assets of the Cray Research business unit from SGI on April 1, 2001, and became
the leading company in the world dedicated solely to the development and sale of
supercomputers. Prior to the acquisition, we had been developing for ten years
one supercomputer product based on multithreaded architecture. We had sales to
one customer, limited revenue, and approximately 125 employees. Through the
acquisition we acquired outstanding talent, complementary product lines, leading
technology, a world-wide service organization and customer relationships with
most supercomputer users in the United States and overseas.

In particular, we acquired the Cray SVI and T3E current product lines and
the SV2 and other products under development, a service organization supporting
Cray supercomputers installed in about 200 sites in the United States and
overseas, integrated design and manufacturing capabilities, 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. We paid SGI $15 million in cash upon closing,
$35.3 million pursuant to a non-interest bearing note that we paid in full by
December 2000 and 1,000,000 shares of our common stock. We assumed real property
leases for other Cray offices and holiday and other benefit obligations for the
personnel who transferred from SGI to us.

In acquiring the service of the installed base of Cray supercomputers, we
assumed responsibility for the cost of servicing the Cray T90 vector computers.
Because certain components in the T90 systems sold by SGI have unusually high
failure rates, the cost of servicing these computers exceeds the related service
revenue. We are continuing to take action that commenced prior to our
acquisition of the Cray Research operations to address this problem, which will
not be resolved until all T90 systems are removed from service. We recorded a
warranty reserve of $46.3 million to provide for anticipated future losses on
the T90 service contracts. We apply a portion of this reserve to offset service
costs quarterly based on our T90 service activities during that quarter.

As part of the acquisition we agreed with SGI that we would not utilize
specified technology to develop successor products to the T3E product line. In
addition, we agreed that for a period of the earlier of three years or until SGI
was sold, we would not sell or otherwise transfer any or all of the Cray
products, rights under the intellectual property transferred to us under the
Technology Agreement, or the service and maintenance relationships with the
installed base to Hewlett-Packard Company, Sun Microsystems, Inc., International
Business Machines Corporation, Compaq Computer Corporation, NEC Corporation or
Gores Technology Group. We also agreed that for the same period, or until such
time that our revenue for a period of four fiscal quarters from the sale of the
Cray products was less than 50% of our total revenue, we would not transfer
these assets to any other party without providing SGI a right of first refusal.

PRODUCT OFFERINGS AND THE HIGH PERFORMANCE COMPUTER MARKET

Since the pioneering Cray-1(R) system arrived in 1976,
supercomputers -- defined simply as the most powerful class of computers at any
time -- have contributed substantially to the advancement of knowledge and the
quality of human life. Problems of major economic, scientific and strategic
importance typically are addressed by supercomputers years before becoming
tractable on less-capable systems. For scientific applications, the increased
need for computing power has been driven by highly challenging problems that can
be solved only through numerically intensive computation. For engineering
applications, high performance computers boost productivity and decrease 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

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computer systems, which typically sell for mutiple millions of dollars each, is
of critical importance to the economic, scientific and strategic competitiveness
of the United States.

In conjunction with some of the world's most creative scientific and
engineering minds, these formidable tools already have made automobiles safer
and more fuel-efficient; located new deposits of oil and gas; saved lives and
property by predicting severe storms; created new materials and life-saving
drugs; powered advances in electronics and visualization; safeguarded national
security; and unraveled mysteries ranging from protein-folding mechanisms to the
shape of the universe.

Applications promising future competitive and scientific advantage create a
demand for more supercomputer power -- 10 to 1,000 times greater than anything
available today, according to users. Automotive companies are targeting
increased passenger cabin comfort, improved safety and handling. Aerospace firms
envision more-efficient planes and space vehicles. The petroleum industry wants
to "see" subsurface phenomena in greater detail. Urban planners hope to ease
traffic congestion. Integrated digital imaging and virtual surgery -- including
simulated sense of touch -- are high on the wish list in medicine. The
sequencing of the human genome promises to open an era of burgeoning research
and commercial enterprise in the life sciences.

Our customized supercomputer products provide high bandwidth and other
capabilities needed for exploiting new and existing market opportunities. Among
supercomputer vendors, we offer the largest variety of products in order to
address the broadest range of customer requirements and market segments.

Vector Supercomputer Systems. For certain important classes of scientific
and industrial applications, vector supercomputer systems remain unequaled.
Starting in 1976, Cray Research pioneered the use of vector systems in a variety
of market sectors. Vector systems typically use a moderate number (one to 64) of
custom processors, each of which is two to 100 times faster in practice than the
fastest commercially available microprocessors at any time. Earlier, vector
systems effectively were the only type of system available and therefore
dominated the supercomputer market. In the past decade, supercomputers employing
alternative designs ("architectures"), including the Cray T3E(TM) highly
parallel system and others, have emerged to capture substantial marketshare.
Today, increasingly powerful vector systems remain an important market factor
and are typically reserved for the most demanding class of applications and
workloads. Our vector systems include unique features, traditionally employed by
classified government customers, that in preliminary tests have demonstrated
substantial performance advantages over microprocessor-based systems for
mainstream problem solving in the emerging bioninformatics market. The same
unique, hard-to-replicate features will be included in our forthcoming Cray
MTA-2(TM) systems.

The Cray SV1ex(TM) system, scheduled for availability in mid-2001, provides
substantial enhancements to the predecessor Cray SV1(TM) product. These
enhancements elevate this product line from a successful upgrade path for
midrange and prior-generation high-end Cray vector supercomputers, to a product
that for important, non-bandwidth-intensive applications is expected to perform
as well as current high-end systems. The system's clock rate, at 500 megahertz,
is the fastest of any currently available supercomputer, vector or non-vector;
and the Cray SV1ex system's cache-based memory, unique among vector
supercomputers, significantly improves performance for problems that make good
use of cache memory. The targeted selling focus for the SV1ex systems is 8 to 64
gigaflops (billions of calculations per second), with typical selling prices
ranging from $1 million to $2 million. We expect to sell some Cray SV1ex systems
larger than 64 gigaflops.

In February 2001, we signed an agreement with NEC Corporation to distribute
and service NEC SX-5(TM) vector supercomputers and their successors. This
agreement provides us with exclusive distribution and servicing rights in the
United States, Canada and Mexico, and non-exclusive rights in the rest of the
world. The SX-5 computers are the world's current best-selling high-end,
high-bandwidth vector supercomputers, with a strong installed base in industry,
government and academia. Current duties under a U.S. anti-dumping ruling
effectively prohibit the importation of these computers into the U.S. We have
requested that the U.S. Government remove these duties. Assuming that these
duties are removed as expected, we plan on marketing NEC SX-5 series computers
to customers with a need for high-end, high-bandwidth vector supercomputers,
particularly in the United States. The targeted selling focus for the SX-5
supercomputers will be from 10 to 160 gigaflops, with expected selling prices
ranging from $1.5 million to $15 million.
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Microprocessor-based Highly Parallel Systems. In recent years highly
parallel supercomputer products have captured substantial market share by
providing greater performance and price/performance on a range of applications
for which vector supercomputers are less well suited. Highly parallel
supercomputers typically link together tens, hundreds or thousands of standard
microprocessors to act either concurrently on multiple tasks, or in concert on a
single computationally-intensive task. In these systems, each processor
typically is directly connected to its own private ("distributed" or "local")
memory and the programmer must manage the movement of data among memory units.
As a result, computer systems relying on this architecture can be difficult to
program and are most suited for applications that can be partitioned easily into
discrete tasks that do not need to communicate often with each other and do not
require the high memory and interconnect system bandwidth of supercomputers such
as the forthcoming Cray SV2(TM), NEC SX-5 and Cray MTA-2 systems.

The Cray T3E system, introduced in 1996 and able to employ up to 2,048
processors, is widely recognized as the first technically and commercially
successful highly parallel system. The Cray T3E holds the world record for
actual ("sustained") performance on a real application and was named
"Supercomputer Product of the Year" for the year 2000 by the readers of
Scientific Computing & Instrumentation magazine. We expect continued strong
demand for T3E systems in 2001, driven by the product's proven superiority among
highly parallel systems in handling large, complex applications and workloads.
In May 2000, we sold an 816-processor T3E system upgrade to the U.S. Army High
Performance Computing Research Center for $18.5 million. In August 2000, we sold
the first enhanced Cray T3E-1350 system, totaling 136 processors, to Phillips
Petroleum Company. We recently sold and installed a T3E system with teraflop
capacity to the U.S. Department of Defense for approximately $21 million.

In January 2001, we announced plans to introduce the Cray SuperCluster(R)
series, a product line designed to extend the leadership of the Cray T3E system
while exploiting commercially available third-party technologies to a greater
degree. With the SuperCluster system, we plan to address market demand for COTS
(commercial-off-the-shelf) clusters with higher capabilities than those
available today, especially by leveraging the approximately $45 million software
investment that has made the Cray T3E system the most scalable, usable system in
its category. In addition to our own significant software contribution, we plan
to use leading COTS components, including Alpha processor technology from API
NetWorks, Inc., advanced Linux system software and the highly scalable Myrinet
cluster-interconnect network from Myricom, Inc. Over the next two years, we plan
to add advanced data center management capabilities to the SuperCluster
operating system, leveraging the Cray T3E software investment. Target markets
for the SuperCluster systems include government, scientific research and select
industries, such as petroleum and the life sciences. Unlike our vector and
multithreaded architecture products, the SuperCluster is aimed at scalar
applications and workloads, and at the growing number of customers and new
prospects considering microprocessor-based COTS clusters. The SuperCluster is
targeted for first customer ship in the second half of 2001.

Cray SV2 System. We are currently developing the revolutionary Cray SV2
system, which incorporates in its design both vector processing capabilities
from the long line of Cray Research vector systems, and highly parallel
capabilities analogous to those of our T3E system. The SV2 is an "extreme
performance" supercomputer aimed at the high end of the vector processing market
and the high end of the market for highly parallel systems. The SV2 has been
under development since 1997, and first customer ship is scheduled for the
second half of 2002. Our expected selling focus for the SV2 is 200 gigaflops to
multiple tens of teraflops (trillions of calculations per second). The U.S.
Government is providing substantial funding support for the development of the
SV2 system and conducts rigorous progress reviews on a quarterly basis. Our SV2
development has satisfactorily completed all quarterly reviews to date.

Multithreading Systems. Tera Computer Company was originally formed to
pursue a significant breakthrough in high-performance computing by developing a
scalable, uniform shared memory, latency tolerant system that utilizes a
multithreaded architecture and a high bandwidth interconnection system. In the
past year we have been heavily engaged in reimplementing the MTA(TM) system from
gallium arsenide technology to more-mainstream CMOS (complementary metal-oxide
silicon) technology. In January 2001 we announced a $5.4 million contract from
Logicon, a Northrup Grumman company, to deliver a 28-processor, all-CMOS MTA-2
system to the Naval Research Laboratory in the fourth quarter of 2001, with
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substantial upgrade options over a four-year period. The Naval Research
Laboratory plans to make this system available for investigative purposes to its
own researchers and to the Department of Defense national research community.
With the MTA-2 system, we are targeting customers in the defense community, in
scientific research -- including burgeoning new life sciences field such as
bioinformatics, and in advanced imaging. The MTA-2 is aimed at new applications
not well served by vector or highly parallel systems, such as dynamically
adaptive meshes, data sorting and problems benefiting from advanced scalability,
large uniform shared memory and easier parallel programming. The MTA-2 has shown
a significant performance advantage, for example, on so-called Monte Carlo codes
used in a wide range of sectors, from nuclear physics to medicine to finance.

