UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.  )

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Cray Inc.

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NOTICE OF 2009 ANNUAL MEETING OF SHAREHOLDERS

 

Dear Cray Inc. Shareholder:

 

You are cordially invited to attend our Annual Meeting of Shareholders, which will be held at our principal executive offices located at 901 Fifth Avenue, Fifth Avenue Conference Room, Seattle, Washington 98164 on Wednesday, May 13, 2009, at 3:00 p.m. Pacific Time.

 

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

 

 

Any action on the items of business described above may be considered at the Annual Meeting at the scheduled time and date specified above or at any time and date to which the Annual Meeting may be properly adjourned or postponed. Your Board of Directors recommends a vote FOR the election of the nominees for director, FOR the approval of our 2009 Long-Term Equity Compensation Plan and FOR ratification of the appointment of our independent auditors.

 

Only shareholders of record on March 16, 2009, the record date for the Annual Meeting, are entitled to vote on these matters.

 

At the Annual Meeting, we will review our performance during the past year and comment on our outlook. You will have an opportunity to ask questions about Cray and our operations.

 

As we did last year, we are furnishing proxy materials over the Internet. Please read the Proxy Statement for more information on this alternative for distributing our proxy materials, which we believe will allow us to provide shareholders with the information they need, while lowering the costs of delivering the Proxy Statement and related materials and reducing the environmental impact of the Annual Meeting.

 

Your vote is important regardless of the number of shares you own or whether you plan to attend the Annual Meeting in person. You may vote through several different ways, and instructions on the various voting methods are contained in the accompanying Proxy Statement. Even if you plan to attend the Annual Meeting, we urge you to vote at your earliest convenience so we avoid further solicitation costs. Any shareholder attending the meeting may vote in person even if he or she has voted previously.

 

Details of the business to be conducted at the Annual Meeting are more fully described in the accompanying Proxy Statement.

 

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

 

Sincerely,

 

 

Peter J. Ungaro
President and Chief Executive Officer

 

Seattle, Washington

March 31, 2009

 

PROXY STATEMENT

 

TABLE OF CONTENTS

 

 

 

 

CRAY INC.
901 Fifth Avenue, Suite 1000
Seattle, WA 98164

 

PROXY STATEMENT FOR
ANNUAL MEETING OF SHAREHOLDERS
To Be Held At:
901 Fifth Avenue, Fifth Avenue Conference Room
Seattle, WA 98164
3:00 P.M. Pacific Time
May 13, 2009

 

 

 

 

 

 

The following table shows, as of March 16, 2009, the number of shares of our common stock beneficially owned by the following persons: (a) all persons we know to be beneficial owners of at least 5% of our common stock, (b) our directors, (c) the executive officers named in the Summary Compensation Table on page 26, and (d) all current directors and executive officers as a group. As of March 16, 2009, there were 34,052,839 shares of our common stock outstanding.

 

 

 

 

 

 

 

 

 

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

 

We are required to tell you in this Proxy Statement if we know about any failure to report as required. We reviewed copies of all reports furnished to us and obtained written representations that no other reports were required. Based on this, we believe that all of these reporting persons complied with their filing requirements for 2008.

 

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

 

The goals of our Board of Directors are to build long-term value for our shareholders and to assure our vitality for our customers, employees and others that depend on us. Our Board has adopted and follows corporate governance practices that our Board and our senior management believe promote these purposes, are sound and represent best practices. To this end we have established the following:

 

 

Under our Corporate Governance Guidelines and the applicable Committee charters, each director has complete access to the management of the Company, and the Board and each Committee have the right to consult and retain independent legal counsel, accountants and other advisers at the expense of the Company. All of the foregoing documents are available on the Internet at our website at: www.cray.com under “ Investors — Corporate Governance.” We will post on this website any amendments to the Code of Business Conduct or waivers of the Code for directors and executive officers.

 

We periodically review our governance practices against requirements of the SEC, the listing standards of the Nasdaq Global Market (“Nasdaq”), the laws of the State of Washington and practices suggested by recognized corporate governance authorities.

 

Currently our Board has eight members. The Board has determined that all our directors, except for Mr. Ungaro, our Chief Executive Officer and President, meet the Nasdaq and SEC standards for independence and that all members of the Audit Committee meet the heightened independence standards required for audit committee members under Nasdaq and SEC standards. Only independent directors may serve on our Audit, Compensation and Corporate Governance Committees.

 

As set forth in our Corporate Governance Guidelines, the Board believes that at least two-thirds of the Board should consist of independent directors and that, absent compelling circumstances, the Board should not contain more than two members from our management. Currently, seven of our eight directors are considered independent, and one member of management, Mr. Ungaro, our Chief Executive Officer and President, is on the Board.

 

In determining the independence of our directors, the Board affirmatively decides whether a non-management director has a relationship that would interfere with that director’s exercise of independent judgment in carrying out the responsibilities of being a director. In coming to that decision, the Board is informed of the Nasdaq and SEC rules that disqualify a person from being considered as independent, considers the responses from each director to an annual questionnaire and reviews the applicable standards with each Board member.

 

The Board met 9 times and the Board’s standing committees held a total of 25 meetings during 2008. The rate of attendance in 2008 for all directors at Board and standing committee meetings was 99.3%.

 

The non-management directors meet in executive session of the Board on a regular basis, generally at the beginning and the end of each scheduled Board meeting. In addition, the Board committees meet periodically without members of Company management present.

 

The Board has established an Audit Committee, a Compensation Committee, a Corporate Governance Committee and a Strategic Technology Assessment Committee as standing committees of the Board. None of the directors who serve as members of these committees is, or has ever been, one of our employees.

 

Audit Committee.  The current members of the Audit Committee are: Daniel C. Regis (Chair), Sally G. Narodick and Stephen C. Richards. The Audit Committee and the Board have determined that each individual who currently is and who in 2008 was a member of the Audit Committee is “independent,” as that term is defined in SEC and Nasdaq rules and regulations, and that Mr. Regis is an “audit committee financial expert,” as that term is defined in SEC regulations. The Audit Committee had 13 meetings during 2008. As noted above, the Committee’s charter is available at: www.cray.com under “Investors — Corporate Governance.” The Audit Committee assists the Board of Directors in fulfilling its responsibility for oversight of:

 

 

 

The Audit Committee reviews all reports submitted on our anonymous, confidential reporting system and is directly and solely responsible for appointing, determining the compensation payable to, overseeing, terminating and replacing any independent auditor engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for us. See “Discussion Of Proposals Recommended By The Board — Proposal 3: To Ratify the Appointment of Peterson Sullivan LLP as Our Independent Auditors — Audit Committee Pre-Approval Policy” below.

 

The report of the Audit Committee regarding its review of the financial statements and other matters is set forth below beginning on page 44.

 

Compensation Committee.  The current members of the Compensation Committee are: Frank L. Lederman (Chair), John B. Jones, Jr., Stephen C. Kiely and Stephen C. Richards. The Compensation Committee and the Board have determined that each individual who currently is and who in 2008 was a member of the Compensation Committee is “independent,” as that term is defined in Nasdaq rules and regulations, and an “outside director” within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended. The Compensation Committee held 4 meetings in 2008. As noted above, the Committee’s charter is available at: www.cray.com under “Investors — Corporate Governance.” The Compensation Committee assists the Board of Directors in fulfilling its responsibilities for the oversight of:

 

 

See “Compensation of the Executive Officers — Compensation Discussion and Analysis” for further information regarding the Compensation Committee and its actions with respect to senior officer compensation. The Compensation Committee’s Report on the Compensation Discussion and Analysis and related matters is set forth below on page 31.

