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1994 Annual Report To Stockholders

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Sectors: Computer Hardware
Effective Date: March 24, 1995
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1994 Annual Report


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Cray Computer Corporation


Historical Financial Summary................................................ 1


Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................... 2


Independent Auditors' Report................................................ 8


Statements of Operations.................................................... 9


Balance Sheets.............................................................. 10


Statements of Cash Flows.................................................... 11


Statements of Stockholders' Equity.......................................... 12


Notes to Financial Statements............................................... 13


Investor Information........................................................ 21


Corporate Information....................................................... 22


CRAY COMPUTER CORPORATION (A Development Stage Enterprise) - --------------------------------------------------------------------------------


Historical Financial Summary


Selected Financial Data: The following table presents information regarding the financial condition and results of operations of Cray Computer Corporation (the Company) for the past five years as a separate company and while a division of Cray Research, Inc., (CRI). The table does not reflect any adjustments related to the Bankruptcy Filing on March 24, 1995. The data as of December 31, 1994 and 1993, for the three-year period ended December 31, 1994, and cumulative from October 1983 (inception) through December 31, 1994, should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources," and the financial statements and notes included elsewhere in this Annual Report. The Company has never declared or paid cash dividends on its Common Stock.


Years ended December 31,
Cumulative from -----------------------------------------------------------------
October 1983
(inception) through
December 31, 1994 1994 1993 1992 1991 1990 - ---------------------------------------------------------- ----------- ------------ ----------- ----------- ----------- Summary of Operations (In thousands, except per share data) Revenue $ 16,534 2,512 352 334 333 13,003 Operating costs and expenses:
Cost of sales and services 8,327 40 160 161 160 7,806
Research and development 350,090 35,742 45,034 49,258 52,777 47,542
Marketing 3,497 1,212 707 668 475 435
General and administrative 17,814 2,409 3,208 2,474 2,411 2,951 Other income (deductions), net 908 (895) 826 2,733 3,276 (718) Litigation settlement expense 1,000 - - 1,000 - -
------------ ----------- ------------ ----------- ----------- ----------- Net loss $(363,286) (37,786) (47,931) (50,494) (52,214) (46,449)
============ =========== ============ =========== =========== =========== Loss per share $ (0.97) (1.50) (2.08) (2.50) (2.61)
----------- ------------ ----------- ----------- -----------


December 31, - ----------------------------------------------------------------------------------------------------------------------------- Financial Position (In thousands) 1994 1993 1992 1991 1990
----------- ------------ ----------- ----------- ----------- Current assets $ 4,953 23,415 32,693 56,838 16,710 Current liabilities 11,655 5,697 4,437 5,174 3,817 Working capital (deficit) (6,702) 17,718 28,256 51,664 12,893 Spares, net - 40 200 361 521 Property, plant and equipment, net 21,213 25,132 33,256 44,637 54,989 Long-term marketable securities and other assets - 12 564 15,038 1,396
Total 14,511 42,902 62,276 111,700 69,799 Less long-term liability 5,416(1) 250 - - - Less capital lease obligations, noncurrent - - - 58 138
Total stockholders' equity $ 9,095 42,652 62,276 111,642 69,661
(1) In default on March 24, 1995.
December 31, - ----------------------------------------------------------------------------------------------------------------------------- General Data and Ratios (at year end) 1994 1993 1992 1991 1990
----------- ------------ ----------- ----------- ----------- Current ratio 0.4:1 4.1:1 7.4:1 11.0:1 4.4:1 Common shares outstanding (in thousands) 41,906 37,792 24,522 24,100 18,354 Book value per share $ 0.22 1.13 2.54 4.63 3.80 Stockholders of record 7,020 7,207 7,378 6,734 6,942 Number of employees 350 383 372 384 266


1


Management's Discussion and Analysis of Financial Condition and Results of Operations


The following is a discussion of the historical results of operations and financial condition of Cray Computer Corporation. This discussion should be read in conjunction with the financial statements and notes included elsewhere in this Annual Report.