SOFTWARE

We offer UNIX-based operating systems, compiler software and diagnostic
tools. We currently support multiple operating systems, including UNICOS/mk(R)
in the T3E, UNICOS(R) in the SV1 and earlier vector processing systems and a
UNIX-based system called Cray MTX(TM) for the Cray MTA system. The SuperCluster
operating system will be based on open-source version of LINUX with extensions
to support high performance computing in a production environment, while the SV2
operating system will be UNIX-based with common UNICOS extensions. The NEC SX-5
systems and its successors use NEC's SUPER-UX(TM) operating system, which is
also based on UNIX.

We continue to design and build highly optimizing programming environments,
performance management diagnostic software products that allow our customers to
obtain maximum benefit from our systems. In addition to supporting third-party
applications, we also research advanced algorithms and other approaches to
improving application performance. We also purchase or license software
technologies from third parties when necessary to provide appropriate support to
our customers, while focusing on our own resources where we add the highest
value.

MAINTENANCE AND SUPPORT

Our extensive worldwide maintenance and support systems provide us with a
competitive advantage. Our employees providing these services include field
service engineers, product and applications specialists and product support
engineers. They are usually based at customer sites. We currently have
approximately 110 support personnel in the field in the U.S., another 100
support personnel in other countries and 80 employees providing central support
services based in Chippewa Falls, Wisconsin, including extensive data center
operations.

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. In the nine months of our
combined operations in 2000, our support revenues exceeded $71 million. At
year-end we had deferred support revenue in excess of $15 million representing
prepaid support.

SALES AND MARKETING

We primarily sell our system products through our direct sales force which
operates throughout the United States and in all significant international
markets. We serve smaller international markets through representatives and
distributors.

We have 60 sales staff, including sales representatives, sales managers,
pre-sale analysts and administrative personnel located in the United States and
28 sales staff located internationally.

Information with respect to our international operations and export sales
is set forth in Note 14 to the Consolidated Financial Statements included in
Part II, Item 8 of this Form 10-K. No single end-user customer accounted for 10%
or more of our revenue for each of the last three years, but agencies of the
United States government, both directly and indirectly through system
integrators and other resellers, accounted for approximately 54% of our 2000
revenue.

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RESEARCH AND DEVELOPMENT

We are committed to leadership in the high performance computer market. Our
leadership depends on successful development and introduction of new products
and enhancements to existing products. Prior to April 2000, our primary research
and development activity was the design of the hardware components and software
required for our MTA system. Since April 2000, we have continued development of
the MTA system, the development of the enhancements to the Cray T3E system and
Cray SV1 series leading to the SV1ex, and the development of the SV2 system. We
expect that the SuperCluster system will involve software development with
minimal hardware engineering, and we do not anticipate any development
expenditures on the NEC SX-5 and successor SX systems

Our research and development expenses, net of governmental funding, were
$13.7 million in 1998, $15.2 million in 1999 and $48.4 million in 2000 (of which
$43.9 million was spent in the nine months of combined operations). These
amounts represent 687%, 720% and 41% (including 37% in the nine months of
combined operations), respectively, of total revenue. We received government
funding of $253,000 in 1998, $72,000 in 1999 and $9.3 million in 2000 (all of
which was in the nine months of combined operations). While we will be required
to continue to devote a substantial portion of our resources to research and
development activities, our goal is to have research and development expenses
represent approximately 15 -- 18% of revenue. We expect to achieve this goal
primarily by increasing revenue while holding research and development
expenditures to modest increases.

MANUFACTURING

While we design many of the hardware components for all of our products, we
subcontract the manufacture of these components, including integrated circuits,
printed circuit boards, flex circuits, memory modules, machined enclosures and
support structures, cooling systems, high performance cables and other items to
third-party suppliers. Our strategy is to avoid the large capital commitment and
overhead associated with establishing full-scale manufacturing facilities and to
maintain the flexibility to adopt new technologies as they become available
without the risk of equipment obsolescence. We perform final system integration
and testing, and design and maintain our system software internally.

Our manufacturing facilities are located in Chippewa Falls, Wisconsin. We
maintain a development and support capability in Seattle, Washington. At
December 31, 2000, we had 160 full-time employees in manufacturing, with 137
located in Chippewa Falls, Wisconsin.

Our systems incorporate components that are available from one or limited
sources. Key components that are sole-sourced include our integrated circuits
and processors, interconnect systems and memory products. We obtain integrated
circuits for our vector systems from IBM and for the MTA-2 system from Taiwan
Semiconductor Manufacturing Corporation; IBM also provides packaging for our
vector systems while Kyocera America, Inc., provides packaging for our MTA-2
system; we obtain processors for our T3E system from Compaq Computer and for our
SuperCluster system from API Networks, Inc.; we obtain custom interconnect
components for our T3E and MTA-2 systems from InterCon Systems, Inc., and
interconnect switches for our SuperCluster system from Myricom, Inc. We obtain
custom memory products for our vector, MTA-2 and T3E systems from Samsung
Semiconductor, Inc. We use Celestica, Inc., to assemble our vector and T3E
systems and for repair of components for these systems. Our purchases from these
vendors are primarily through purchase orders. We have chosen to deal with sole
sources in these cases because of specific technologies, economic advantages and
other factors. We also have sole or limited sources for less critical
components, such as peripherals, power supplies, cooling and chassis. 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.

COMPETITION

The high performance computer market is intensely competitive. The barriers
to entry are high, as is the cost of remaining competitive. Our competitors can
be divided into two general categories: established companies that are
well-known in the high performance computer market and new entrants capitalizing
on
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developments in architecture or techniques to increase computer performance
through linking together clusters or networks of microprocessor based
systems -- servers, workstations or personal computers.

Participants in the market include IBM, Fujitsu, Ltd., Hitachi, Ltd., and
NEC Corporation. To date, the Japanese suppliers, as a group, have been largely
unsuccessful in the U.S. high performance computer market but have been enjoying
success in foreign markets. Once our distribution agreement with NEC becomes
effective, we will have exclusive rights to market NEC vector processing
supercomputers in North America; we have non-exclusive rights to market these
computers elsewhere, which means we would be competing with NEC in the rest of
the world. We compete with these companies by offering systems with superior
performance, coupled with our excellent post-sale service capabilities and
established customer relationships.

A number of companies, including IBM, Silicon Graphics, Inc., Hitachi,
Ltd., Fujitsu, Ltd., Sun Microsystems, Inc., Hewlett-Packard Corporation and
Compaq Computer Corporation, offer clusters or other highly parallel systems for
the high performance market. While our T3E system competes primarily on
performance, we expect that our SuperCluster system will compete on
price/performance, more extensive software capabilities and superior post-sale
service.

Each of our competitors named above has substantially greater engineering,
manufacturing, marketing and financial resources than we do.

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. Although we have not been a party to any
material intellectual property litigation, third parties may assert proprietary
rights claims covering certain of our products and technologies.

We have a number of patents relating to our hardware and software systems.
We license certain patents and other intellectual property from Silicon
Graphics, Inc., as part of our acquisition of the Cray Research operations.
These licenses contain restrictions on use of the underlying technology,
generally limiting the use to historic Cray products, vector processor computers
and the Cray SV2 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 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 significant
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. Litigation
may be necessary in the future to enforce patents we obtain, and to protect
copyrights, trademarks, trade secrets and know-how we own. Such litigation, if
necessary, could result in substantial expense to us and a diversion of our
efforts.

EMPLOYEES

As of December 31, 2000, we employed 886 employees (compared to 123 at the
end of 1999 as Tera Computer Company) on a full-time basis, of whom 303 were in
development and engineering, 160 were in manufacturing, 88 were in sales and
marketing, 290 in field service and 45 were in administration. We also employed
57 individuals on a part-time or temporary basis or as interns. We have no
collective bargaining agreement with our employees. We have never experienced a
work stoppage and believe that our employee relations are excellent.

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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 SV1 series and T3E systems, for significant product revenue in 2001. To
obtain these sales, we need 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 SuperCluster, 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, 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 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. 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,
would cause us to increase our need for capital and reduce our research and
development expenditures.

IF THE U.S. GOVERNMENT PURCHASES FEWER SUPERCONDUCTORS, OUR REVENUE WOULD
BE REDUCED. Historically, sales to the U.S. government have been a significant
market for supercomputers. In the fiscal year ended December 31, 2000,
approximately 54% of our revenue was derived from sales to various agencies and
departments of the U.S. government. Sales to the U.S. government may be affected
by factors out of 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 revenues 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.

FAILURE TO OBTAIN RENEWAL OF SERVICE CONTRACTS WILL REDUCE OUR REVENUES AND
EARNINGS. High-performance computer systems are typically sold with maintenance
service contracts. These contracts generally are for

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11

annual periods, although some are for multi-year periods. We have been
performing most of the services under the existing Silicon Graphics maintenance
contracts as a sub-contractor to Silicon Graphics and are in the process of
having these contracts assigned to us. As these contracts expire, we need to
sell new maintenance service contracts to these customers. Revenue from service
contracts has declined from approximately $125 million in 1999 to approximately
$95 million in 2000 and is expected to further decline until new products are
designed and sold. If customers do not renew their maintenance service contracts
with us, our revenues and earnings will be reduced.

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. The SuperCluster system will be built
entirely from commercial off-the-shelf components on a sole-source basis. We
also use a contract manufacturer to assemble our SV1 and T3E components, and
plan to do so for our MTA-2 and SV2 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 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.

Cray has experienced delays in obtaining circuit boards, integrated
circuits and flex circuits on a timely basis from its suppliers, which have
resulted in delays in the development of our products.

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 and 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 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
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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 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 $31.5 million as of December 31, 2000, 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, whether we will
continue to achieve earnings will depend upon a number of factors, including:

- our ability to market and sell our existing products, the SV1 and T3E,
and complete the development of the SV1ex, SuperCluster, 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 key personnel. In particular we have
an ongoing project to add software developers to assist our development efforts.
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 December 31, 2000, we had outstanding:

- 35,280,785 shares of common stock;

- warrants to purchase 14,801,096 shares of common stock;

- 8% convertible promissory notes due March 31, 2001, in the principal
amount of $494,291, convertible at $5.00 per share into 98,858 shares of
common stock; and

- stock options to purchase an aggregate of 8,224,005 shares of common
stock, of which 2,428,813 options were then exercisable.

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Almost all of our outstanding shares of common stock may be sold without
substantial restrictions. All of the shares purchased under the options are
available for sale in the public market, subject in some cases to volume and
other limitations.

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 such 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.

ADDITIONAL FINANCINGS MAY BE DILUTIVE TO EXISTING SHAREHOLDERS. Over the
next twelve months our significant cash requirements relate to operational
expenses, consisting primarily of personnel costs, costs of inventory and
third-party engineering expenses, and acquisition of capital goods. We expect to
have positive cash flow from our anticipated product sales and maintenance
services over the next twelve months. We secured a $15 million credit facility
in March 2001 and, upon completion of the NEC distribution agreement in May
2001, NEC invested $25 million in us. At any particular time, given the high
average selling price of our products, our capital position is impacted by the
timing of particular product sales, and the receipt of prepaid maintenance.
Delays in the completion of the SV1ex system and the development of the MTA-2
and SuperCluster systems, all planned to be completed in 2001, or delays in the
SV2 development program may require additional capital earlier than planned. We
may raise additional equity or debt capital through our shelf registration
statement covering $20 million of common stock, private placements or enhanced
credit facilities to provide sufficient working capital and enhance our 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.

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 sales, which
have 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 SuperCluster, the MTA-2 and the SV2
systems 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.