 

Corporate Governance Committee.  The current members of the Corporate Governance Committee are: Stephen C. Kiely (Chair), Frank L. Lederman and Daniel C. Regis. The Corporate Governance Committee and the Board have determined that each individual who currently is and who in 2008 was a member of the Corporate Governance Committee is “independent,” as that term is defined in Nasdaq rules and regulations. The Corporate Governance Committee held 4 meetings in 2008. As noted above, the Committee’s charter is available at: www.cray.com under “Investors — Corporate Governance.” The Corporate Governance Committee has the responsibility to:

 

 

See the section below entitled “Shareholder Communications, Director Candidate Recommendations and Nominations and Other Shareholder Proposals” regarding the Committee’s processes for evaluating potential Board members and how shareholders can nominate director candidates, propose matters to come before the shareholders and communicate with the Board.

Strategic Technology Assessment Committee.  The current members of the Strategic Technology Assessment Committee are William C. Blake (Chair), Frank L. Lederman and John B. Jones, Jr. The Strategic Technology Assessment Committee and the Board have determined that each individual who currently is and who in 2008 was a member of the Strategic Technology Assessment Committee is “independent,” as that term is defined in Nasdaq rules and regulations, although such independence is not a requirement for membership on this Committee. The Strategic Technology Assessment Committee held 4 meetings in 2008. As noted above, the Committee’s charter is available at: www.cray.com under “Investors — Corporate Governance.” The Strategic Technology Assessment Committee has the responsibility:

 

 

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

 

Mr. Kiely has served as Chairman of the Board, a non-executive position, since August 2005. As Chairman, Mr. Kiely consults with Mr. Ungaro, as Chief Executive Officer, regarding agenda items for Board meetings; chairs executive sessions of the Board’s independent directors; on behalf of the independent directors, provides feedback, coaching and mentoring to the Chief Executive Officer; and performs such other duties as the Board deems appropriate.

 

We encourage but do not require our directors to attend the Annual Meeting of Shareholders. We usually schedule a regular Board meeting on the morning before the Annual Meeting. In 2008, all eight of our directors attended the 2008 Annual Meeting.

 

Communications.  The Corporate Governance Committee has established a procedure for our shareholders to communicate with the Board. Communications should be in writing, addressed to: Corporate Secretary, Cray Inc., 901 Fifth Avenue, Suite 1000, Seattle, WA 98164, and marked to the attention of the Board or any of its individual committees or the Chairman of the Board. Copies of all communications so addressed will be promptly forwarded to the chairman of the committee involved, in the case of the communications addressed to the Board as a whole, to the Corporate Governance Committee or, if addressed to the Chairman, to the Chairman of the Board.

 

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

 

Once the Corporate Governance Committee has identified a potential director nominee, the Committee in consultation with the Chief Executive Officer evaluates the prospective nominee against the specific criteria that the Board has established and as set forth in our Corporate Governance Guidelines. If the Corporate Governance Committee determines to proceed with further consideration, then members of the Corporate Governance Committee, the Chief Executive Officer and other members of the Board, as appropriate, interview the prospective nominee. After completing this evaluation and interview, the Corporate Governance Committee makes a recommendation to the full Board, which makes the final determination whether to elect the new director.

The Corporate Governance Committee will consider candidates for director recommended by shareholders and will evaluate those candidates using the criteria set forth above. Shareholders should accompany their recommendations with a sufficiently detailed description of the candidate’s background and qualifications to allow the Corporate Governance Committee to evaluate the candidate in light of the criteria described above, a document signed by the candidate indicating his or her willingness to serve if elected and evidence of the nominating shareholder’s ownership of our common stock. Such recommendation and documents should be submitted in writing to: Corporate Secretary, Cray Inc., 901 Fifth Avenue, Suite 1000, Seattle, WA 98164, marked to the attention of the Corporate Governance Committee.

 

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

 

 

The Chairman of the Board, in his discretion, may determine that a proposed nomination was not made in accordance with the required procedures and, if so, disregard the nomination.

 

Shareholder Proposals.

 

2009 Annual Meeting.  In order for a shareholder proposal to be raised from the floor during the 2009 Annual Meeting, written notice of the proposal must be received by us not less than 60 nor more than 90 days prior to the meeting or, if later, by the 10th business day following the first public announcement of the meeting. The proposal must also contain the information required in our Bylaws for shareholder proposals, including:

 

 

The Chairman of the Board, if the facts so warrant, may direct that any business was not properly brought before the meeting in accordance with our Bylaws.

 

2010 Proxy Statement.  In order for a shareholder proposal to be considered for inclusion in our proxy statement for the 2010 Annual Meeting, we must receive the written proposal no later than December 1, 2009. Shareholder proposals also must comply with SEC regulations regarding the inclusion of shareholder proposals in company-sponsored proxy materials.

If you wish to obtain a free copy of our Articles, Bylaws or any of our corporate governance documents, please contact Kenneth W. Johnson, Corporate Secretary, Cray Inc., 901 Fifth Avenue, Suite 1000, Seattle, WA 98164. These documents also are available on our website: www.cray.com under “Investors — Corporate Governance.”

 

In setting director compensation in order to attract and retain highly qualified individuals to serve on our Board, the Corporate Governance Committee considers the significant amount of time that directors expend in fulfilling their duties, the skill level required of members of the Board, and a general understanding of director compensation at companies of similar size and complexity. Directors who are employed by us receive no compensation for their service on the Board. As described more fully below, director compensation is in the form of cash and, in order to align further the longer-term interests of the individual directors and shareholders, equity, with the grant of a vested stock option with a ten-year term upon first joining the Board and annual grants of restricted stock vesting generally over two years.

 

The Corporate Governance Committee reviews director compensation annually but has made no changes to director compensation since 2006 except to increase the compensation of the chair of the Compensation Committee to $6,000 annually, the same as the chair of the Audit Committee, effective for the fourth quarter of 2007, given the increased duties and responsibilities of that role. In reaching decisions about director compensation, the Corporate Governance Committee has used publicly available professional compensation surveys, proxy data and the individual experience of the Committee members. To date the Committee has decided not to engage a compensation consultant with respect to director compensation.

 

Cash Compensation

 

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

 

Equity Compensation

 

Stock Options.  Each non-employee director, upon his or her first election to the Board, is granted an option for 5,000 shares, vesting immediately, with an exercise price equal to the fair market value of our common stock on the date of such first election.

 

Restricted Stock Awards.  We currently grant to each continuing non-employee director elected by the shareholders restricted shares of common stock with a value equal to that director’s fees earned in the previous fiscal year. The per share value of shares granted is determined by using the fair market value of our common stock on the date of such election. One-half of the shares are restricted against sale or transfer for a period of approximately one year from date of grant; the balance is restricted against sale or transfer for a period of approximately two years from the date of grant. The non-employee directors may vote and receive dividends on the restricted shares while the restrictions remain in place; we have not granted any dividends on our common stock and have no plans to do so. The restricted shares vest in full if a non-employee director can no longer serve due to death or Disability or if, following a Change of Control, the non-employee director is removed from the Board or is not nominated to continue to serve as a Director. The restricted shares are forfeited if, while unvested, a non-employee director resigns or retires from the Board (other than with the express approval of the Corporate Governance Committee), is asked to leave the Board by the Corporate Governance Committee for Cause or is not nominated by the Board to continue as a director other than following a Change of Control.