Overview


On March 24, 1995 Cray Computer Corporation (the "Company") filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Colorado (the "Court") after the Company determined it would be unable to complete a planned private placement financing of up to $25 million of Common Stock with foreign and United States institutional investors and the Company ceased to have sufficient liquid assets which would allow it to continue in operation. The Company's existing directors and officers have remained in possession of the assets and business of the Company, but are subject to the supervision and orders of the Court. The Company has terminated most of its employees and stopped work on its supercomputer systems.


Under Chapter 11 the Company may attempt to reorganize, enabling it to resume operations, or it may dispose of assets followed by distribution of the amount realized to creditors and, if any excess remains, to shareholders of the Company. If the assets of the Company are disposed of, that disposition may be accomplished by the management of the Company as Debtor in Possession or by an appointed trustee following conversion of the Chapter 11 proceeding to a liquidation under Chapter 7 of the United States Bankruptcy Code.


Management of the Company has commenced discussions with potential strategic partners which may result in the resumption of the Company's operation, either by the Company or a different entity. Management of the Company does not know as of the date of this Report whether such discussions will result in a plan of reorganization permitting the Company to resume its operations. Management intends to resolve no later than July 1, 1995, whether a plan of reorganization is feasible. If such a plan does prove feasible, it will be presented for approval, as required, by interested parties including the Bankruptcy Court.


The Company, a development stage enterprise, had a net loss for the year ended December 31, 1994 of $37,786,000. The Company had accumulated losses of approximately $363 million from its inception through December 31, 1994. Approximately $123 million of its cumulative deficit was incurred while the Company was a division or wholly owned subsidiary of Cray Research, Inc. (CRI). Research and development expenses were $35,742,000 in 1994, $45,034,000 in 1993, and $49,258,000 in 1992. Substantially all of the Company's funding since its incorporation in 1989 has come from CRI ($98,640,000) between October 1989 and October 1991, the sale of a CRAY-2 supercomputer ($12,760,000) in December 1990, a public stock offering (net proceeds of approximately $61,088,000) in July 1991, ongoing maintenance revenues ($1,593,000) on the CRAY-2 supercomputer, a sale of shares of Common Stock to institutional and private investors (net proceeds of approximately $27,805,000) in June 1993, loan proceeds ($12,719,000), contract revenue ($2,125,000) on the cost sharing development contract with the National Security Agency (NSA) entered into in August 1994, sales of shares of Common Stock to private and foreign institutional investors (net proceeds of approximately $3,822,000) in the fourth quarter of 1994, and sales of shares of Common Stock to Seymour R. Cray, Chairman of the Board and Chief Executive Officer (1,165,501 shares) and to foreign institutional investors (3,200,000 shares) in the first quarter of 1995 (aggregate net proceeds of approximately $3,909,000).


Until the date of its bankruptcy filing, the Company was engaged in the design, development, manufacture and marketing of the CRAY-3/Super Scalable System (SSS) and CRAY-4 high-performance computer system and the marketing of the CRAY-3 supercomputer system. The CRAY-3 and CRAY-4 are modular upgradeable general purpose supercomputers designed to provide balanced, high-performance computing for many types of scientific and engineering applications. The Company was addressing the high-performance, large-scale scientific computing segment of the supercomputer market. The number of potential customers in this market is and always has been limited. The market for supercomputers has been characterized by continuing advancement of


2


Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)


technology and the development of increasingly sophisticated and powerful systems which render existing systems obsolete within a few years.


The CRAY-3, CRAY-3/SSS, and CRAY-4 incorporate a modular or building-block architecture designed to allow customers to add processing and memory capability. The CRAY-4 configuration can range from 4 to 64 processors with base prices in the approximate range of $3.5 million to $40 million. The CRAY-3/SSS is designed to utilize a 2-processor CRAY-3 in conjunction with Processor-in- Memory (PIM) chips developed and manufactured by a third party to provide vector parallel processing, scalable parallel processing, and the combination of both. All of these systems are designed to incorporate advanced Gallium Arsenide (GaAs) logic circuits, fast semiconductor Static Random Access Memory (SRAM) circuits, advanced semiconductor packaging and interconnect technologies, and advanced liquid cooling techniques.