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IF WE ARE UNABLE TO COMPETE SUCCESSFULLY IN THE HIGH-PERFORMANCE COMPUTER
MARKET OUR REVENUES 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 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, 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. These 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 quoted 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 $5.00 for an extended period, or we are
unable to continue to meet Nasdaq's 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 the Nasdaq
SmallCap Market or for quotation on the American Stock Exchange or a regional
stock exchange. However, listing or quotation on these markets or exchanges
could reduce the liquidity for our common stock. If our common stock were not
listed or quoted on another market or exchange, trading of our common stock
would be conducted in our over-the-counter market on an electronic bulletin
board established for unlisted securities or in what are commonly referred to as
the pink sheets. If our common stock was trading 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 or quotation 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

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obtain listing or quotation 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. If the market price of our common stock falls to below
$5.00 per share, we may become subject to penny stock rules even if our common
stock is still quoted 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. We must also give Silicon Graphics a right of first refusal
for any sale of these assets to other purchasers for the period expiring on the
earlier of March 31, 2003, the sale of Silicon Graphics or, if over a period of
four fiscal quarters, the revenue from product sales of Cray products is less
than 50% of our total revenue.

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 of nine 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 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 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.

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ITEM 2. PROPERTIES

The Company's principal properties are as follows:

APPROXIMATE
LOCATION OF PROPERTY USES OF FACILITY SQUARE FOOTAGE
-------------------- ---------------- --------------

Chippewa Falls, Wisconsin.............. Manufacturing, hardware development, service, 222,000
and warehouse
Seattle, Washington.................... Executive offices, MTA hardware and software 85,000
development
Mendota Heights, Minnesota............. Software development, sales and marketing 40,000
operations

We lease the properties described above except that we own 179,000 square
feet of manufacturing, development, service and warehouse space in Chippewa
Falls, Wisconsin.

We also lease a total of approximately 10,654 square feet, primarily for
sales and service offices, in various domestic locations. In addition, various
foreign sales and service subsidiaries have leased an aggregate of approximately
22,720 square feet of office space. We believe our facilities are adequate to
meet our needs in 2001.

ITEM 3. LEGAL PROCEEDINGS

We are not a party to any legal proceedings.

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 2000.

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ITEM E.O. EXECUTIVE OFFICERS OF THE COMPANY

Our executive officers as of March 19, 2001, were as follows:

NAME AGE POSITION
---- --- --------

Burton J. Smith...................... 60 Chief Scientist and Director
James E. Rottsolk.................... 56 Chief Executive Officer, President and Chairman
Rene G. Copeland..................... 53 Vice President -- Sales and Marketing
Kenneth W. Johnson................... 58 Vice President -- Finance, Chief Financial Officer,
and Secretary
David R. Kiefer...................... 52 Vice President -- Hardware Development
Brian D. Koblenz..................... 40 Vice President -- Software Development
Gerald E. Loe........................ 51 Vice President -- Worldwide Service
John D. Neale........................ 59 Vice President -- Human Resources
Douglas C. Ralphs.................... 42 Vice President -- Corporate Controller
Katherine L. Rowe.................... 44 Vice President -- Manufacturing
Richard M. Russell................... 56 Vice President -- International

Burton J. Smith is one of our co-founders and has been our Chief Scientist
and a Director since our inception in 1987. He is a recognized authority on high
performance computer architecture and programming languages for parallel
computers, and is the principal architect of the MTA system. Mr. Smith was a
Fellow of the Supercomputing Research Center (now Center for Computing
Sciences), a division of the Institute for Defense Analyses, from 1985 to 1988.
He was honored in 1990 with the Eckert-Mauchly Award given jointly by the
Institute for Electrical and Electronic Engineers and the Association for
Computing Machinery, and was elected a Fellow of both organizations in 1994. Mr.
Smith received S.M., E.E. and Sc.D. degrees from the Massachusetts Institute of
Technology.

James E. Rottsolk is one of our co-founders and has served as our Chief
Executive Officer, President and a Director since our inception in 1987. He
became Chairman of the Board in December 2000. Prior to 1987, Mr. Rottsolk
served as an executive officer with several high technology start-up companies.
Mr. Rottsolk received a B.A. degree from St. Olaf College and A.M. and J.D.
degrees from the University of Chicago.

Rene G. Copeland joined us as Vice President -- Sales and Marketing in
February 2000. From 1998 to joining us, Mr. Copeland worked at IBM, where he
served as the Manager of the Worldwide Manufacturing Segment for the RS6000 SP
Supercomputer. Prior to joining IBM, Mr. Copeland held a variety of senior
management, marketing and sales positions at Silicon Graphics, Inc., and Cray
Research, Inc. Mr. Copeland graduated from the U.S. Military Academy at West
Point with a B.S. Electrical Engineering, and received a M.B.A. from the
University of Chicago.

Kenneth W. Johnson joined us in September 1997 as Vice
President -- Finance, Chief Financial Officer and Secretary. Prior to joining
us, Mr. Johnson practiced law in Seattle for twenty years with Stoel Rives LLP
and predecessor firms, where his practice emphasized corporate finance. Mr.
Johnson received an A.B. degree from Stanford University and a J.D. degree from
Columbia University Law School.

David R Kiefer joined us as Vice President -- Hardware Engineering in April
2000. From 1996 to 2000, Mr. Kiefer was Director of Hardware Engineering at the
Cray Research operations of Silicon Graphics, Inc. Prior to joining Silicon
Graphics, he held a variety of engineering and engineering management positions
with Univac and Cray Research, Inc. Mr. Kiefer received his B.S. in Electrical
Engineering from the University of Wisconsin.

Brian D. Koblenz served as our Group Leader, Languages and Compilers, from
1990 until May 1994, when he assumed his present position as Vice
President -- Software Development. Prior to joining us, Mr. Koblenz was
Principal Software Engineer at Digital Equipment Corporation from 1986 to 1989.
He was lead designer of Digital's high performance vector FORTRAN compiler and
participated in the Alpha architecture and VAX vectorization efforts. He
received a B.S. from the University of Vermont and a M.S. from the University of
Washington.

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Gerald E. Loe joined us in 1992 as Vice President -- Hardware Engineering
and Manufacturing. He was named Vice President -- Hardware Engineering in 1996,
and Vice President -- Worldwide Service in April 2000. Prior to joining us, he
was Vice President of Operations at Siemens Quantum Inc., a high-end radiology
ultrasound company, from 1989 to 1992. Mr. Loe received a B.S.M.E. from the
Massachusetts Institute of Technology and a M.B.A. from Harvard Business School.

John D. Neale joined us as Vice President -- Human Resources in December
2000. He served in various positions with Battelle Memorial Institute in
Columbus, Ohio, from 1988 to 2000, most recently as Director of Human Resources.
From 1974 to 1988, Mr. Neale held various managerial positions with components
of General Electric Co. He received a Masters in Industrial Relations at the
University of Wisconsin and his undergraduate degree at St. Francis College in
Ft. Wayne, Indiana.

Douglas C. Ralphs joined us as Vice President -- Corporate Controller in
November 2000. He was chief financial officer at Interpoint, Inc. from 1998
until he joined us, and held various financial management positions at Itron,
Inc. from 1989 to 1998, serving as treasurer from 1997 to 1998. He previously
held financial positions with Hewlett-Packard Co. and Morrison Knudsen. He
received a M.B.A. from the University of Chicago and a B.A. from Boise State
University.

Katherine L. Rowe joined us as Director of Manufacturing in 1994 and was
named Vice President -- Manufacturing in 1996. Prior to joining us, Ms. Rowe was
an Engineering Manager at ELDEC Corporation, an aerospace electronics company,
and was Manufacturing Manager and Project Manager in new product development at
Physio-Control Corporation, a medical electronics company. She received her S.M.
from Massachusetts Institute of Technology and her B.S.M.E. from Purdue
University.

Richard M. Russell joined us as Director of New Business Development in
1995 and was named Vice President -- Marketing in March 1998. In February 2000
he was appointed Vice President -- International. Prior to joining us, he worked
in a variety of sales and marketing positions at several high technology
companies, including Cray Research, Inc. from 1976 through 1990 and Kendall
Square Research Corporation from 1991 through 1994. Mr. Russell was educated in
England.

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PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

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 March
19, 2001, we had 39,375,541 shares of common stock outstanding that were held by
763 holders of record. We have not paid cash dividends on our common stock. We
currently anticipate that we will retain all available funds for use in our
business and do not anticipate paying any cash dividends on our common stock in
the foreseeable future. In addition our credit facilities restrict our ability
to pay cash dividends.

The quarterly high, low and closing sales prices of our common stock for
the periods indicated are as follows:

1999 2000
-------------------- --------------------
HIGH LOW CLOSE HIGH LOW CLOSE
---- ----- ----- ----- ---- -----

First Quarter........................................ 9 3/ 4 7 1/4 11 1/ 4 1/ 6 7/1
Second Quarter....................................... 7 4 1/2 5 1/2 6 7/8 3 3 7/1
Third Quarter........................................ 6 3/1 2 7/8 4 1/8 7 5/8 3 9/3 4 15/3
Fourth Quarter....................................... 5 5/ 2 15/1 4 1/2 4 1/2 1 1/ 1 1/2

On March 19, 2001, the closing sale price for the common stock was $1.78.
These quotations reflect inter-dealer prices, without retail mark-up, mark-down
or commission, and may not represent actual transactions.

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ITEM 6. SELECTED FINANCIAL DATA

Financial data for fiscal year 2000 in the following table includes nine
months of activity of the Cray Research business acquired on April 1, 2000.

YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
1996 1997 1998 1999 2000
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS AND STATISTICAL DATA)

Operating Data:
Product Revenue....................... $ $ $ 1,274 $ 1,794 $ 46,617
Service Revenue....................... 714 320 71,455
Cost of Product Revenue............... 3,759 15,165 32,505
Cost of Service Revenue............... 584 273 34,077
Research and Development.............. 10,319 13,142 13,664 15,216 48,426
Net Loss.............................. (12,077) (15,755) (19,803) (34,532) (25,388)
Comprehensive Loss.................... (18,806) (18,672) (20,736) (34,647) (25,516)
Net Loss per Common Share............. $ (3.53) $ (2.13) $ (1.70) $ (1.74) $ (0.78)
Weighted Average Outstanding Shares... 5,321 8,785 12,212 19,906 32,699
Balance Sheet Data:
Cash and Cash Equivalents............. $ 929 $ 13,329 $ 3,162 $ 10,069 $ 4,626
Working Capital....................... (22) 14,342 7,269 9,208 (28,205)
Warranty Reserves, Long-term
Portion............................ 14,285
Capital Leases, Long-term Portion..... 114 532 573 390 284
Notes Payable, Long-term Portion...... 1,022 254
Total Assets.......................... 4,617 20,859 20,288 23,410 136,193
Redeemable Securities................. 9,478
Shareholders' Equity.................. 1,128 6,368 11,889 14,307 36,147
Statistical Data:
Number of Full-time Employees......... 61 84 109 123 886

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

PRELIMINARY NOTE REGARDING 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 21E of the Securities Exchange Act of
1934, and is subject to the safe harbor created by that Section. Factors that
realistically could cause results to differ materially from those projected in
the forward looking statements are set forth in this section and under
"Business -- Factors That Could Affect Future Results." The following discussion
should also be read in conjunction with the Financial Statements and
accompanying Notes thereto.

OVERVIEW

We design, develop, market and service high-performance computer systems,
commonly known as supercomputers. We presently market two computer systems, the
Cray SV1 and T3E, and provide maintenance services to the world-wide installed
base of these and earlier models of Cray computers. We are developing
enhancements to the Cray SV1, and we are developing three new computer systems,
the MTA-2, based on our multithreaded architecture system, the SuperCluster, a
highly parallel system using leading commercial off-the-shelf components, and
the SV2, which will combine elements of the SV1 and T3E computers.

In 2000 we largely were involved in the separation of the Cray Research
operations from those of SGI and integrating them with our own. This process
included establishing separate network, communications and other infrastructure
services, reconstituting the marketing and sales operations, setting up
subsidiary opera-

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tions for international sales and services, implementing new operational
policies and procedures, and identifying and filling openings in management,
administration and other areas.

We have experienced net losses in each year of operations. We incurred net
losses of approximately $25.4 million in 2000, $34.5 million in 1999 and $19.8
million in 1998.