For purposes of the director restricted stock agreements, the following definitions apply:

 

“Cause” means a good faith determination by the Board of Directors that a director has willfully failed or refused in a material respect to follow reasonable policies or directives established by the Board of Directors, including the Corporate Governance Guidelines, or willfully failed to attend to material duties or obligations of the director’s office (other than any such failure resulting from his incapacity due to physical or mental illness), which the director has failed to correct within a reasonable period following written notice to the director; or there has been an act by the director involving wrongful misconduct which has a demonstrably adverse impact on or material damage to us or our subsidiaries, or which constitutes a misappropriation of our assets; or the director has engaged in an unauthorized disclosure of our confidential information; or the director has materially breached his or her obligations under the agreement or in another agreement with us.

 

“Change of Control” means and includes each and all of the following: our shareholders approve a merger or consolidation of us with any other corporation (other than to change our state of incorporation or which does not effect a substantial change in ownership), or our shareholders approve a plan of complete liquidation or an agreement for the sale or disposition of all or substantially all of our assets; the acquisition by any person or entity as “beneficial owner,” directly or indirectly, of securities representing 50% or more of the total voting power represented by our then outstanding voting securities except pursuant to a negotiated agreement with us and pursuant to which such securities are purchased from us; a majority of the Board in office at the beginning of any 36-month period is replaced during the course of such 36-month period (other than by voluntary resignation of individual directors in the ordinary course of business) and such placement was not initiated by the Board as constituted at the beginning of such 36-month period.

 

“Disability” means that, at the time a director’s employment is terminated, the director has been unable to perform the duties of the director’s position for a period of six consecutive months as a result of the director’s incapability due to physical or mental illness.

 

Stock Ownership Guidelines.  The Board has established the following stock ownership guidelines for non-employee directors:

 

 

Each director was in compliance with the foregoing stock ownership guidelines as of December 31, 2008.

Director Compensation for 2008

 

The following table sets forth information regarding compensation earned by our non-employee directors for the year ended December 31, 2008, even if paid in 2009. Mr. Ungaro is not included in this table as he is an employee and he receives no compensation for his service as a director. His compensation as an employee is shown in the Summary Compensation Table on page 32.

 

 

 

 

Additional Information About Non-Employee Director Equity Awards

 

The following table provides additional information about non-employee director equity awards, including the stock awards made to non-employee directors during 2008, the grant date fair value of each of those awards, and the number of stock options and shares of restricted stock held by each non-employee director on December 31, 2008:

 

 

 

 

Each of these non-employee directors has been nominated for reelection to a one-year term at the Annual Meeting of Shareholders to be held on May 13, 2009. If these individuals are reelected for another year, then each will receive additional shares of common stock that will vest 50% approximately one year after grant and the remaining 50% approximately two years after grant, as discussed under “Equity Compensation — Restricted Stock Awards” above. The number of such shares issued will be determined by dividing the total amount of cash fees earned for 2008 set forth in the above table entitled “Director Compensation for 2008” by the fair market value of our common stock on the date of the 2009 Annual Meeting. See “Discussion of Proposals Recommended by the Board — Proposal 1: To Elect Eight Directors For One-Year Terms” below.

 

The following discussion describes the material elements of compensation for our executive officers identified in the “Summary Compensation Table” below (the “Named Executive Officers”) and our other senior officers.

 

Summary of Compensation Decisions in 2008

 

For the reasons and as described in more detail below, with respect to our Named Executive Officers:

 

 

Philosophy and Objectives

 

Our compensation philosophy for all employees, including the Named Executive Officers, is to provide policies, plans and programs designed to attract, retain and motivate the best employees at all levels to allow us to achieve our goals of market leadership and sustained profitability. To assist in these efforts, our compensation program has the following objectives:

 

 

Compensation Program Components and Purposes

 

We believe the components of our compensation program described below provide an appropriate mix of fixed and variable pay, balance incentives for short-term operational performance with long-term increases in shareholder value, reinforce a high performance culture and encourage recruitment and retention of our employees and officers. As employees assume greater levels of responsibility, an increasing proportion of their compensation is linked to performance. We review our compensation program periodically and make adjustments as needed or appropriate in order to meet our objectives. We have described below the principal components of our compensation program and the purpose of each component.

 

 

 

 

 

 

 

 

 

 

 

 

 

We do not provide to the Named Executive Officers or our other senior officers any deferred compensation or special retirement or pension plans or perquisites that are not available to our employees generally.

 

The Executive Compensation Process

 

Role and Authority of the Compensation Committee

 

The current members of the Compensation Committee are: Frank L. Lederman (Chair), John B. Jones, Jr., Stephen C. Kiely and Stephen C. Richards. The Compensation Committee and the Board have determined that each individual who served on the Compensation Committee in 2008 and each current member of the Committee is “independent,” as that term is defined in Nasdaq rules and regulations, and an “outside director” within the meaning of Section 162(m) of the Internal Revenue Code of 1986.

 

The Compensation Committee assists our Board of Directors in fulfilling its responsibilities for the oversight of our compensation policies, plans and benefit programs, the compensation of our Chief Executive Officer and other senior officers, and the administration of our equity compensation plans and our 401(k) plan. After reviewing our corporate goals, business plan and objectives for the year, the Committee determines base salary, the level of target awards under our annual cash incentive plan, including the balanced scorecard goals and objectives, and the number and type of equity grants to be awarded under our long-term equity incentive plans for our senior officers during that year. The Committee has the authority to determine the annual compensation for our senior officers, other than for the Chief Executive Officer. The Committee evaluates the performance of and recommends the compensation of our Chief Executive Officer to the full Board. In practice, our full Board reviews and approves the compensation of all of our Named Executive Officers and certain other senior officers in executive sessions of non-employee directors.

 

Role of the Chief Executive Officer and Management

 

The Compensation Committee, which met in person or by telephone four times in 2008 and six times in 2007, confers regularly with Mr. Ungaro, our Chief Executive Officer, and other senior officers and members of our Human Resources department regarding the structure and effectiveness of our compensation plans and proposals

for changes to our compensation programs. As members of our Board, Committee members obtain information regarding our tactical and strategic objectives, goals, operational and financial results, our annual financial plan and the outlook regarding our future performance. The Committee meets in executive session twice annually with Mr. Ungaro to review his performance and his evaluation of the performance of other senior officers and annually to review his recommendations for the compensation of the other senior officers, including the other Named Executive Officers. These recommendations cover base salary, the structure of the annual cash incentive plan, including target awards and performance goals and objectives for each senior officer, and the level and form of equity grants.

 

Role of Compensation Consultants

 

In August 2007, the Compensation Committee retained the compensation firm of Watson Wyatt Worldwide to conduct a competitive review of our compensation programs for senior officers and to advise the Committee regarding a total compensation philosophy. The Committee previously had obtained significant executive compensation information through our mid-2005 restructuring of our senior executive team, which included promoting Peter J. Ungaro first to President and later to Chief Executive Officer, and adding Margaret A. Williams, Brian C. Henry and Steven L. Scott to key executive officer positions, and through subsequent searches for a senior high performance computing sales executive in 2006 and 2007 which culminated with Ian W. Miller joining us in early 2008. The decision to retain a compensation consultant was in part in recognition that the market information obtained in connection with the 2005 officer hires was aging, and that the Committee could use an independent broad view of current compensation levels, practices and programs, particularly in the high technology industry. Watson Wyatt completed its review and made its recommendations in November 2007. Given this timing, these recommendations did not affect 2007 compensation but were used by the Committee as a framework for its decisions regarding 2008 compensation for the Named Executive Officers and other senior officers. Watson Wyatt reported directly to the Committee, and was not previously retained by our management and has not since performed any tasks for our management. If our management wishes to retain Watson Wyatt for any services, those services must receive the prior approval of the Chair of the Compensation Committee.