On August 17, 1994, the Company entered into a joint development contract with the National Security Agency (NSA), to produce a CRAY-3/SSS offering vector parallel processing, scalable parallel processing, and the combination of both. Under the NSA contract, the Company received revenues from NSA for a portion of the Company's costs of developing the system. The CRAY-3/SSS is designed to utilize a CRAY-3 and a large number of Processor-In-Memory (PIM) chips developed by the Supercomputing Research Center of the Institute for Defense Analyses and manufactured by National Semiconductor Corporation. The system was to consist of a dual processor 256 million word CRAY-3, and a 512,000 processor, 128 million byte Single Instruction Multiple Data (SIMD) array. The Company successfully completed the first of a number of major tasks required under the development contract which consisted of the successful test and demonstration of an array of 256,000 single bit processors packaged using the Company's multi-chip-module technology. Upon filing of bankruptcy, the Company stopped work on the CRAY-3/ SSS. The Company is reviewing the terms and conditions of the development contract to assess the ramifications of the bankruptcy filing.


Significant technical progress was made during 1994 on the CRAY-4, which takes advantage of technologies and manufacturing processes developed during the design and manufacture of the CRAY-3. The Company announced introduction of the CRAY-4 to the market on November 10, 1994. Several single processor CRAY-4 prototype systems, each with 64 megawords of memory, were undergoing diagnostic testing prior to the Company filing for bankruptcy. The Company began testing individual CRAY-4 modules at the start of 1994 and planned to be able to deliver a 4-processor CRAY-4 prototype system by approximately the end of the second quarter of 1995. Upon filing of bankruptcy, the Company stopped work on the CRAY-4.


Following expiration of certain restrictions in its license agreements from CRI on July 31, 1994, the Company began to engage in discussions with potential strategic partners. Any such partnership could include joint manufacturing and/or marketing activities, a commitment to provide funding to the Company in exchange for an interest in the Company's technology (which may include the licensing of hardware, software, know-how, patents, or marketing rights to certain products or technology), an equity or debt investment, or any combination of the above. The Company is continuing its efforts to secure a corporate strategic partnership. Any such relationship would require approval of the Court and possibly the Company's lender under its secured debt financing agreement. Although these discussions are continuing while in bankruptcy, no agreements are currently pending. No partnership discussions have progressed beyond the preliminary stage.


On February 27, 1995, the stockholders of the Company approved an amendment to the Company's Restated Certificate of Incorporation increasing the number of authorized shares of Common Stock, $0.01 par value, from 60,000,000 to 120,000,000 shares in order to have sufficient authorized unissued shares to permit additional equity financing.


As of the date of this report, the Company's Common Stock is listed and trading on the NASDAQ Stock Market--National Market. NASDAQ By-Laws state that "should an issuer file under any of the sections of the Bankruptcy Act or announce that liquidation has been authorized by


3


Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)


its Board of Directors and that it is committed to proceed, the Association may suspend or terminate the issuers securities unless it is determined that the public interest and the protection of investors would be served by continued designation." Again, the Company has filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code. No liquidation has been authorized by the Company's Board of Directors, as of the date of this report, and Management has submitted information to the NASDAQ Stock Market supporting its position that the Company's Common Stock should continue to be listed. There can be no assurance that the Company's Common Stock will continue to be listed on the NASDAQ National Market or the NASDAQ SmallCap Market.


Results of Operations


Revenue and cost of revenue: Service fees revenue and cost of services relate to the maintenance of the CRAY-2 supercomputer installed at the National Energy Research Supercomputer Center (NERSC) in April 1990. Service fees revenue for 1994 totaled $351,000 compared with $332,000 for 1993. The $19,000 increase in service fees revenue results from the terms of a new NERSC maintenance agreement which was signed in March 1994 and renewed through March 31, 1995. The maintenance agreement was extended through April 30, 1995 and is currently being negotiated to be effective through March 31, 1996. Services under the maintenance agreement are performed by CRI as a subcontractor and have not been interrupted by the bankruptcy filing. The service fee revenues described herein are net of payments to the subcontractor.