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 may affect our future results and financial condition are
set forth above, beginning on page 9.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998

With the acquisition of the Cray Research business unit on April 1, 2000,
period-to-period comparisons of our operating results that include periods prior
to the acquisition are not indicative of results for any future period.

Revenue. We had revenue from product sales of $46.6 million for 2000, up
from $1.8 million in 1999 and $1.3 million in 1998. Product revenue represented
39% of total revenues for 2000 and consisted primarily of $19.1 million for our
SV1 product line and $27.3 million for our T3E product line. Product sales for
Cray Research products declined during each of the three years prior to our
acquisition of the Cray Research business unit, primarily because SGI had
stopped development funding on new Cray Research products. We expect that our
product sales revenue will increase as we introduce upgrades to the current
product line and our new products currently under development. 1999 revenues
included $1.7 million from the upgrade of the MTA system at the San Diego
Supercomputer Center ("SDSC") to eight processors, and 1998 revenues included
$1.3 million from the sale of the two-processor MTA system to SDSC, our first
revenue as Tera Computer Company from product sales.

We had service revenue of $71.5 million for 2000, up from $320,000 in 1999
and $714,000 in 1998. 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. The overall increase in
service revenue is due to the acquisition of the Cray product line and related
service business in April 2000. Service revenue has continued to decline over
the periods prior to our acquisition of the Cray Research business unit and we
expect this decline to continue 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 61% of total revenues for 2000.

Operating Expenses. Cost of product revenue was $32.5 million for 2000,
$15.2 million for 1999 and $3.8 million for 1998. Cost of product revenue for
2000 represented 70% of product revenue for 2000. The high cost of product
revenue in 2000 is due to the age of the SV1 and T3E product lines and inventory
adjustments for SV1 and MTA gallium arsenide parts. Cost of product revenue was
high in 1999 and 1998 as a percentage of the revenue due to the inclusion of
manufacturing costs and inventory adjustments relating to the MTA product line
and favorable pricing terms provided to our first MTA customer.

Cost of service revenue was $34.1 million for 2000, $273,000 for 1999 and
$584,000 for 1998. Cost of service revenue for 2000 was net of $18.4 of warranty
reserve utilization. Cost of service revenue represented 48% of service revenue
for 2000.

Research and development expenses reflect our costs associated with the
enhancements to the Cray SV1 and T3E systems and the development of the MTA 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 $48.4 million in 2000, $15.2 million for

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1999 and $13.7 million for 1998 with governmental developmental funding being
$9.3 million in 2000, $72,000 in 1999 and $253,000 in 1998. Research and
development expenses in 2000 represented 41% of revenue. We expect that research
and development expenses will decrease slightly in 2001, with increases in
engineering personnel, principally software engineers, being offset by decreases
in third-party non-recurring engineering expenses as we complete development of
the MTA-2 and SV-2 systems. In subsequent years, unless we obtain additional
governmental development funding to replace funding for projects as they are
completed, the net amount of research and development expenditures will
increase. Over time, with receipt of increased revenue from products currently
under development and sales of the NEC SX-5 series of computers, we expect
research and development expenses to decrease as a percentage of overall
revenue.

Marketing and sales expense were $14.4 million in 2000, $2.5 million in
1999 and $1.8 million in 1998. The increase in these expenses for 2000 over 1999
was due to the acquisition of the Cray Research business unit, which required us
to re-establish the Cray sales and customer support staff and increase
expenditures in connection with sales and marketing, benchmarks and development
of third party applications software. The increase in these expenses for 1999
over 1998 was due largely to higher wages and operating costs.

General and administrative expenses were $7.0 million for 2000, $3.1
million in 1999 and $2.1 million in 1998. The increase in these expenses for
2000 over 1999 was due to the acquisition of the Cray Research operations, which
required us to add managerial and administrative staff and increases in legal,
accounting and consulting expenses in connection with establishing foreign
operations and implementing new accounting systems. The increase in 1999
expenses over 1998 was due largely to higher wages, and operating costs
associated with being a publicly owned company. General and administrative
expenses are expected to increase as we complete our administrative staffing,
but should decline as a percentage of revenue.

We incurred amortization expense of $5.2 million in 2000 primarily related
to the goodwill and intangible assets from the acquisition of the Cray Research
business unit.

Interest Income (Expense). Interest income was $690,000 for 2000, $537,000
for 1999, and $366,000 for 1998, reflecting the Company's increased cash
position due to the sales of equity securities in the first quarter of 2000, and
in 1999 and 1998.

Interest expense was $2.4 million for 2000, $815,000 for 1999 and $189,000
for 1998. The increase in 2000 was largely due to imputed interest expense of
$1.4 million for 2000 on the non-interest bearing note issued to SGI, a non-cash
interest expense of approximately $336,000 associated with the value of the
conversion feature of certain investor promissory notes, a non-cash expense of
$200,000 for the value of warrants issued in conjunction with investor
promissory notes and $92,000 of interest paid on a line of credit. The increase
in 1999 was largely due to a non-cash interest expense of approximately $278,000
associated with the value of the conversion feature of certain convertible
promissory notes issued in the first quarter of 1999. The 1999 results also
include a non-cash expense for the value of detachable warrants issued in
conjunction with convertible promissory notes, of which $249,000 was recognized
upon conversion in the second quarter of 1999.

Taxes. We made a provision of $831,000 for international income taxes in
2000. As of December 31, 2000, we had net operating loss carryforwards of
approximately $119.4 million which expire in years 2003 through 2020, if not
utilized.

Net Loss. Our net loss in 2000 of $25.4 million was less than our net loss
in 1999 of $34.5 million and greater than our net loss of $19.8 million in 1998.
The 2000 net loss includes a loss of $8.0 million during the first quarter,
prior to our acquisition of the Cray Research business operations. We continue
to incur substantial research and development expenses, particularly as a
percentage of revenue. To become profitable we need to increase our product
revenue from sales of our enhancements of our current products and our products
under development in order to support this level of research and development
expenditures. See "Business -- Product Offerings and the High Performance
Computer Market" and "Business -- Research and Development."

Preferred Stock. In the second quarter of 1999, all of our outstanding
preferred stock was converted to common stock. The dividends for 1998 were
accrued on our Series A Convertible Preferred Stock, and were
22
23

higher than that accrued during the comparable period of 1999 because we had
more shares of Preferred Stock then outstanding.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents totaled $4.6 million at December 31, 2000
compared to $10.1 million at December 31, 1999. Restricted cash balances, which
serve as collateral for capital equipment loans and leases, totaled $761,000 at
December 31, 2000, and $1.1 million at December 31, 1999.

Net cash provided by operating activities was $5.1 million for the year
ended December 31, 2000, compared to net cash used of $26.3 million in 1999. On
a pro forma basis, in the nine months subsequent to the Cray acquisition we had
net cash provided by operating activities of $13.7 million. For 2000, net
operating cash flows were primarily attributed to increases in depreciation and
amortization, accounts payable and deferred revenue offset in part by increases
in accounts receivable and warranty reserves.

Net cash used in investing activities was approximately $57.4 million for
the year ended December 31, 2000, compared to $427,000 for 1999. In 2000, we
paid a total of $50.2 million to SGI to acquire the Cray Research business unit.
We also spent $5.8 million on fixed assets, primarily consisting of computer
hardware and software and electronic test equipment.

Net cash provided by financing activities was $47.0 million for the year
ended December 31, 2000, compared to $33.6 million for 1999. In 2000, we raised
$25.2 million in a private placement of 5.2 million shares of common stock and
$8.9 million from the exercise of common stock warrants. We also raised $12.5
million through the issuance of promissory notes to two investors, retiring $4.2
million of these notes by year-end through conversion into common stock.
Subsequent to December 31, 2000, we have paid the remaining $8.3 million
principal amount and interest through sales of common stock to the investors.

Over the next twelve months our significant cash requirements relate to
operational expenses, consisting primarily of personnel costs, costs of
inventory and third-party engineering expenses, and acquisition of property and
equipment. These expenses include our commitments to acquire components and
manufacturing and engineering services. We expect that anticipated product sales
and maintenance services over the next twelve months will generate positive cash
flow from operations. We secured a $15 million credit facility in March 2001,
and expect that the NEC distribution agreement will be completed in the second
quarter of 2001, at which time NEC will invest $25 million in us. At any
particular time, given the high average selling price of our products, our cash
position is affected by the timing of product sales and the receipt of prepaid
maintenance revenue. In addition, delays in the development of the SV1ex, MTA-2
and SuperCluster systems, all planned to be completed in the next twelve months,
and the SV2 system may require additional capital earlier than planned. While we
believe our cash resources will be adequate for the next 12 months, we may need
to raise additional equity and/or debt capital through our shelf registration
statement, private placements and/or enhanced credit facilities. If we are
successful in our product development and market conditions were favorable, we
may wish to consider financings to enhance our cash position and 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.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board ("FASB") issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, in June 1998,
which is effective for us beginning January 1, 2001. SFAS No. 133 requires that
all derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if it is, the type of hedge
transaction. Since we do not currently hold any derivative instruments, SFAS No.
133 is not expected to have any impact on the consolidated financial statements.

In December 1999, the United States Securities and Exchange Commission
(SEC) released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in
Financial Statements, which was required to be

23
24

adopted in our fourth fiscal quarter of 2000. SAB No. 101 provides guidance on
revenue recognition and the SEC staff's views on the application of accounting
principles to selected revenue recognition issues. The adoption of SAB No. 101
did not have a material impact on our consolidated financial statements.

In March 2000, the FASB issued Interpretation No. 44 (FIN 44), Accounting
for Certain Transactions Involving Stock Compensation -- an Interpretation of
Accounting Principles Board (APB) Opinion No. 25, which addresses certain
accounting issues which arose under the previously established accounting
principles relating to stock-based compensation. The adoption of this
interpretation did not have a material effect on our consolidated financial
statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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, but with significant sales in 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 believe that a
10% change in foreign exchange rates would not have a material impact on the
financial statements. 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.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS*

Consolidated Balance Sheets at December 31, 1999 and
December 31, 2000......................................... F-1
Consolidated Statements of Operations and Comprehensive Loss
for each of the three years in the period ended December
31, 2000.................................................. F-2
Consolidated Statements of Shareholders' Equity for each of
the three years in the period ended December 31, 2000..... F-3
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2000............... F-4
Notes to Consolidated Financial Statements.................. F-5
Independent Auditors' Report................................ F-19

---------------
* The Financial Statements are located following page 30.

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26

QUARTERLY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The following table presents unaudited quarterly financial information for
the two years ended December 31, 2000. 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
are not necessarily indicative of results for any future periods.

1999 2000
----------------------------------------- -----------------------------------------
3/31 6/30 9/30 12/31 3/31 6/30 9/30 12/31
FOR THE QUARTER ENDED ------- ------- -------- ------- ------- ------- ------- --------

Revenue....................... $ 661 $ 260 $ 850 $ 343 $ 43 $50,973 $33,688 $ 33,368
Cost of Sales................. 3,017 1,785 9,039 1,597 2,029 27,503 18,426 18,624
Gross margin.................. (2,356) (1,525) (8,189) (1,254) (1,986) 23,470 15,262 14,744
Research and Development...... 3,033 3,686 4,752 3,745 4,483 13,865 13,272 16,806
Marketing and Sales........... 632 545 611 729 768 2,822 4,397 6,378
General and Administrative.... 465 638 551 1,437 1,101 1,898 1,645 2,389
Net Loss...................... (6,811) (6,672) (13,934) (7,115) (8,005) 2,661 (6,097) (13,947)
Comprehensive loss............ (6,881) (6,717) (13,934) (7,115) (8,005) 2,661 (6,097) (13,875)
Net Income (Loss) Per Common
Share, Basic and Diluted.... $ (0.47) $ (0.40) $ (0.59) $ (0.29) $ (0.27) $ 0.08 $ (0.18) $ (0.41)

On April 1, 2000, we acquired the operating assets of the Cray Research
business unit from Silicon Graphics, Inc. ("SGI"), and changed our corporate
name from Tera Computer Company to Cray Inc. With that acquisition we 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 in 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. For discussions that relate to
periods prior to April 1, 2000, refer to our operations as Tera Computer Company
and for discussions relating to periods after April 1, 2000, refer to our
combined operations as Cray Inc. Revenue in the quarter ended June 30, 2000 was
high due to the sale of a $17.1 million T3E system while revenue decreased in
the subsequent two quarters of 2000 due to lower than planned product sales. Net
loss for the quarter ended December 31, 2000 increased over the quarter ended
September 30, 2000 primarily due to an impairment loss of $3.3 million on MTA
test equipment, higher prototype expenses for the MTA2 and SV2, as well as
higher sales expenses from our foreign subsidiaries.