 

In preparing its recommendations to the Compensation Committee, Watson Wyatt reviewed numerous sources of competitive data, particularly the 2006-2007 Watson Wyatt Data Services’ Top Management Report, the 2006/2007 Mercer Executive Compensation Survey and the 2007 Radford Executive Compensation Survey. In addition to these published surveys, Watson Wyatt also analyzed the compensation of named executives of 20 peer companies through their most recently filed proxy statements. The peer companies are high technology companies with employee counts and revenue similar to ours (we ranked between the 50^th and 75^th percentile in employee count and just above the 25^th percentile in revenue, based on 2007 information). The peer companies Watson Wyatt used were: Adaptec, Inc., Datalink Corporation, Dot Hill Systems Corp., Electro Scientific Industries Inc., F5 Networks, Inc., FEI Company, Hypercom Corporation, Intevac Inc., Iomega Corporation, Isilon Systems, Inc., Lattice Semiconductor Corporation, Mercury Computer Systems, Inc., Overland Storage, Inc., Park Electochemical Corp., Presstek, Inc., Rackable Systems, Inc., Rimage Corporation, Silicon Graphics, Inc., Stec Inc., and TriQuint Semiconductor, Inc.

 

Benchmarking and Other Factors

 

For its 2008 decisions the Compensation Committee considered the Watson Wyatt recommendations to frame the overall total compensation approach and general market competitiveness. As in previous years, the Committee, in making specific decisions regarding each Named Executive Officer’s compensation, also considered internal and external relative parity among senior management, the experience and performance of individual officers, their current compensation levels and the reasonableness of the officer’s compensation in light of our compensation objectives and our operational and financial performance. Historically, we have had a relatively flat salary structure for our senior officers, with the significant differences in total compensation among the senior officers being reflected in short-term cash and long-term equity incentive awards. This approach helps us manage our fixed costs and yet provides the potential for higher compensation levels based on performance-dependent short-term and long-term incentives.

 

The Committee did not benchmark to a specified level of compensation in the surveys or the peer companies for these reasons. The Committee also recognized that competition for most of our Named Executive Officers often

comes from much larger companies, whether in the high performance computing industry or other technology companies, for which directly comparable compensation information is not publicly available. The Committee also believes that for technical and engineering positions, such as those held by Ms. Williams and Mr. Scott, there are less consistently defined positions across technology companies so that the survey and peer group compensation information is less directly applicable to them, and that each of these officers has significant high performance computing experience and achievements and roles not reflected in general survey and peer group analyses. In the end, the Committee relied substantially on its collective experience and judgment to establish the 2008 compensation for the Named Executive Officers and other senior officers.

 

Analysis of 2008 Compensation Determinations

 

Overview — Total Target Compensation

 

After considering the Watson Wyatt recommendations, the Compensation Committee adopted a total target compensation approach for our Named Executive Officers and other senior officers that framed its decisions covering:

 

 

Given our operational and financial performance prior to 2008 and in light of the Watson Wyatt recommendations and other factors described below, the Committee, with respect to each of the Named Executive Officers, did not make any changes in 2008 to their respective base salaries, which have been unchanged since 2005, or the target awards under the balanced scorecard component of our 2008 cash incentive compensation plan from 2007 levels which in turn were unchanged from 2006 levels; the Committee added a component to our 2008 cash incentive plan based on achieving at least $5 million of net income for the Named Executive Officers and other senior officers who were with us for most of 2007; and the Committee granted long-term equity awards — the most recent previous equity grants were in December 2006.

 

As a result of these decisions, approximately two-thirds of the total 2008 target compensation for our Named Executive Officers was performance based and at risk, except for Mr. Ungaro, who had over 80% of his total target compensation that was performance based and at risk. Although in specific situations particular components of compensation were at different levels from the Watson Wyatt suggestions, the total target compensation for Mr. Ungaro, Mr. Henry and Ms. Williams was generally in line with the Watson Wyatt total target compensation market levels. Mr. Scott’s total target compensation exceeded the Watson Wyatt recommendations, which the Committee believed under-stated his technological experience, his recognized expertise in the high performance computing industry and his role with us, and reflected the limitations on survey and peer group information in his situation.

 

Mr. Miller’s compensation was negotiated when he joined us in early 2008, and each component was above the Watson Wyatt suggested target levels, particularly the annual incentive plan targets and equity grants. The Committee considered these decisions appropriate given Mr. Miller’s experience and past performance in high technology sales and marketing positions and the Committee’s experience over the last two years looking at other potential candidates for this position. Although Mr. Miller had the principal sales and marketing function, he did not receive a commission or override based on sales volumes but instead a high annual plan target award when compared to the other Named Executive Officers (other than Mr. Ungaro). As a result, over 70% of Mr. Miller’s total target compensation was performance based and at risk.

 

The Committee believes that the overall structure of the compensation for the Named Executive Officers is in furtherance of our compensation philosophy and objectives in providing, within our means and for our industry, competitive total target compensation with sufficient base salaries with a significant proportion of the total target compensation based upon performance and at risk, including a meaningful proportion that is equity-based, to align the officers’ interests with those of our shareholders and provide a strong retention and performance incentive.

Base Salary

 

Watson Wyatt concluded that the 2007 Radford Executive Compensation Survey had the most relevant information for its analysis of our base salaries. Watson Wyatt advised the Compensation Committee to revise the base salary structure for our senior officers to use five consistently structured bands rather than the three disparate bands we previously had used. Each band was separated into seven segments, with positions in the range depending upon experience, qualifications and performance. With Mr. Ungaro’s assistance, each executive officer was assigned a position in that range. Following this review, the Committee determined that each Named Executive Officer had a base salary that was substantially in the range suggested by the Watson Wyatt survey data, except that Mr. Ungaro’s base salary was significantly less than the suggested level for his experience, qualifications and performance, and Mr. Scott’s base salary exceeded the suggested level for his chief technology officer position. After review of all the factors described above, the Committee did not change the base salary levels for any Named Executive Officer for 2008 from their previous levels, which have stayed constant since 2005, in order to provide consistency with prior years and to continue to have a high percentage of each Named Executive Officer’s total target compensation at risk. Mr. Miller’s negotiated base salary was essentially consistent, given his experience and background, with the base salary structure for our other senior officers although slightly higher than the base salary levels suggested by Watson Wyatt.

 

Annual Cash Incentive Compensation Plan

 

Our annual cash incentive plan is an important element of the compensation program for all of our employees, including the Named Executive Officers. This plan provides performance-based cash incentives based on Company and individual performance against specific targets, with the purpose of motivating and rewarding achievement of our critical tactical, strategic and financial goals. For 2008 the annual cash incentive plan for our senior officers, including all Named Executive Officers, had two components — a balanced scorecard award plan based on quantitative financial and qualitative operational goals, consistent with prior years, and an additional payment for the Named Executive Officers and certain other senior officers who were with us for most of 2007 if we achieved at least $5 million in net income for 2008. These awards were payable only if the specified performance objectives were achieved. As a matter of retention, officers must continue to be employed by us when the awards are paid, generally in March following the applicable year, in order to receive the cash payments.