Service fees revenue for 1993 totaled $332,000 compared with $334,000 for 1992. The $2,000 decrease results from the terms of a NERSC maintenance agreement which was signed in March 1993 and renewed through February 28, 1994.


Development contract revenue related to the joint development contract entered into between the Company and the NSA in August 1994. The contract provided that the Company would be paid up to $4,200,000 for development costs, and the Government would provide approximately $400,000 in software consulting services. As of December 31, 1994, the Company had cumulatively invoiced the NSA approximately $2,125,000 pursuant to the terms of the joint development contract and had related outstanding accounts receivable of approximately $562,000, which amount was collected subsequent to December 31, 1994.


Other revenue of $36,000 for 1994 relates to GaAs wafer qualification work performed for a third party.


Cost of services for 1994 totaled $40,000 compared with $160,000 for 1993. The $120,000 decrease in cost of services results from maintenance spare parts that became fully depreciated in 1994.


Research and development expenses: Research and development expenses in 1994 relate primarily to the design and development of the CRAY-3/SSS and CRAY-4 high-performance computer systems, including costs associated with the manufacture of prototype systems, and depreciation expenses on facilities and equipment used in research and development activities.


Research and development expenses for 1994 totaled $35,742,000 compared with $45,034,000 for 1993. The $9,292,000 decrease in research and development expenses is primarily due to decreases in depreciation of approximately $3,893,000 as a result of assets becoming fully depreciated in 1994, material charges of approximately $2,236,000 due to decreased material usage as a result of decreased CRAY-3 manufacturing, the write-off of $834,000 of obsolete prepaid CRAY-3 material in 1993, charges for equipment of approximately $622,000, mask fabrication and PCB drill bits of approximately $255,000, employee relocation of approximately $153,000, equipment and building repair and maintenance of approximately $264,000, and equipment leases that matured in 1993 of approximately $837,000. The equipment previously leased was purchased by the Company in 1993 and 1994.


Research and development expenses include certain related party transactions. Related party expenses for 1994 totaled $319,000 compared with $3,499,000 for 1993. The $3,180,000 decrease in related party expenses is due to the fact that the Company was purchasing SRAM circuits from a related party in 1993, and in 1994 purchased them from Toshiba Corporation, a non-related party.


4


Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)


Research and development expenses for 1993 totaled $45,034,000 compared with $49,258,000 for 1992. The $4,224,000 decrease in research and development expenses for 1993 is due to decreases in depreciation as a result of assets becoming fully depreciated, reduced compensation charges associated with the declining amortization of stock grant expense over the life of the 1989 Employee Benefit Stock Plan and allocation of some general and administrative expenses that were previously allocated to research and development expenses.


Marketing: Marketing expenses for 1994 totaled $1,212,000 compared with $707,000 for 1993. The $505,000 increase in marketing expenses was the result in part of increased labor and benefit expenses of approximately $475,000 and increased fixed charges for leased office space of approximately $31,000 associated with the addition of employees to the marketing staff. Additional increases were associated with increased marketing activities, such as travel expenses which increased approximately $38,000 and trade show expenses which increased approximately $26,000. These increases were partially offset by a decrease of approximately $36,000 in charges for consulting services and a decrease of approximately $26,000 in employee relocation costs.


Marketing expenses for 1993 totaled $707,000 compared with $668,000 for 1992. The $39,000 increase in marketing expenses for 1993 was a result of increased marketing promotional expenses and employee relocation expenses associated with relocating the Pleasanton, California office to Colorado Springs, Colorado in February 1993. Increased relocation and marketing promotional expenses were partially offset by reduced facilities expenses and allocation of some general and administrative expenses that were previously allocated to marketing expenses.


General and administrative expenses: General and administrative expenses for 1994 totaled $2,409,000 compared with $3,208,000 for 1993. The $799,000 decrease in general and administrative expenses was due primarily to decreased depreciation expenses of approximately $177,000 as a result of assets becoming fully depreciated, decreased fixed expenses of approximately $282,000 for directors' and officers' insurance coverage that was not renewed by the Company in July 1993, and decreased legal expenses associated with the June 1993 litigation settlement. These decreases were partially offset by expenses associated with the Company's acquisition of debt and equity financing, such as employee travel expense which increased approximately $20,000 and other business expenses which increased approximately $42,000.