The Company's future operating results may be subject to quarterly
fluctuations as a result of a number of factors, including the timing of
deliveries of the Company's products. See "Business -- Factors That Could Affect
Future Results." Quarter-to-quarter comparisons should not be relied upon as
indicators of future performance.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

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PART III

Certain information required by Part III is omitted from this Report as we
will file a definitive proxy statement for the Annual Meeting of Shareholders to
be held on May 16, 2001, pursuant to Regulation 14A (the "Proxy Statement") not
later than 120 days after the end of the fiscal 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 specifically address
the items set forth herein are incorporated by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

Information with respect to our Directors may be found under the captions
"The Board of Directors" and "Election of Three Directors" in our Proxy
Statement. Such information is incorporated herein by reference. Information
with respect to Executive Officers may be found beginning on page 16 above,
under the caption "The Executive Officers 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 caption "Information About Our Common
Stock Ownership" in the Proxy Statement and is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information in the Proxy Statement set forth under the captions "How We
Compensate Directors," "How We Compensate Executive Officers," "The Board of
Directors" and "The Committees of the Board" is incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information in the Proxy Statement set forth under the caption
"Information About Our Common Stock Ownership" is incorporated herein by
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information set forth under the caption "Certain Transactions" in the
Proxy Statement is incorporated herein by reference.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) Exhibit Listing

EXHIBIT
NUMBER DESCRIPTION
------- -----------

27
28

EXHIBIT
NUMBER DESCRIPTION
------- -----------

10.4 1995 Independent Director Stock Option Plan(2)
10.5 1999 Stock Option Plan(5)
10.6 2000 Non-Executive Stock Option Plan(5)
10.7 Lease Agreement between Merrill Place, LLC and the Company,
dated November 21, 1997(6)
10.8 Agreement between CIT Group/Business Credit, Inc. and the
Company, dated June 29, 2000(1)
10.9 Fab I Building Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000.(7)
10.10 Conference Center Lease Agreement between Union
Semiconductor Technology Corporation and the Company, dated
as of June 30, 2000.(7)
10.11 Mendota Heights Office Lease Agreement between the Teachers
Retirement System of the State of Illinois and the Company,
dated as of August 10, 2000.(7)
23.1 Independent Auditors' Consent.

---------------
(1) Incorporated by reference to the Company's Report on Form 10-Q as filed with
the Commission on August 14, 2000.

(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.

(3) Incorporated by reference to the Company's Report on Form 8-K, as filed with
the Commission on April 17, 2000.

(4) Incorporated by reference to the Company's Report on Form 8-K, as filed with
the Commission on May 15, 2000.

(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, Registration No. 333-57970, as filed with the Commission on March 30,
2001.

(6) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.

(7) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 2000.

(b) Reports on Form 8-K

We filed no reports on Form 8-K in the fourth quarter of 2000.

28
29

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Company
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Seattle, State of Washington, on September 14, 2001.

CRAY INC.

By /s/ JAMES E. ROTTSOLK
------------------------------------
James E. Rottsolk
Chief Executive Officer and
President

In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of Company and in the capacities indicated on
September 14, 2001.

SIGNATURE TITLE
--------- -----

By /s/ JAMES E. ROTTSOLK Chief Executive Officer, President and
----------------------------------------------- Chairman of the Board of Directors
James E. Rottsolk

By /s/ BURTON J. SMITH Chief Scientist and Director
-----------------------------------------------
Burton J. Smith

By /s/ KENNETH W. JOHNSON Chief Financial Officer
-----------------------------------------------
Kenneth W. Johnson

By /s/ DOUGLAS C. RALPHS Chief Accounting Officer
-----------------------------------------------
Douglas C. Ralphs

By /s/ DAVID N. CUTLER Director
-----------------------------------------------
David N. Cutler

By /s/ DANIEL J. EVANS Director
-----------------------------------------------
Daniel J. Evans

By /s/ KENNETH W. KENNEDY Director
-----------------------------------------------
Kenneth W. Kennedy

By /s/ STEPHEN C. KIELY Director
-----------------------------------------------
Stephen C. Kiely

By /s/ WILLIAM A. OWENS Director
-----------------------------------------------
William A. Owens

By /s/ TERREN S. PEIZER Director
-----------------------------------------------
Terren S. Peizer

By /s/ DEAN D. THORNTON Director
-----------------------------------------------
Dean D. Thornton

29
30

EXHIBIT INDEX

EXHIBIT
NUMBER DESCRIPTION
------- -----------

2.1 Asset Purchase Agreement between Silicon Graphics, Inc. and
the Company, dated as of March 1, 2000(3)
2.2 Amendment No. 1 to the Asset Purchase Agreement between
Silicon Graphics, Inc., and the Company, dated as of March
31, 2000(3)
2.3 Technology Agreement between Silicon Graphics and the
Company, effective as of March 31, 2000(4)
2.4 Services Contract Agreement between Silicon Graphics, Inc.
and the Company, dated as of March 31, 2000(4)
2.5 Transition Services Agreement between Silicon Graphics,
Inc., and the Company, dated as of March 31, 2000(4)
3.1 Restated Articles of Incorporation(1)
3.2 Restated Bylaws.(7)
10.1 1988 Stock Option Plan(2)
10.2 1993 Stock Option Plan(2)
10.3 1995 Stock Option Plan(2)
10.4 1995 Independent Director Stock Option Plan(2)
10.5 1999 Stock Option Plan(5)
10.6 2000 Non-Executive Stock Option Plan(5)
10.7 Lease Agreement between Merrill Place, LLC and the Company,
dated November 21, 1997(6)
10.8 Agreement between CIT Group/Business Credit, Inc. and the
Company, dated June 29, 2000(1)
10.9 Fab I Building Lease Agreement between Union Semiconductor
Technology Corporation and the Company, dated as of June 30,
2000.(7)
10.10 Conference Center Lease Agreement between Union
Semiconductor Technology Corporation and the Company, dated
as of June 30, 2000.(7)
10.11 Mendota Heights Office Lease Agreement between the Teachers
Retirement System of the State of Illinois and the Company,
dated as of August 10, 2000.(7)
23.1 Independent Auditors' Consent.

---------------
(1) Incorporated by reference to the Company's Report on Form 10-Q as filed with
the Commission on August 14, 2000.

(2) Incorporated by reference to Form SB-2 Registration Statement, Registration
No. 33-95460-LA, as filed with the Commission on August 3, 1995.

(3) Incorporated by reference to the Company's Report on Form 8-K, as filed with
the Commission on April 17, 2000.

(4) Incorporated by reference to the Company's Report on Form 8-K, as filed with
the Commission on May 15, 2000.

(5) Incorporated by reference to the Company's Registration Statement on Form
S-8, Registration No. 333-57970, as filed with the Commission on March 30,
2001.

(6) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 1997.

(7) Incorporated by reference to the Company's Report on Form 10-K, as filed
with the Commission for the fiscal year ended December 31, 2000.

30
31

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

ASSETS

DECEMBER 31, DECEMBER 31,
1999 2000
------------ ------------

Current assets:
Cash and cash equivalents................................. $ 10,069 $ 4,626
Restricted cash........................................... 1,132 761
Accounts receivable....................................... 641 25,159
Inventory, net............................................ 4,513 23,637
Prepaid expenses and other assets......................... 544 2,835
-------- ---------
Total current assets.............................. 16,899 57,018
Property and equipment, net................................. 5,829 25,535
Service spares, net......................................... 21,139
Goodwill and intangible assets, net......................... 186 29,578
Other assets................................................ 496 2,923
-------- ---------
Total............................................. $ 23,410 $ 136,193
======== =========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,366 $ 16,247
Accrued payroll and related expenses...................... 2,147 12,028
Accrued loss on purchase commitment....................... 6,006
Other accrued liabilities................................. 209 6,574
Deferred revenue.......................................... 68 17,666
Current portion of warranty reserves...................... 17,996
Current portion of obligations under capital leases....... 612 349
Current portion of notes payable.......................... 289 8,357
-------- ---------
Total current liabilities......................... 7,691 85,223
Warranty reserves........................................... 14,285
Obligations under capital leases............................ 390 284
Notes payable............................................... 1,022 254
Commitments and contingencies
Shareholders' equity:
Common Stock, par $.01 -- Authorized, 100,000 shares;
issued and outstanding, 25,212 and 35,250 shares....... 111,443 158,799
Accumulated deficit....................................... (97,136) (122,524)
Accumulated other comprehensive income:
Cumulative currency translation adjustment................ (128)
-------- ---------
14,307 36,147
-------- ---------
Total............................................. $ 23,410 $ 136,193
======== =========

See accompanying notes.
F-1
32

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

YEARS ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
-------- -------- --------

Revenue:
Product.................................................. $ 1,274 $ 1,794 $ 46,617
Service.................................................. 714 320 71,455
-------- -------- --------
Total revenue.................................... 1,988 2,114 118,072
-------- -------- --------
Operating expenses:
Cost of product revenue.................................. 3,759 15,165 32,505
Cost of service revenue.................................. 584 273 34,077
Research and development................................. 13,664 15,216 48,426
Marketing and sales...................................... 1,830 2,517 14,365
General and administrative............................... 2,131 3,091 7,033
Amortization of goodwill and intangible assets........... 5,217
-------- -------- --------
Total operating expenses......................... 21,968 36,262 141,623
-------- -------- --------
Loss from operations....................................... (19,980) (34,148) (23,551)
Other income (expense), net................................ (106) 675
Interest income (expense), net............................. 177 (278) (1,681)
-------- -------- --------
Loss before income taxes................................... (19,803) (34,532) (24,557)
Provision for income taxes................................. 831
-------- -------- --------
Net loss................................................... (19,803) (34,532) (25,388)
Preferred stock dividend................................... (468) (115)
Amortization of preferred stock discount................... (465)
-------- -------- --------
Net loss for common shareholders........................... (20,736) (34,647) (25,388)
Other comprehensive income:
Currency translation adjustment.......................... (128)
-------- -------- --------
Comprehensive loss......................................... $(20,736) $(34,647) $(25,516)
======== ======== ========
Basic and diluted net loss per common share................ $ (1.70) $ (1.74) $ (0.78)
======== ======== ========
Weighted average shares outstanding, basic and diluted..... 12,212 19,906 32,699
======== ======== ========

See accompanying notes.
F-2
33

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)

SERIES B CONVERTIBLE
PREFERRED STOCK COMMON STOCK
--------------------- -------------------- PREFERRED CURRENCY
NUMBER OF NUMBER OF STOCK ACCUMULATED TRANSLATION
SHARES AMOUNT SHARES AMOUNT DIVIDEND DEFICIT ADJUSTMENT TOTAL
---------- -------- --------- -------- --------- ----------- ----------- --------