 

In preparing its cash incentive plan compensation recommendations to the Compensation Committee, Watson Wyatt determined a competitive range of total cash compensation, using the market base salary midpoint from its base salary review and an average of (a) the average target percentages from the three compensation surveys — Watson Wyatt Data Services, Mercer Executive Compensation and Radford Executive — described above, and (b) a regression analysis of target incentives as a percent of base salary from the peer group companies. This process demonstrated that our total cash compensation targets, when our 2008 base salaries were combined with the target awards in our 2007 annual cash incentive plan, were generally consistent with the market total cash compensation amounts as determined by Watson Wyatt for each of our Named Executive Officers, with the exception of Mr. Scott and Ms. Williams for the reasons described earlier, with each of their potential awards being substantially above the Watson Wyatt data. When the additional potential award based on reported net income is considered, our total cash compensation targets were above the Watson Wyatt market compensation levels for each Named Executive Officer, with Mr. Scott and Ms. Williams continuing to be more significantly above those levels, as was the negotiated compensation for Mr. Miller. For 2008, the Committee did not change the incentive plan target awards, however, concluding that as we have not reported net income since 2003 it was important that the Named Executive Officers and other senior officers have a specific incentive to achieve a significant level of net income; the Committee also believed that the target awards for Mr. Scott and Ms. Williams were each appropriate, given their significant high performance computing experience, achievements and roles, which were not well reflected in the general survey and peer group analysis. As noted earlier, Mr. Miller did not receive a commission or override incentive based on sales volumes, and in lieu he received the second highest target award under the annual incentive plan. Mr. Ungaro’s target award continued to be substantially higher than the other Named Executive Officers to offset his relatively low base salary compared to the Watson Wyatt information regarding chief executive officer compensation and to bring his total cash compensation target income in line with the Watson Wyatt chief executive officer compensation information.

Balanced Scorecard Awards

 

The following table shows the 2008 target award amount for each Named Executive Officer under the balanced scorecard component of our 2008 annual cash incentive plan:

 

 

General Conditions.  The threshold for incentive awards was 25% of the target award to a maximum of 150% of the target award. Unless our Adjusted Operating Income, as defined below, was at least $5 million, the maximum award was 12.5% of the target award. Any payout over 100% of the target award required that we obtain at least $225 million in Product Bookings in 2008 in order to emphasize the need for revenue over a term longer than 2008 and to replace the revenue anticipated to be recognized in 2008.

 

Scorecard Goals.  In setting performance goals for the 2008 incentive plan, the Committee set performance goals weighted differently for each Named Executive Officer, depending on their areas of responsibility and the factors on which they have the most influence. Each Named Executive Officer had one or more of the following quantitative financial goals for 2008 as set out in the following table. All dollar figures are in millions. If actual results fell between the specified points in the table, a resulting percentage would be interpolated — for example, if 2008 Gross Profit Dollars were $102 million, that component would have been weighted at 116.7%. The financial targets were based on our 2008 financial plan presented to our Board in February 2008 and were set at levels so that if we achieved but did not substantially surpass that financial plan we would report positive net income and the Named Executive Officers would achieve incentive awards of approximately 35% of their respective target awards.

 

 

The Committee selected the foregoing financial measurement factors for the following reasons:

 

 

In addition, the Named Executive Officers responsible for technical areas had similar quantitative financial goals and qualitative product development and marketing goals for the year, weighted as appropriate for their respective areas of responsibility, and each Named Executive Officer had qualitative Leadership goals.

 

Individual Scorecards.  The 2008 scorecards for each Named Executive Officer are described below.

 

Peter J. Ungaro — As our Chief Executive Officer, Mr. Ungaro’s scorecard was based on our overall financial performance and most heavily weighted on Leadership, with weightings of 25% for Product Bookings, 15% for Gross Profit Dollars, 15% for Adjusted Operating Income and 45% for Leadership; the latter category included Business Management goals for growing market share and hiring of key executives, Operations Management goals for achieving specific product development goals, and Strategy Development and Execution goals regarding our custom engineering activities, improving our long-term business model and overall competitiveness and completing our arrangements with Intel Corporation.

 

Brian C. Henry — As our Chief Financial Officer, Mr. Henry’s scorecard was based on our overall financial performance and most heavily weighted on Adjusted Operating Income in order to drive towards reporting positive net income, with weightings of 10% for Product Bookings, 15% for Gross Profit Dollars, 50% for Adjusted Operating Income and 25% for Leadership; the latter category included goals relating to cash management, capital expenditures, Sarbanes-Oxley and SEC reporting compliance, succession planning within the finance department, finance department budget management, improved monthly management reporting, improving our long-term business model and overall competitiveness, and completing our arrangements with Intel Corporation.

 

Margaret A. Williams — As our Senior Vice President responsible for research and development, Ms. Williams’ targets were weighted 60% on specific product development achievements and engineering budgets, 20% on Adjusted Operating Income and 20% for Leadership, including advancing succession planning for key positions within the research and development group, improving product quality, developing an integrated multi-year development schedule across all product programs, improving department efficiency and reducing the development cycle time, and achieving the 2008 DARPA High Performance Computer System (“HPCS”) program milestones and specific product development goals.

 

Steven L. Scott — As our Chief Technology Officer, Mr. Scott’s plan was most highly weighted in the area of Leadership, with 25% on Product Bookings, 25% on Adjusted Operating Income and 50% on Leadership, including completing amendments to our DARPA HPCS program, specific product development goals, representing our technical capabilities publicly and supporting our sales and marketing efforts, managing our principal engineer program and corporate architecture team, supporting Ms. Williams in achieving our research and development budget and schedule targets, budget management of the chief technology group, achieving our DARPA HPCS milestones, and working with our government programs office regarding government funding of our development programs.

 

Ian W. Miller — As Senior Vice President responsible for worldwide sales and marketing, Mr. Miller’s plan was most heavily weighted to Product Bookings and Product Gross Profit Dollars, with 30% on Product Bookings, 30% on Product Gross Profit Dollars, 20% on Adjusted Operating Income and 20% on Leadership, including advancing succession planning efforts within the sales organization, managing the sales and marketing budgets, managing our principal marketing programs and trade shows, developing programs to build the Cray brand, developing near-time programs to include Intel processors, future growth strategy and opportunities, timing of cash payments in new sales contracts and improving customer satisfaction.

 

For 2008, we met our target goal for Product Bookings and exceeded our stretch goals for each of Gross Profit Dollars, Product Gross Profit Dollars and Adjusted Operating Income.

 

Mr. Ungaro, as chief executive officer, subject to final approval by the Compensation Committee, retained the right to adjust the formula incentive award (from 0% to 125%) for each officer, based on his judgment as to the officer’s performance; Mr. Ungaro did not adjust any awards for 2008. The Board, in executive session, approved the final incentive award for Mr. Ungaro and in practice approved the final incentive awards to the other senior officers, including the other Named Executive Officers, also using no discretion to increase or decrease any of the awards.

Award Based on Net Income Target

 

The Named Executive Officers and other senior officers who served in such positions with us for most of 2007 were eligible to receive an additional cash payment equal to 25% of target award if our net income for 2008 was at least $5 million. This component of our annual incentive plan served as a performance-based retention incentive for senior officers who were with us for most of 2007. Mr. Miller, who joined us in February 2008, was not eligible for this component of the cash incentive plan. For 2007, no incentive awards were paid to senior officers although a significant contributing factor to our failure to reach the 2007 required performance targets was the failure of a third-party supplier to provide necessary parts on time. Adding this component to the 2008 plan expanded to a total of eleven the number of senior officers with performance-based awards similar to those previously given in 2007 to Mr. Ungaro, Mr. Henry and Ms. Williams. In order to receive this payment, we had to achieve financial results significantly above the February 2008 Board financial plan, results that would have approached performance levels approximately mid-way between the 50% and 100% specified points in the above table of balanced scorecard goals. We have not reported positive net income since 2003, and no incentive award payments were made to Named Executive Officers in 2007 and only once since 2003. As our net income for 2008 would have substantially exceeded $5 million except for a non-cash goodwill impairment charge largely due to overall market factors, the Committee determined that the objectives of this incentive component had been achieved and authorized payment of this award.