General and administrative expenses for 1993 totaled $3,208,000 compared with $2,474,000 for 1992. The $734,000 increase in general and administrative expenses for 1993 reflects changes in the allocation of certain costs that were previously allocated to research and development and marketing expenses. This increase was partially offset by decreased fixed charges for directors' and officers' insurance coverage that was not renewed by the Company in 1993 and reduced personal property taxes as a result of depreciating assets.


Other income (deductions), net: Other income (deductions), net for 1994 totaled ($895,000) compared with $826,000 for 1993. The $1,721,000 decrease in other income, net is a result in part of reduced interest income of approximately $565,000 resulting from decreased cash and short-term investments. Interest expense increased approximately $532,000 as a result of acquiring the secured line of credit financing. (See "NOTES TO FINANCIAL STATEMENTS - (9) Bank Borrowings"). Other expenses increased approximately $925,000 primarily for costs relating to the debt financing (i.e., broker fees, legal fees, travel, title insurance and loan fees.) The increase was partially offset by other income which increased approximately $170,000 due to miscellaneous tax refunds received. The loss on sale of fixed assets also decreased approximately $131,000 because of obsolete and idle equipment that was written off in 1993.


Other income (deductions), net for 1993 totaled $826,000 compared with $2,733,000 for 1992. The $1,907,000 decrease for 1993 is primarily due to reduced interest income resulting from decreased cash and short-term investments, and lower interest rates. The Company


5


Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)


wrote off $227,000 of obsolete and idle equipment in 1993.


Litigation settlement: On June 17, 1993, the Company reached a final settlement with the consolidated plaintiffs in a lawsuit against the Company. The Company paid $1,000,000 in April 1993 towards the settlement and the Company's directors' and officers' liability insurer paid an additional $4,000,000. The Company accrued its share of the tentative settlement, $1,000,000, in its financial statements as of and for the year ended December 31, 1992.


Liquidity and Capital Resources


The Company's Independent Auditors in their report for the year ended December 31, 1994, stated that because of the Company's recurring losses, continued utilization of cash flows, working capital deficit at December 31, 1994, and the bankruptcy filing on March 24, 1995 by the Company, substantial doubt is raised about the Company's ability to continue as a going concern and that the Company's historical Financial Statements do not include any adjustments that might result from the outcome of this uncertainty. The Auditors' Report for the year ended December 31, 1993, and 1992 also stated there was substantial doubt about the Company's ability to continue as a going concern.


The Company utilized $33,132,000 for operating activities in 1994 and had a deficit in working capital at December 31, 1994 of $6,702,000. The Company needed substantial additional funds to continue operations past March 1995, which it was unable to obtain.


After the Company determined it would be unable to complete a planned private placement financing of up to $25 million of Common Stock with foreign and United States institutional investors, and the Company ceased to have sufficient liquid assets which would allow it to continue in operation on March 24, 1995 it filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Colorado (the "Court"). The Company's existing directors and officers have remained in possession of the assets and business of the Company but are subject to the supervision and orders of the Court.


The Company has terminated most of its employees and stopped work on its supercomputer systems. The Company's cash resources are very limited and it will incur continuing administrative expenses. The Company is operating within the requirements of the U.S. Bankruptcy Code and the Rules thereunder.


In June 1994, the Company obtained a $17.5 million secured line of credit commitment from an asset-based lender, comprised of a $6.5 million term loan and a revolving line of credit of up to $11.0 million. The amount advanced is secured by a senior security interest in all the assets of the Company, including the Company's plant, equipment, technology, and intellectual property rights. Additional collateral was provided by Seymour R. Cray, Chairman of the Board and Chief Executive Officer, in the form of a $5.0 million standby letter of credit in June 1994 and a $1.0 million standby letter of credit in December 1994. The Company received the funds
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