BALANCE, January 1, 1998........ $ 11,248 $ 49,168 $ $ (42,801) $ $ 6,367
Exercise of stock options..... 153 220 220
Exercise of warrants.......... 433 125 125
Issuance of shares under
Employee Stock Purchase
Plan........................ 30 271 271
Issuance of common stock for
leasehold improvements...... 176 1,314 1,314
Issuance of common stock for
services.................... 3 27 27
Common stock issued in private
placement................... 800 8,000 8,000
Issuance of common stock for
prepaid rent................ 13 97 97
Conversion of Series A
preferred shares............ 1,342 9,478 9,478
Issuance of Series B preferred
stock, net of issuance costs
of $326..................... 6 5,674 5,674
Issuance of common stock for
accrued dividends........... 6 45 45
Preferred stock dividend...... 75 75
Net loss...................... (19,803) (19,803)
-- ------- ------- -------- ---- --------- ----- --------
BALANCE, December 31, 1998...... 6 5,674 14,204 68,745 75 (62,604) 11,890
Issuance of shares under
Employee Stock Purchase
Plan........................ 55 270 270
Preferred stock dividend
distributed in
common stock................ 36 190 (75) 115
Common stock issued in private
placement, net of issuance
costs of $1,378............. 7,685 33,148 33,148
Beneficial conversion feature
in notes and interest
expense recognized on
convertible warrants........ 595 595
Conversion of Series B
preferred shares............ (6) (5,674) 1,275 5,559 (115)
Issuance of shares under
Company 401(k)
Plan........................ 36 144 144
Exercise of stock options..... 112 55 55
Exercise of warrants.......... 1,375 14 14
Options issued for services... 77 77
Warrants issued for
services.................... 602 602
Common stock issued in
exchange for notes.......... 434 2,046 2,046
Net loss...................... (34,532) (34,532)
-- ------- ------- -------- ---- --------- ----- --------
BALANCE, December 31, 1999...... 25,212 111,443 (97,136) 14,307
Issuance of shares under
Employee Stock Purchase
Plan........................ 179 754 754
Cash received on subscribed
common stock................ 900 900
Common stock issued in private
placement, net of issuance
costs of $1,847............. 5,227 24,287 24,287
Beneficial conversion feature
in notes and interest
expense of $200 recognized
on options.................. 1,283 1,283
Common stock issued in
exchange for notes, net of
issuance costs of $294...... 1,671 3,906 3,906
Issuance of shares under
Company
401(k) Plan................. 14 92 92
Exercise of stock options..... 69 182 182
Exercise of warrants.......... 1,878 8,885 8,885
Options issued for services... 156 156
Warrant issued for services... 211 211
Issuance of common stock to
SGI......................... 1,000 6,700 6,700
Other comprehensive income:
Cumulative currency
translation adjustment...... (128) (128)
Net loss...................... (25,388) (25,388)
-- ------- ------- -------- ---- --------- ----- --------
BALANCE, December 31, 2000...... $ 35,250 $158,799 $ $(122,524) $(128) $ 36,147
== ======= ======= ======== ==== ========= ===== ========

See accompanying notes.
F-3
34

CRAY INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1999, AND 2000
(IN THOUSANDS)

1998 1999 2000
-------- -------- --------

Operating activities
Net loss.................................................. $(19,803) $(34,532) $(25,388)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization............................. 803 1,881 14,349
Amortization of goodwill and intangible assets............ 5,217
Loss on disposal of assets................................ 3,289
Imputed interest on non interest bearing note............. 1,437
Beneficial conversion feature of notes payable............ 595 336
Non-cash warrant and option expense....................... 602 567
Inventory write down...................................... 6,589
Cash provided (used) by changes in operating assets and
liabilities, net of effects of the Cray Research
acquisition:
Accounts receivable....................................... (279) 78 (20,483)
Inventory................................................. (5,955) (2,047) 2,681
Other assets.............................................. (837) 467 (2,416)
Accounts payable.......................................... 3,332 (501) 11,587
Other accrued liabilities................................. (49) 5,331
Accrued payroll and related expenses...................... (169) 603 6,032
Warranty reserves......................................... (15,053)
Deferred revenue.......................................... 19 49 17,598
-------- -------- --------
Net cash provided by (used by) operating activities......... (22,889) (26,265) 5,084
Investing activities
Cash used for acquisition................................. (51,585)
Purchases of property and equipment....................... (2,076) (427) (5,835)
-------- -------- --------
Net cash used by investing activities....................... (2,076) (427) (57,420)
Financing activities
Restricted cash........................................... (1,132) 371
Related party (receivable)/payments....................... 61 (34) (129)
Issuance of notes payable................................. 1,900 12,500
Issuance of common stock.................................. 8,860 33,488 26,033
Proceeds from exercise of options......................... 55 182
Proceeds from exercise of warrants........................ 8,885
Principal payments on bank note........................... (71) (253)
Sale of preferred stock................................... 5,674
Capital leases............................................ 203 (607) (568)
-------- -------- --------
Net cash provided by financing activities................... 14,798 33,599 47,021
-------- -------- --------
Effect of foreign exchange rate changes on cash and cash
equivalents............................................... (128)
Net increase (decrease) in cash and cash equivalents........ (10,167) 6,907 (5,443)
Cash and cash equivalents
Beginning of period....................................... 13,329 3,162 10,069
-------- -------- --------
End of period............................................. $ 3,162 $ 10,069 $ 4,626
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest.................................... $ 202 $ 174 $ 347
Non-cash investing and financing activities
Inventory reclassified to property and equipment.......... 1,191 5,233
Common stock issued for acquisition of business........... 6,700
Fixed asset additions through common stock................ 1,314 164
Fixed asset additions through notes payable............... 933
Fixed asset additions through capital leases.............. 493 199
Note payable converted to common stock.................... 2,045 4,200
Accounts payable converted to notes....................... 594
Stock dividends........................................... 250 190
Beneficial conversion feature on notes payable............ 1,083

See accompanying notes.
F-4
35

CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ TABLES IN THOUSANDS)

NOTE 1. DESCRIPTION OF BUSINESS

Cray Inc. ("Cray" or the "Company") (formerly "Tera Computer Company")
designs, develops, markets and services high-performance computer systems,
commonly known as supercomputers. The Company presently markets two computer
systems, the Cray SV1 and T3E, and provides maintenance services to the
installed base of these and earlier models of Cray computers. The Company is
developing enhancements to the Cray SV1, and is developing three new computer
systems, the MTA-2, based on the Company's multithreaded architecture system;
the SuperCluster, a highly parallel system using leading commercial
off-the-shelf components; and the SV2, which will combine elements of the SV1
and T3E computers.

The Company has a net loss of $25.4 million for the year ended December 31,
2000. Management's plans project sufficient cash flows to finance its planned
operations for the next twelve months. In addition, subsequent to December 31,
2000, the Company entered into a $15 million financing agreement. (See Note
15 -- Subsequent Events). The Company also plans on finalizing a distribution
agreement with NEC, which will provide an equity investment of $25 million.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Principles

The consolidated financial statements and accompanying notes are prepared
in accordance with accounting principles generally accepted in the United States
of America.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. Intercompany balances and transactions have
been eliminated. Investments in affiliates which are not majority owned are
reported using the equity method.

Business Combinations

For business combinations that have been accounted for under the purchase
method of accounting, the Company includes the results of operations of the
acquired business from the date of acquisition. Net assets of the companies
acquired are recorded at their fair value at the date of acquisition. The excess
of the purchase price over the fair value of tangible net assets acquired is
included in goodwill and intangible assets in the accompanying consolidated
balance sheets.

Use of Estimates

Preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents consist of highly liquid financial instruments
that are readily convertible to cash and have original maturities of three
months or less at the time of acquisition.

F-5
36
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

Restricted Cash

Restricted cash consists of cash equivalents that serve as collateral
pursuant to lease and indebtedness agreements entered into in 1999 for the
acquisition of capital equipment.

Goodwill and Intangible Assets

Goodwill and intangible assets are amortized on a straight-line basis over
five years.

The Company periodically analyzes the carrying value of its goodwill and
intangible assets to determine that the recorded amounts are reasonable and are
not impaired. Management considers whether specific events have occurred, such
as a loss of a major customer or abandonment or loss of a product line, in
determining whether goodwill is impaired at each balance sheet date. The
determination of whether an impairment exists is based on any excess of the
carrying value over the expected future cash flows, as estimated through
undiscounted cash flows, excluding interest charges. Any resulting necessary
impairment charge would be measured based on the difference between the carrying
value of the asset and its fair value, as estimated through expected future
discounted cash flows, discounted at a rate of return for an alternate similar
investment. Based on its most recent analysis, Cray believes that no material
impairment exists at December 31, 2000.

Fair Values of Financial Instruments

At December 31, 2000, the Company had the following financial instruments:
cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and notes payable. The carrying value of cash and cash equivalents,
accounts receivable, accounts payable, accrued liabilities and notes payable
approximates their fair value based on the liquidity of these financial
instruments or based on their short-term nature.

Revenue Recognition

Cray generally recognizes revenue from product sales upon customer
acceptance; however, depending on sales contract terms, revenue may be
recognized upon shipment, or delayed until funding is definite. Service revenues
from the maintenance of computers are recognized ratably over the term of the
maintenance contract. Funds from maintenance contracts that are paid in advance
are recorded as deferred revenue.

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 US
dollars at year-end exchange rates, and revenues and expenses are translated at
average rates prevailing during the year. Translation adjustments are included
in accumulated other comprehensive loss and as 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, which have been insignificant, are included in the consolidated
statements of operations.

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
implementations of systems. Research and development costs are expensed as
incurred. Statement of Financial Accounting Standards (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
F-6
37
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

between the technological feasibility a product and completion of product
development and the insignificance of related costs incurred during this period,
no software development costs were capitalized.

Inventories

Inventories are valued at the lower of cost (first-in, first-out) or market
(LCM). The Company regularly evaluates the technological usefulness of various
inventory components. When it is discovered that previously inventoried
components do not function as intended in a fully operational system, the costs
associated with these components are expensed.

Property and Equipment

Property and equipment are recorded at cost less accumulated depreciation
and amortization. Depreciation is calculated on a straight-line basis over the
estimated useful lives of the related assets, ranging from three to seven years.
Equipment under capital leases is depreciated over the lease term. Leasehold
improvements are amortized over the lesser of their estimated useful lives or
the term of the lease.

Service Spares

Service spares are stated at cost, less accumulated depreciation.
Depreciation on service spares is computed using the straight-line method over
the estimated useful lives of three or four years.

Impairment of Long-Lived Assets

Pursuant to SFAS No. 121, management periodically evaluates long-lived
assets, consisting primarily of property and equipment and goodwill and
intangible assets, to determine whether there has been any impairment of these
assets and the appropriateness of their remaining useful lives. The Company
evaluates impairment whenever events or changes in circumstances indicate that
the carrying amount of the Company's assets might not be recoverable.
Accordingly, during 2000, the Company recorded an impairment loss of $3.3
million on certain obsolete fixed assets included in cost of product sales in
the Consolidated Statement of Operations and Comprehensive Loss.

The fixed assets consisted primarily of test equipment used to support the
gallium arsenide Cray MTA-1 product line. As the Company transitioned from
gallium arsenide technology to CMOS (complementary metal-oxide silicon)
technology, the gallium arsenide equipment had no further value to the Company
and was written off completely. Fair value is zero as there is no future use or
salvage value for this equipment. The equipment has not yet been disposed of.

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
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. The Company provides a valuation
allowance, if necessary, to reduce deferred tax assets to their estimated
realizable value.

Reclassifications

Certain prior-year amounts have been reclassified to conform with the
current-year presentation.

F-7
38
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

Net Loss Per Share

Basic and diluted net loss per share is computed based on the weighted
average number of shares of common stock outstanding.