 

For more information about the awards and cash payments under the 2008 cash incentive plan to the Named Executive Officers, see the “Summary Compensation Table” and “Grants of Plan-Based Awards” table under “Compensation Tables” below.

 

Difficulty of Performance and Net Income Targets

 

We believe that the Committee and the Board in general have set performance targets for our annual cash incentive plans that are achievable but require significant effort to be met, with annual incentive awards at target being at substantial risk and incentive awards above target being very difficult to realize. In the past eight years, we paid no cash incentive awards for 2001, 2004, 2005 or 2007, paid at-target awards for 2006 and paid above-target awards for 2002, 2003 and now for 2008. The 2008 financial performance targets were based on our financial plan delivered to the Board in February 2008 with the expectation of achieving, if we only met that plan, an approximately 35% target award and not receiving the award based on net income.

 

Long-Term Equity Awards

 

We grant stock options and restricted stock for certain new hire situations, principally for senior manager and officer positions and generally on an annual basis as part of the total target compensation plan for the Named Executive Officers and other senior officers. In accordance with our compensation philosophy and objectives described above, these grants are designed to:

 

 

As noted earlier, in the past several years we have recruited a number of key senior officers and through that process have learned that the available talent pool in our industry is limited and that candidates and our officers have significant other opportunities. Given these circumstances, the Committee has emphasized the retention nature of equity awards to keep our senior management team in place. For this reason, the Committee did not add specific performance criteria to any of the grants. The Committee has undertaken to continue to review whether to add performance criteria to at least part of future equity grants.

 

In order to provide longer-term performance and retention incentives, we generally grant stock options with ten-year terms and four-year vesting schedules, with exercise prices equal to 100% of grant date fair market value (determined by the most recent closing price for our common stock prior to the grant decision or, for new hires, the

most recent closing price prior to the first date of employment). As financial gain from stock options is dependent upon increases in the market price for our common stock after the date of grant, we believe option grants encourage recipients to focus on performance and initiatives that should lead to an increase in the market price of our common stock, which benefits all of our shareholders. In addition, when the market price for the underlying common stock is higher than the exercise prices of stock options that are not fully vested, those options provide a retention incentive. Stock options, however, represent a high-risk and potential high-return component, as the realizable value, and consequently the retention incentive, of each option can fall to zero if the market price for the underlying common stock falls below the exercise price. On December 31, 2008, the market price of our common stock was below the exercise prices of all of the outstanding stock options held by our Named Executive Officers, and as a consequence those options then had no realizable or intrinsic value, and little if any retention value. See the “Outstanding Equity Awards at Fiscal Year-End” table below.

 

We grant restricted stock with vesting dependent on continued employment, generally with four-year vesting schedules, with half of the granted shares vesting after two years and the balance vesting after four years (the actual vesting date is designed to occur during open trading window periods following filing of our quarterly or annual reports with the SEC). Awards of restricted stock are designed to increase each recipient’s ownership of our common stock, thereby aligning their interests with shareholders and, with a longer-term vesting schedule, to provide a significant long-term retention incentive.

 

In preparing its recommendations to the Committee for long-term equity compensation, Watson Wyatt determined a competitive range of total compensation, using the market base salary midpoint from its base salary review and an average of (a) the average target percentages from the three compensation surveys described above and (b) a regression analysis of target incentives as a percent of base salary from the peer group companies, with the difference between the target total compensation and target total cash compensation (combining base salary and target annual cash incentive awards) resulting in a suggested value for long-term compensation. Watson Wyatt suggested using valuation methods analogous to the expensing of these awards for financial reporting purposes to determine the number of options and restricted shares to grant.

 

The Committee determined to issue in 2008 generally an equal number of stock options and shares of restricted stock to the Named Executive Officers and other senior officers to provide a performance incentive while also providing a strong retention incentive to the senior officers in order to maintain the current management team. The Committee believes that, under Mr. Ungaro’s leadership, we have made great strides in a very competitive market and in difficult times, and that he has built a strong management team. However, when considering the need to reserve shares for adequate equity grants for new hires in 2008 and 2009, for directors pursuant to the director compensation plan for those years and for equity grants to senior managers and officers in 2009, the Committee found that the size of the 2008 individual grants was constrained by the number of options and restricted shares then available for grant under our option and equity incentive plans. Other factors considered by the Committee in making 2008 individual equity grants involved considerations of the contribution the officer has made to our overall performance, the officer’s potential performance and contribution and retirement plans, the current stock ownership of the officer, the extent and frequency of prior option grants and restricted stock awards, the officer’s unvested stock option and restricted stock position, the range of outstanding options with exercise prices below or above the current market price for our common stock and the remaining duration of the outstanding options. After considering all these factors and that the total cash compensation targets were above the Watson Wyatt recommendations, the values of the 2008 equity grants to the Named Executive Officers were less than the Watson Wyatt equity recommendations except for Mr. Scott, for the reasons described above, and for Mr. Miller, which were negotiated as part of the hiring process when we commonly award larger initial equity grants. In the end, however, the value of 2008 equity grants to the Named Executive Officers was in the range of approximately 43% to 49% of their respective total target compensation, and thus in furtherance of our compensation philosophy and objectives described above.

 

As explained above, the Committee has not used any one factor in its equity grant determinations nor set a specific burn or use rate, although the Committee generally expects that the pool of options and restricted stock should be available for grants for at least three years following shareholder approval. See “Guidelines for Granting Equity Compensation” below.

For information regarding equity grants in 2008 and in prior years, see the tables and associated footnotes and narratives under “Compensation Tables” below.

 

Severance Policy and Change of Control Agreements

 

We have adopted an executive severance policy and entered into certain change of control agreements, titled management retention agreements, designed to attract and retain officers in a competitive marketplace for talent, to retain officers during the uncertainty of rumored or actual fundamental corporate changes and to ensure that the officers evaluate any potential acquisition situations impartially without concern for how they may be personally affected. We believe that these plans are important competitive considerations, as it is generally believed that it takes senior corporate officers significant time to find new employment after their employment ends. The basic terms of the executive severance policy and the management retention agreements were first established a number of years ago and have not been changed substantively since their commencement in order to provide consistency for all covered officers, except for changes negotiated from time to time in connection with hiring new individual executive officers. In late 2008, we adopted a new executive severance policy and entered into new management retention agreements designed to comply with Section 409A of the Internal Revenue Code, although we maintained the basic structure of the previous policy and agreements to provide continuity.

 

Executive Severance Policy.  In October 2002, our Board of Directors adopted an Executive Severance Policy that covered our then senior executive officers. As described above, we updated the Executive Severance Policy in late 2008 in order to comply with Section 409A of the Internal Revenue Code. If officers are terminated without Cause or resign for Good Reason, as those terms are defined in the Policy, the officers receive for certain periods, ranging from six to 12 months, depending on their office and how long they have served us as officers, continuation of base salary, health and term life insurance benefits, an extended time to exercise vested options and outplacement services. Mr. Ungaro and Mr. Henry also receive their target cash incentive plan awards and the other covered officers could receive part or all of their respective target cash incentive awards for the year in which their employment terminates. To receive these benefits, the officer must provide us with a general release and continue to comply with his or her confidentiality and other agreements with us. For officers who are not parties to the management retention agreements discussed below, the Policy provides benefits following a Change of Control. Our obligations under this Policy are unfunded, and our Board has the express right to modify or terminate this Policy at any time prior to a Potential Change of Control or Change of Control, as those terms are defined in the Policy, or prior to delivery of a notice of termination of employment for a covered officer.