Net loss per share has been computed in accordance with SFAS No. 128,
Earnings per Share. Under the provisions of SFAS No. 128, basic net loss per
share is computed by dividing the net comprehensive loss for the period by the
weighted average number of common shares outstanding. Common stock equivalent
shares related to stock options, warrants and shares subject to repurchase are
excluded from the calculation as their effect is antidilutive. Accordingly,
basic and diluted net loss per share are equivalent.

Segment Information

The Company has organized and managed its operations in a single operating
segment providing global sales and service of high performance computers. See
Note 14 -- Segment Information.

Warranty Reserve

Certain components in the T90 vector computers sold by Silicon Graphics
Inc. ("SGI") prior to the Company's acquisition of the Cray Research operations
have an unusually high failure rate. The cost of servicing the T90 computers
exceeds the related service revenues. The Company is continuing to take action
that commenced prior to the acquisition to address this problem, and has
recorded a reserve to provide for anticipated future losses on the T90
maintenance service contracts. Included in warranty reserves at December 31,
2000, is an accrual of $31.5 million for estimated losses on service contracts
covering the Cray Business' T90 product line. The reserve is calculated as the
excess of estimated service costs over estimated service revenues for the term
of the related contracts. Estimated service costs include cost of repair parts,
direct costs of service, indirect labor, and overhead allocations based on
management estimates of time dedicated to service T-90 contracts. Stated
contract terms are adjusted for management estimates of when T-90 products will
be replaced before the expiration of the service contract term. A summary of
warranty reserve is as follows (in thousands):

BALANCE BALANCE
DECEMBER 31, 2000 2000 DECEMBER 31,
1999 ADDITIONS DEDUCTIONS 2000
------------ --------- ---------- ------------

Warranty Reserve............................... $ -- $47,461 $(15,180) $32,281
==== ======= ======== =======

Recent Accounting Pronouncements

The Financial Accounting Standards Board issued SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, in June 1998, which is
effective for the Company beginning January 1, 2001. SFAS No. 133 requires that
all derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if it is, the type of hedge
transaction. Since the Company does not currently hold any derivative
instruments, SFAS No. 133 is not expected to have any impact on the consolidated
financial statements.

In December 1999, the United States Securities and Exchange Commission
(SEC) released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in
Financial Statements, which was required to be adopted in the Company's fourth
fiscal quarter of 2000. SAB No. 101 provides guidance on revenue recognition and
the SEC staff's views on the application of accounting principles to selected
revenue

F-8
39
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

recognition issues. The adoption of SAB No. 101 did not have a material impact
on the consolidated financial statements.

NOTE 3. PROPERTY AND EQUIPMENT, NET

A summary of property and equipment is as follows (in thousands):

DECEMBER 31,
-------------------
1999 2000
------- --------

Land.................................................... $ $ 139
Building................................................ 8,130
Furniture and equipment................................. 736 1,504
Computer equipment...................................... 8,458 28,754
Leasehold improvements.................................. 1,974 2,309
------- --------
11,168 40,836
Accumulated depreciation................................ (5,339) (15,301)
------- --------
Property and equipment, net............................. $ 5,829 $ 25,535
======= ========

NOTE 4. INVENTORY, NET

A summary of inventory is as follows (in thousands):

DECEMBER 31,
------------------
1999 2000
------- -------

Components and subassemblies............................. $ 8,044 $14,884
Work in process.......................................... 806 10,148
Finished goods........................................... 1,137 936
------- -------
9,987 25,968
LCM adjustment........................................... (5,474) (2,331)
------- -------
Inventory, net........................................... $ 4,513 $23,637
======= =======

BALANCE BALANCE
DECEMBER 31, 2000 2000 DECEMBER 31,
1999 ADDITIONS DEDUCTIONS 2000
------------ --------- ---------- ------------

LCM adjustment....................... $5,474 $3,200 $(6,343) $2,331
====== ====== ======= ======

F-9
40
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

NOTE 5. SERVICE SPARES, NET

A summary of service spares is as follows (in thousands):

DECEMBER 31,
---------------
1999 2000
---- -------

Service spares.............................................. $-- $27,697
Accumulated depreciation.................................... -- (6,558)
---- -------
Service spares, net......................................... $-- $21,139
==== =======

NOTE 6. ACQUISITION

The Company acquired certain assets of the Cray Research business unit from
Silicon Graphics, Inc. ("SGI") on April 1, 2000, in exchange for cash of $15.0
million, the issuance of one million shares of common stock valued at $6.7
million, and the issuance of a $35.3 million non-interest bearing promissory
note. Commencing April 1, 2000, the Company has included the results of
operations of the Cray Research business unit in its consolidated results of
operations.

The Company has accounted for this transaction under the purchase method of
accounting in accordance with the APB Opinion No. 16. Under the purchase method
of accounting, the purchase price was allocated to the assets acquired and
liabilities assumed based on their estimated fair values.

The following table summarizes the purchase accounting for the acquisitions
(in thousands):

Current and long term assets................................ $ 80,165
Goodwill and intangible assets.............................. 34,906
Liabilities assumed......................................... (58,223)
--------
Net assets acquired......................................... 56,848
Less: acquisition costs..................................... (1,326)
--------
Purchase price.............................................. $ 55,522
========

The following table presents the results of operations of the Company on a
pro forma basis. These results are based on the individual historic results of
the Company and the Cray Research business unit and reflect adjustments to give
effect to the acquisitions as if they had occurred at the beginning of the
periods presented (in thousands):

DECEMBER 31,
--------------------
1999 2000
-------- --------
(UNAUDITED)

Revenue................................................ $287,771 $183,820
======== ========
Net income............................................. $ 31,536 $ 5,142
======== ========
Basic and diluted net income per common share.......... $ 1.51 $ 0.16
======== ========
Weighted average shares used to compute basic and
diluted net income per common share.................. 20,906 32,949
======== ========

NOTE 7. RELATED PARTY TRANSACTIONS

During 2000, the Company accepted promissory notes in the aggregate
principal amount of $326,000 as collateral for payment by the Company of option
exercises and federal income taxes due from the exercise of employee stock
options. These notes replaced promissory notes in the aggregate principal amount
of $341,000 originally issued during 1999. The notes are due and payable in
twelve months and bear interest at a rate

F-10
41
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

of 5.74% per year. These notes and the unpaid accrued interest are secured by a
pledge of shares of Cray's common stock. The Company's rights to payment are not
limited to such security. The options exercised under these notes are considered
to be variable employee stock options under current accounting literature.
Accordingly, compensation is recognized to the extent the fair value of the
Company's stock exceeds the options' exercise price.

The Company also has an unsecured promissory note in the aggregate
principal amount of $138,000 from the Chief Executive Officer of the Company.
The note is due and payable on March 31, 2001, including accrued interest at a
rate of 9.5%. The Company recorded interest income of $1,100 for year ended
December 31, 2000, on the note. The note was paid in full on February 6, 2001.

The Company paid fees of $1.8 million as part of a private placement
completed in February 2000 to a company whose Chairman, CEO and principal
shareholder is one of the Company's directors.

As part of a common stock purchase agreement in October and December 2000
(See Note 12 -- Shareholders' Equity) the Company has accrued fees of $294,000
to a company whose Chairman, CEO and principal shareholder is one of the
Company's directors.

NOTE 8. LEASE AGREEMENTS

The Company leases certain property and equipment under capital leases
pursuant to master equipment lease agreements. Under such agreements, the
Company has acquired computer and other equipment in the amount of $1,856,000
and $2,114,000, for which $1,023,000 and $1,550,000 of accumulated depreciation
was recorded as of December 31, 1999, and 2000, respectively.

Minimum lease commitments are (in thousands):

CAPITAL OPERATING
LEASES LEASES
------- ---------

2001...................................................... $403 $ 3,474
2002...................................................... 218 3,529
2003...................................................... 88 3,013
2004...................................................... 5 3,083
2005...................................................... 2,929
Thereafter................................................ 8,251
---- -------
714 $24,279
=======
Less amounts representing interest........................ (81)
----
$633
====

Rent expense for 1998, 1999, and 2000 was $961,000, $1,929,000 and
$2,520,000, respectively.

NOTE 9. COMMITMENTS

The Company is contractually committed to acquire components, and
manufacturing and engineering services totaling $16.3 million. Commitments are
for goods and services to be provided to Cray by either specific dates or by
achieving milestones identified in the contracts.

F-11
42
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

NOTE 10. FEDERAL INCOME TAXES

Due to continued losses from operations, there has been no provision for
federal income taxes for any period. The provision for income taxes consisted of
(in thousands):

DECEMBER 31,
--------------------
1998 1999 2000
---- ---- ----

Federal:
Current.............................................. $ $ $
Deferred.............................................
State:
Current..............................................
Deferred.............................................
Foreign:
Current.............................................. 831
Deferred.............................................
--- ---- ----
Total provision for income taxes............. $ $ $831
=== ==== ====

The Company did not pay any income taxes in 1998, 1999 and 2000 due to
losses from operations. In 2000, the company purchased the assets of the Cray
Research business unit from SGI. Consequently, this is the Company's first year
with foreign income tax liabilities.

Loss before provision for income taxes consisted of (in thousands):

DECEMBER 31,
--------------------------------
1998 1999 2000
-------- -------- --------

United States...................................... $(19,803) $(34,532) $(27,219)
International...................................... 1,831
-------- -------- --------
$(19,803) $(34,532) $(25,388)
======== ======== ========

The following table reconciles the federal statutory income tax rate to the
Company's effective tax rate.

1998 1999 2000
------ ------ ------

Federal income tax rate.................................. (34.00)% (34.00)% (34.00)%
State taxes..............................................
Foreign taxes............................................ 3.27%
Other.................................................... 0.82%
Effect of net operating loss carryforwards and valuation
allowance.............................................. 34.00% 34.00% 33.18%
------ ------ ------
Effective income tax rate................................ 0.00% 0.00% 3.27%
====== ====== ======

F-12
43
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

Deferred income taxes reflect the net tax effects of temporary differences
between the tax basis of assets and liabilities and the corresponding financial
statement amounts. Significant components of the Company's deferred income tax
assets are as follows:

1999 2000
-------- --------

Warranty reserve....................................... $ 68 $ 10,976
Inventory reserve...................................... 1,862 699
Accrued compensation................................... 246 735
Stock issued for services.............................. 231
Fixed assets........................................... 123 3,340
Research and experimentation........................... 3,022 4,541
Net operating loss carryforwards....................... 29,986 40,587
State tax loss carryforwards........................... 1,577 1,500
-------- --------
Net deferred tax assets................................ 37,115 62,378
Valuation allowance for deferred tax assets............ (37,115) (62,378)
-------- --------
Deferred tax balance................................... $ $
======== ========

As of December 31, 1998, 1999 and 2000, the Company had federal net
operating loss carryforwards of approximately $60.7 million, $88.3 million and
$119.4 million, respectively. The Company also had federal research and
experimentation tax credit carryforwards of approximately $2.5 million, $3.0
million and $4.5 million, respectively. The net operating loss credit
carryforwards will expire at various dates beginning in 2003 through 2020 if not
utilized. The utilization of the federal net operating loss and credit
carryforwards are subject to annual limitations due to ownership changes of
stock in prior years.

The Company has fully reserved its deferred tax assets. Management believes
sufficient uncertainty exists regarding the realizability of the deferred tax
assets such that a full valuation allowance is required. The net change in the
valuation allowance during the years ended December 31, 1999 and 2000 was $13.0
million and $25.3 million, respectively.