 

The following briefly describes the significant changes to the Executive Severance Policy implemented with the December 2008 revision:

 

 

For officers covered by the Policy other than Mr. Ungaro and Mr. Henry, the amount of the severance payment was revised to include base salary and the target incentive award under our annual cash incentive plan pro-rated for the officer’s covered period (six months to one year) and adjusted for our actual performance; previously the severance payments for these officers covered only base salary. This change was made in light of the importance of the annual cash incentive plan as part of our total target compensation approach. The amounts payable as severance payments under the Policy to Mr. Ungaro and Mr. Henry were not changed and are based upon base salary and full

target incentive award in accordance with our previous agreements with each of them, which were negotiated in 2005 when Mr. Ungaro was named our President and Mr. Henry first joined us.

 

Management Retention Agreements.  We previously entered into change of control agreements with each of the Named Executive Officers and certain other senior officers. In late 2008, we entered into new management retention agreements with our senior officers, including each Named Executive Officer, which were modified to comply with Section 409A of the Internal Revenue Code (Mr. Miller’s agreement was executed when he joined us in February 2008). Payments are made under these agreements only if two events occur (often referred to as a “double-trigger” form of agreement): first, there must be a Change of Control and, second, within two years after the Change of Control, the officer’s employment is terminated without Cause or the officer resigns for Good Reason, as such terms are defined in the agreement. If the agreements apply, the officer is to receive a lump sum payment equal to two times the officer’s annual compensation (base salary plus cash incentive plan award at target), payment of the COBRA costs for medical benefits for 18 months, reimbursement of the cost of term life insurance for 24 months, the acceleration of vesting of all stock options and 12 months to exercise all options after termination or, if earlier, until the options expire, and outplacement services. If these payments are subject to an “excess parachute payment” excise tax, we have agreed to provide a tax gross-up payment. We believe that tax gross-up payments are appropriate so that the recipient receives the benefit of the intended compensation without regard to the complexity of the calculations of “excess parachute payments” and as the payment is limited to two times annual compensation and benefits, rather than the higher levels generally permitted by the Internal Revenue Code before the excise tax is imposed.

 

The following is a brief description of the significant changes to the Management Retention Agreements implemented in the December 2008 agreements from the previous agreements:

 

 

In addition, Mr. Ungaro and Mr. Henry each has a new provision that provides that, for a one-month period beginning six months following a Change of Control, he can resign and receive the benefits under his Agreement if at such time he no longer holds his same position and reporting relationship at a company registered under the Securities Exchange Act of 1934 as he held with us prior to the Change of Control. This was added as a competitive

provision and balanced the key nature of their current positions with a publicly-held company, the loss of which constitutes a substantial diminution of job responsibilities and duties, and the provision of an appropriate period following a Change of Control to permit negotiations as to their respective positions, if any, with the new controlling entity.

 

Stock Option Plans and Restricted Stock Agreements.  Our stock option plans and restricted stock agreements provide that if the Company is sold, unless the existing options and restricted stock are continued or assumed by the successor entity, then each optionee would have the opportunity to exercise his or her options in full, including any portion not then vested, and the options would terminate upon the sale becoming effective, and the restricted stock would vest in full. We believe that acceleration of vesting of options and restricted stock is appropriate when the options and restricted stock grants are not continued or assumed by the successor company, as the recipient has not received the full contemplated benefit of the equity award due to circumstances beyond the recipient’s control.

 

The Executive Severance Policy, the Management Retention Agreements and the stock option plans and restricted stock agreements are described in more detail under “Narrative to the Termination of Employment and Change of Control Payments Table” below.

 

Retirement Plans

 

Our only retirement plan for all U.S. employees, including the Named Executive Officers, is a qualified 401(k) plan under which employees may contribute a portion of their salary on a pre-tax basis. Participants may invest in a limited number of mutual funds, and may sell, but may not direct the purchase of, shares of our common stock. We match 25% of participant contributions, with half of the match paid in shares of common stock on a quarterly basis during the year and the balance paid after year-end in cash and/or shares of common stock, as the Board of Directors, acting through the Compensation Committee, decides. In recent years the final matching contribution has been made in shares of our common stock.

 

We do not have any pension plan for any of our U.S. employees, including our Named Executive Officers. We do not have any plan for any of our Named Executive Officers or other employees that provides for the deferral of compensation on a qualified or non-qualified basis under the Internal Revenue Code other than our 401(k) plan.

 

Additional Benefits and Perquisites

 

We have health and welfare plans available on a non-discriminatory basis to all employees in the United States designed to meet the health and welfare needs of our employees and their families and to provide a total competitive compensation package. We provide these benefits to the Named Executive Officers and other senior officers on the same terms and conditions as provided to all other eligible employees:

 

 

We do not provide perquisites for the Named Executive Officers or other senior officers that are not available on the same terms to our employees generally.

Stock Ownership Guidelines

 

We have not implemented formal stock ownership guidelines for our officers. We expect that our executive officers will discuss potential sales of our common stock with our Chief Executive Officer. We continue to review the practices regarding such guidelines and may reevaluate our position with respect to stock ownership guidelines for officers.

 

Guidelines for Granting Equity Compensation

 

In 2005 and 2006, the Compensation Committee made decisions regarding base salaries and annual cash incentive awards in the spring of each year and decisions regarding annual equity grants in December. In 2007 the Committee decided to make all awards to senior officers in the spring concurrent with compensation decisions for all employees in order to have a more cohesive approach to total compensation for each senior officer, and for that reason the Committee made no general equity grants to senior executive officers in 2007. In 2008, the general equity grants were made in May. While the Committee expects to complete the senior officer compensation awards, including equity grants, this spring, the 2009 awards have not yet been made.

 

As stated above, while the Compensation Committee has the authority to determine the equity grants to executive officers, other than the Chief Executive Officer, in practice all grants to senior officers are reviewed and approved by the Board in executive sessions of non-management directors.

 

The Committee approves new-hire equity grants for vice presidents and has established guidelines for equity grants of new hires below that rank for awards approved by the Chief Executive Officer pursuant to those guidelines. New-hire grants are effective on the first day employment begins, with the exercise prices for stock options set at the closing price for our common stock on the immediately prior trading day. As the date of grants is pre-established, the timing of the release of material nonpublic information does not affect the grant dates for new-hire equity awards.

 

Under our option plans, we may not grant stock options at a discount to the fair market value of our common stock or, except under certain older plans, reduce the exercise price of outstanding options except in the case of a stock split or other recapitalization events. We do not grant stock options with a so-called “reload” feature, and we do not loan funds to employees to enable them to exercise stock options.

 

Securities Trading Policies

 

Our securities trading policies state that directors, officers and employees may not purchase or sell puts or calls to sell or buy our common stock, engage in short sales with respect to our common stock, or buy our common stock on margin or pledge shares of our common stock. Our policies restrict trading in our common stock by directors, officers and certain specified employees to open window periods following the release of our quarterly and annual financial results, except for trades pursuant to approved Rule 10b5-1 plans.

 

Tax Deductibility

 

Section 162(m) of the Internal Revenue Code limits to $1 million per person the amount that we may deduct for compensation paid in any one year to our Chief Executive Officer and certain of our most highly compensated officers. This limitation does not apply, however, to “performance-based” compensation, as defined in the Internal Revenue Code. Our stock options generally qualify as “performance-based” compensation and, except for incentive stock options, may result in a deduction for us at the time of exercise. Payments to our Chief Executive Officer and certain of our most highly compensated officers under our annual cash incentive plan and our outstanding restricted stock grants do not qualify as “performance-based” compensation and are not deductible to the extent that the $1 million limit is exceeded. The deductibility of some types of compensation payments depends upon the timing of the awards and the vesting or exercise of previously granted rights. Interpretations of and changes in applicable tax laws and regulations, as well as other factors beyond our control, also can affect deductibility of compensation. Although deductibility of compensation is preferred, tax deductibility is not a primary objective of our compensation programs, particularly given our considerable net loss carry-forward position for U.S. tax purposes. Rather, we maintain the flexibility to structure our compensation programs in ways that promote the best interests of our shareholders.

 

The Compensation Committee is responsible for overseeing the Company’s compensation policies, plans and benefits program, the compensation of the Chief Executive Officer and other senior officers and the administration of our equity compensation plans and the Cray 401(k) Plan. As set forth in the Committee’s charter, which can be found at: www.cray.com under “Investors — Corporate Governance,” the Compensation Committee acts only in an oversight capacity, and relies on the work and assurances of management and outside advisers that the Committee retains. The Compensation Committee believes it has satisfied its charter responsibilities for 2008.

 

The Compensation Committee has worked with management for the past several years to develop a systematic compensation philosophy and structure. In 2007 the Committee retained Watson Wyatt Worldwide, a leading executive compensation consultant, to advise the Committee. Watson Wyatt personnel conducted an in-depth review of the then current compensation practices, including interviews with a number of managers at the Company, and then reported its findings to the Committee in a series of meetings, some with management and some in executive sessions. The results of that collaboration, which formed the basis for the 2008 executive compensation decisions, are described in the foregoing Compensation Discussion and Analysis.

 

A second focus area of the Compensation Committee has been the structure and strength of the Company’s senior management team. Most of the Company’s current management team came in 2005, when Mr. Ungaro became President, or more recently, including key hires and promotions in 2008 and 2009. The Committee meets twice a year with Mr. Ungaro to review his performance as chief executive officer and to obtain his assessment of the strengths and weaknesses of the management team. The Committee believes that under Mr. Ungaro’s leadership the Company has made great strides in a very competitive market and in difficult times. The Committee has worked with Mr. Ungaro to develop a strong “performance culture” at the Company. One aspect of that process has been emphasis on succession plans, identification of high potential, at-risk and retiring employees, and efforts to improve the officers’ management and leadership skills within a relatively new and thin management group. Another aspect, as is reflected in the Watson Wyatt compensation structure, is to add, to competitive base salaries, significant retention and incentive elements in long-term compensation awards, as discussed in the foregoing Compensation Discussion and Analysis.

 

The Compensation Committee also approves the compensation of new vice-presidents as they are hired, including base salary, annual cash incentive targets, equity grants and hiring bonuses, if any; determines the policy for awarding stock options and/or restricted stock grants to other new hires; reviews and approves amendments to the Company’s 401(k) plan; periodically reviews the Company’s staffing, including open positions and turnover; receives reports on the Company’s health and safety records and any equal employment opportunity claims, investigations and reports; and considers the Company’s medical and other health benefits, including potential changes and enhancements, from both a cost and a competitive perspective. In 2008, the Compensation Committee reviewed and recommended that the Board approve the terms of a new severance policy for officers and new change-of-control agreements for executive officers. These new documents, while drafted to comply with Section 409A of the Internal Revenue Code, also provided an opportunity to revise certain provisions to be more competitive with similar arrangements offered by other companies. The new policy and agreements also are described in the foregoing Compensation Discussion and Analysis.

 

The Compensation Committee has reviewed and discussed with management the above Compensation Discussion and Analysis. Based on that review and discussion, the Compensation Committee has recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this proxy statement.

 

The Compensation Committee

 

Frank L. Lederman, Chair
John B. Jones, Jr.
Stephen C. Kiely
Stephen C. Richards

 

The tables on the following pages describe, with respect to our Named Executive Officers, the 2008, 2007 and 2006 salaries, bonuses, incentive awards and other compensation reportable under SEC rules, plan-based awards granted in 2008, values of outstanding equity awards as of year-end 2008, exercises of stock options and vesting of restricted stock awards in 2008, and potential payments upon termination of employment and following a Change of Control.

 

Summary Compensation

 

The following table summarizes the compensation for the indicated years of our Chief Executive Officer, our Chief Financial Officer and our three highest paid other executive officers for the year ended December 31, 2008.

 

Summary Compensation Table

 

 

 

 

 

Grants of Plan-Based Awards in 2008

 

The following table sets forth certain information with respect to the potential cash incentive awards and the equity awards for the year ended December 31, 2008, to the Named Executive Officers. See “Analysis of 2008 Compensation Determinations — Annual Cash Incentive Compensation Plan” and “— Long-Term Equity Awards” in the Compensation Discussion and Analysis above.

 

Grants of Plan-Based Awards

 

 

 

 

Narrative to the Summary Compensation and Grants of Plan-Based Awards Tables

 

The amounts reported in the Summary Compensation Table include base pay, annual and long-term incentive amounts and benefits and are described more fully above under “Analysis of 2008 Compensation Determinations” in the Compensation Discussion and Analysis above.

As noted in that analysis, for our Named Executive Officers there were no increases in base salaries in 2008 over 2007 or 2006. Our performance in 2008 exceeded the target levels for our annual cash incentive compensation plan; this is the first time our executive officers earned above-target levels of incentive compensation since 2003.

 

As also noted in that analysis, the combination of restricted stock awards and stock option grants is to provide a performance incentive while also providing a strong retention incentive. As of December 31, 2008, none of the stock options granted in May 2008 had any intrinsic value as the per share exercise price of $6.63 for the options exceeded the closing market price of $2.08 per share on December 31, 2008, and the value of the restricted stock, which remains unvested, is substantially less than the grant date fair value.

 

Mr. Miller’s compensation was negotiated when he joined us in February 2008. As he was not an employee in 2007, he was not eligible for the 25% of target award based on net income. His bonus award for 2008 is a one-time hiring bonus, which he agreed to repay in full if he voluntary left us before February 11, 2009, and to repay 50% if he voluntarily leaves us before February 11, 2010.

Outstanding Equity Awards on December 31, 2008

 

The following table sets forth certain information with respect to outstanding equity awards at December 31, 2008, held by our Named Executive Officers.

 

Outstanding Equity Awards at Fiscal Year-End

 

 

 

2008 Option Exercises and Stock Vested

 

The following table sets forth certain information with respect to stock option exercises and restricted stock vesting during the year ended December 31, 2008, by the Named Executive Officers.

 

 

 

 

Termination of Employment and Change of Control Arrangements

 

The following discussion and table summarize the compensation that would have been payable to each Named Executive Officer upon termination of his or her employment at the close of business on December 31, 2008.

 

No special payments are due if any of the Named Executive Officers terminates his or her employment voluntarily without Good Reason, is terminated for Cause or retires. For all terminations, a terminated employee receives accrued and unpaid salary and the balance in his or her 401(k) plan account; we do not accrue vacation pay for the Named Executive Officers or other senior officers. As part of and on the same basis as we provide benefits to all of our U.S. employees, the Named Executive Officers have life insurance and disability benefits.

 

For a description of the applicable provisions regarding employment terminations in our Executive Severance Policy, the Management Continuation Agreements, our stock option plans and our restricted stock agreements, see “Narrative to the Termination of Employment and Change of Control Payments Table” below.

 

The actual amounts to be paid to and the value of stock options and restricted stock held by a Named Executive Officer upon any termination of employment can be determined only at the time of such termination, and are dependent on the facts and circumstances then applicable.

Termination of Employment and Change of Control Payments