F-13
44
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

NOTE 11. NOTES PAYABLE

Notes payable consists of the following at December 31, 1999 and 2000 (in
thousands except original principal and discount amounts):

1999 2000
------ -------

Note payable to bank, dated August 31, 1999, original
principal of $544,000, interest at 10.48%, due August 31,
2002, secured by equipment................................ $ 492 $ 323
Note payable to bank, dated October 7, 1999, original
principal of $389,000, interest at 8.71%, due October 7,
2002, secured by equipment................................ 370 249
Convertible note payable to vendor, dated March 25, 1999,
original principal of $494,000, interest at 8.00%, due
March 31, 2001, unsecured, net of remaining discount of
$45,000 and $8,000 for 1999 and 2000, respectively........ 449 486
Notes payable to investors, dated October 18, 2000, original
principal of $7,500,000, interest at 6.00%, due February
1, 2001, unsecured. (Note 12)............................. 3,300
Notes payable to investors, dated December 12, 2000,
original principal of $5,000,000, interest at 6.00%, due
April 3, 2001, unsecured, net of discount of $747,000.
(Note 12)................................................. 4,253
------ -------
1,311 8,611
Less current portion........................................ (289) (8,357)
------ -------
Total long-term notes payable............................... $1,022 $ 254
====== =======

The aggregate maturities of notes payable for the years 2001 through 2002
are as follows: $8,357,000 and $254,000.

The Company has an unused $5,000,000 revolving credit agreement. The
agreement contains a minimum tangible net capital covenant with which the
Company was not in compliance at December 31, 2000. Subsequent to December 31,
2000, the Company has entered into a new credit agreement. See note 15 --
Subsequent Events.

NOTE 12. SHAREHOLDERS' EQUITY

Common Stock Purchase Agreements: In October and December 2000, the Company
agreed to issue shares of common stock to certain investors covered by the
Company's shelf registration statement and to apply the purchase price for the
shares against repayment of principal and interest on certain notes payable.
Through December 2000, the Company repaid $4.2 million of the notes by
delivering an aggregate of 1,671,094 shares of common stock at an average price
of $2.51 per share, which reflects an 8% discount from the daily volume weighted
average trading price for the Company's stock. Unless the Company prepays the
notes, it will repay the remaining $8.3 million of the notes by issuing
additional shares of common stock to the investors, using a 9% discount from the
average of the daily volume weighted average trading prices over the period from
the first week of January through March 2001. The discounts of 8% or 9%,
respectively, from the daily volume weighted average trading price for the
Company's stock resulted in beneficial conversion features on the notes payable.
These beneficial conversion features were accounted for in accordance with EITF
98-5, Accounting for Convertible Securities with Beneficial Conversion Features
or Contingently Adjustable Conversion Ratios, resulting in the recording of
additional paid in capital and a discount on the notes payable for the intrinsic
value of the beneficial conversion features.

F-14
45
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

Shareholder Warrants: At December 31, 2000, the Company had outstanding and
exercisable warrants to purchase an aggregate of 14,801,096 shares of common
stock, as follows:

SHARES OF EXERCISE PRICE EXPIRATION
COMMON STOCK PER SHARE DATE OF WARRANTS
------------ -------------- ------------------

90,488 $6.00 December 31, 2001
97,208 $6.00 February 28, 2002
282,500 $3.94 April 21, 2002
7,311,055 $4.72 June 21, 2002
155,000 $4.50 June 25, 2002
87,500 $6.00 December 23, 2002
80,672 $4.72 September 28, 2003
100,000 $6.00 January 20, 2004
200,000 $4.72 March 9, 2004
25,000 $5.16 March 9, 2004
1,111,111 $4.72 March 9, 2004
100,000 $6.00 March 30, 2004
14,829 $5.00 March 31, 2004
5,801 $6.00 November 7, 2005
524 $6.00 May 21, 2006
5,139,408 $2.53 June 21, 2009
----------
14,801,096
==========

For expense recorded in the three years ended December 31, 2000, warrants
were valued at their fair values using the Black-Scholes model based on the
volatility of the Company's stock, the contractual life of the warrants, and the
risk-free rate of return.

As part of a financing completed on June 21, 1999, the Company issued a
warrant to a director of the Company, in exchange for cash of $200,000,
exercisable for a minimum of 1,591,723 shares of common stock. In 2000, the
number of shares subject to this warrant increased to 10% of the Company's
issued and outstanding shares, on a fully diluted basis, with certain limited
exceptions to 5,139,408 shares.

Stock Option Plans: The Company has six stock option plans that provide for
option grants to employees, directors and others. Four of these plans, the 1988
Employee Stock Option Plan, the 1993 Employee Stock Option Plan, the 1995
Employee Stock Option Plan, and the 1995 Independent Director Stock Option Plan
were terminated by the Board of Directors in 1995 and 1999. Options granted
under the Company's option plans generally vest over four years or as otherwise
determined by the plan administrator. Options to purchase shares expire no later
than ten years after the date of grant.

F-15
46
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

A summary of Cray's stock option activity and related information follows:

OUTSTANDING
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE
OUTSTANDING PRICE EXERCISABLE PRICE
----------- ----------- ----------- --------

Balance, January 1, 1998.................... 2,035,905 $4.37 931,309 $3.25
Granted................................... 742,090 8.44
Exercised................................. (153,234) 1.43
Canceled.................................. (41,725) 6.61
---------
Balance, December 31, 1998.................. 2,583,036 5.68 1,158,125 4.15
Granted................................... 1,320,439 5.17
Exercised................................. (107,513) 0.56
Canceled.................................. (100,616) 4.65
---------
Balance, December 31, 1999.................. 3,695,346 5.68 1,158,125 5.29
Granted................................... 4,924,513 5.48
Exercised................................. (69,479) 2.69
Canceled.................................. (326,375) 5.16
---------
Balance, December 31, 2000.................. 8,224,005 $5.61 2,428,813 $5.59
=========
Available for grant at December 31, 2000.... 6,535,839
=========

Outstanding and exercisable options by price range as of December 31, 2000
are as follows:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE AVERAGE
EXERCISE PRICE NUMBER REMAINING EXERCISE NUMBER EXERCISE
PER SHARE OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
-------------- ----------- ------------ -------- ----------- --------

$ 0.35 - $ 3.00 256,782 5.3 $ 1.89 148,448 $ 1.64
3.01 - 6.00 5,445,424 8.3 4.88 1,574,596 5.11
6.01 - 9.00 2,512,799 8.5 7.54 699,769 7.44
9.01 - 12.00 -- -- -- -- --
12.01 - 15.00 9,000 7.3 13.69 6,000 13.69
--------------- --------- --- ------ --------- ------
$ 0.35 - $15.00 8,224,005 8.3 $ 5.61 2,428,813 $ 5.59
=============== ========= === ====== ========= ======

In 1996, the Company established an Employee Stock Purchase Plan (1996
ESPP). The maximum number of shares of the Company's common stock that employees
may acquire under the 1996 ESPP is 1,000,000 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 1996 ESPP is the lower of (a) 85% of the fair market value of the Company's
Common Stock at the beginning of each six month offering period or (b) the fair
market value of the Common Stock at the end of each six month offering period.

Fair Value Information: The Company applies APB Opinion No. 25, Accounting
for Stock Issued to Employees and related Interpretations in accounting for its
stock option and purchase plans. Had compensation cost for the Company's stock
option plans and its stock purchase plan been determined based on the fair value
at the grant dates for awards under those plans consistent with the method of
SFAS No. 123, Accounting for Stock-Based Compensation, the Company's net loss
for common stock and net loss per

F-16
47
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

common share for the years ended December 31, 1998, 1999, and 2000 would have
been increased to the pro forma amounts indicated below:

Net loss for common shareholders (in thousands):

1998 1999 2000
-------- -------- --------

As reported........................................ $(20,736) $(34,647) $(25,388)
Pro forma.......................................... $(22,933) $(37,444) $(41,971)

Basic and diluted net loss per common share:

1998 1999 2000
------ ------ ------

As reported.............................................. $(1.70) $(1.74) $(0.78)
Pro forma................................................ $(1.88) $(1.88) $(1.28)

The weighted average Black-Scholes value of options granted under the stock
option plans during 1998, 1999, and 2000 was $9.35, $4.42, and $5.29. Fair
values were estimated as of the dates of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions: no
dividend yield, expected volatility of 94%, 85 % and 98% for 1998, 1999, and
2000, respectively, risk-free interest rate of 5.7%, 5.4%, and 5.2% for 1998,
1999 and 2000, respectively, and an expected term of 9.6, 8.4, and 8.4 years for
1998, 1999, and 2000, respectively.

NOTE 13. 401(K) PLAN

The Company has a defined contribution retirement plan covering
substantially all employees that provides for voluntary salary deferral
contributions on a pre-tax basis in accordance with Section 401(k) on the
Internal Revenue Code of 1986, as amended. The Company may make voluntary
matching contributions in amounts determined annually by the Board of Directors.
Defined contribution pension expense was $139,000, $183,000 and $713,000 for
1998, 1999, and 2000, respectively.

NOTE 14. 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 and the executive
management team. As of December 31, 2000, Cray operates in one business segment:
global sales and service of high performance computers.

Revenue from U.S. Government agencies or commercial customers primarily
serving the U.S. Government totaled approximately $63.4 million in 2000.

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.

F-17
48
CRAY INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
($ TABLES IN THOUSANDS)

Geographic revenue and long-lived assets related to operations as of and
for the year ended December 31, 2000, were as follows:

UNITED ASIA
STATES EMEA JAPAN PACIFIC TOTAL
------- ------- ------ ------- -------

Product revenue............................ $41,368 $ 2,748 $2,501 $ -- $46,617
======= ======= ====== ====== =======
Service revenue............................ $43,926 $17,706 $7,015 $2,808 $71,455
======= ======= ====== ====== =======
Long lived assets.......................... $69,009 $ 5,245 $3,406 $1,515 $79,175
======= ======= ====== ====== =======

No prior year comparative information has been presented as the Company did
not have significant operations outside the United States prior to the Cray
Research acquisition on April 1, 2000.

NOTE 15. SUBSEQUENT EVENTS

In February 2001 the Company signed a distribution agreement with NEC
Corporation to distribute and service NEC SX-5 vector processor computers and
its successors. This agreement provides the Company with exclusive distribution
and servicing in the United States, Canada and Mexico, and non-exclusive rights
in the rest of the world. Current duties under the U.S. anti-dumping laws
effectively prohibit the importation of these computers into the U.S. The
Company has requested that the U.S. Government remove these duties. Assuming
these duties are removed as expected, the Company plans on marketing NEC SX-5
series computers to customers and industries with a need for significant
performance improvements, particularly in the United States. As part of the
agreement, NEC will invest $25 million of cash in Cray, in exchange for
3,125,000 non-voting, preferred shares, convertible into Cray common stock at a
fixed conversion price of $8.00 per share.

In March 2001, the Company entered into a credit agreement with Foothill
Capital Corporation. This line of credit replaced the Company's existing credit
agreement in place at December 31, 2000. The credit agreement makes available
$15 million through March 2004. The credit agreement provides $7.5 million of
borrowings in the form of a revolving line of credit based on eligible domestic
and foreign product accounts receivable, and $7.5 million of borrowings in the
form of a term loan. Borrowings under the credit agreement are secured by
property, plant and equipment and bear interest at the prime rate plus 2% for
the revolving line of credit and at the prime rate plus 3.25% for the term loan.
The credit agreement contains financial covenants relating to tangible net
worth, EBITDA and domestic service revenue.

F-18
49

Deloitte & Touche LLP
Suite 4500
700 Fifth Avenue
Seattle, Washington 98104-5044

Tel: (206) 292-1800
Fax: (206) 343-7809
www.us.deloitte.com

LOGO

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INDEPENDENT AUDITORS' REPORT

Board of Directors and Shareholders
Cray Inc.
Seattle, Washington

We have audited the accompanying consolidated balance sheets of Cray Inc. and
subsidiaries (the Company) as of December 31, 2000 and 1999, and the related
consolidated statements of operations and comprehensive loss, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Cray Inc. and subsidiaries as of
December 31, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2000, in
conformity with accounting principles generally accepted in the United States of
America.

/s/ Deloitte & Touche Signature

February 9, 2001
(March 28, 2001 as to Note 15)

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F-19