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Executives

Paul Hiemstra

Peter J. Ungaro - Chief Executive Officer, President and Director

Brian C. Henry - Chief Financial Officer and Executive Vice President

Analysts

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Glenn Mattson - Sidoti & Company, LLC

Cray (CRAY) Q3 2013 Earnings Call November 11, 2013 4:30 PM ET

Operator

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to Cray Inc.'s Third Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Paul Hiemstra, Corporate Treasurer, you may begin your conference.

Paul Hiemstra

Good afternoon. I'd like to thank everyone for joining us today. Participating from Cray are Peter Ungaro, President and Chief Executive Officer; and Brian Henry, Executive Vice President and Chief Financial Officer.

Today's press release is available on the Investor Relations section of our website at www.cray.com. This call is being broadcast live on the Internet and recorded for replay purposes. A telephonic replay will be available shortly after the call. You can access it by dialing 1 (855) 859-2056. International callers can dial 1 (404) 537-3406. You must then enter the access code 91911477. A replay will also be available in the Investor Relations section of the Cray website for 180 days.

I'd like to remind each of you that today's conference call will contain forward-looking statements that are based on our current expectations. Forward-looking statements include statements about our financial guidance and expected future operating results, our product development and new product introduction and acceptance plans, our ability to expand and penetrate our addressable market and other statements that are not historical facts. These statements are only predictions, and actual results may materially vary from those projected. Please refer to Cray's documents filed with the SEC from time to time concerning factors that could affect the company and these forward-looking statements.

Our presentation includes certain non-GAAP financial measures in an effort to provide additional information to investors. Non-GAAP measures, other than non-GAAP outlook, have been reconciled to their related GAAP measures in accordance with SEC rules. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures and a discussion of non-GAAP outlook in our earnings press release, which is posted on our website and which will be included with a related 8-K furnished with the SEC.

With that, I would like to turn the call over to Peter Ungaro.

Peter J. Ungaro

Thanks, Paul, and thank you all for joining the call today with a special thanks for any veterans on the call for all you've done for our country.

I'm going to start with some comments on our third quarter performance, then turn it over to Brian who will go through our financial results and outlook. I'll wrap up by discussing our plans for the rest of the year, and open up the call for Q&A.

Our third quarter was highlighted by continued progress toward our strategic goals in each of our business units. Despite this, we weren't able to complete a couple of the large system acceptances we were anticipating for the quarter, which caused our Q3 financial results to come in lower than our original expectations. We currently anticipate completing both of them by the end of the year.

For 2013, we are maintaining our revenue outlook at $520 million despite some scheduled compression caused by the recent U.S. government shutdown. At $520 million, our revenue growth over 2012 would be a very strong 23%.

In our supercomputing business, we had a number of good wins this past quarter, including several government and commercial orders for both our XC30 and CS300 systems. The XC30, which we've previously code named Cascade, is our most advanced supercomputer, able to deliver extreme scalability and sustained performance to users in a variety of data-intensive computing industries and applications. The CS300 is our cluster supercomputer, which provides flexible configuration options in an integrated, energy-efficient and modular platform.

One of our commercial customers in Japan put a literal showcase of Cray products into production during the quarter. The Railway Technical Research Institute installed the XC30, a CS300 and a Sonexion Storage System, and they're all in production today. I recently spent time with them in Japan and they told me how they've worked with our Cray team there to integrate these different systems into a single virtual supercomputer, aimed at performing complex simulations to advance railway technologies in Japan and around the world.

We've been working on 2 supercomputing development projects for 2013 that we've now completed, supporting the next-generation Intel Xeon Ivy Bridge processors; and integrating accelerators into the XC30 system, including both NVIDIA GPUs and the Intel Xeon FICO processors, based on our industry-leading OpenACC 2.0 compiler, which is designed to make users of these processors more productive.

We're in the process of beginning to deliver and install supercomputers with these new processors at various customer sites around the world.

Our CS300 product line had a solid quarter with acceptances at several sites and new orders across a number of industry verticals, including government, manufacturing, higher education and financial services. We were awarded a contract in the third quarter by Mississippi State University to deliver a new CS300-LC supercomputer. This new system, nicknamed Shadow, is unique as it will be the first liquid-cooled Cray cluster supercomputer and features the latest-generation Intel Ivy Bridge and Xeon 5 processors.

We also announced 2 new pre-configured virtual shared memory cluster solutions: the CS300 SMP and the CS300 LMS. Both can be managed as a single system, eliminating the need for separate cluster management software or having to update multiple operating systems in associated applications.

The CS300 SMP provides users with nearly 9 terabytes of shared memory across up to 680 processor cores, addressing the need for scalable, complex processing of research simulations and data analytics. The CS300 LMS, or large memory system, offers users the same amount of memory, but with a 20x larger memory per core ratio for unique use cases, needing extreme memory requirements.

Our Storage and Data Management group had a very busy last few months. We had another major win for our Cray Cluster Connect, or C3 offering, which we just announced in June. C3 is a complete Lustre storage solution for x86 Linux clusters across all of the HPC and the big data computing market. Our win was for a significant test bed at a large U.S. national laboratory that includes a number of new products, including C3, for testing and future software development for a forward-looking research program.

In big data analytics, our YarcData team continues to make solid progress. YarcData's Urika system is a data discovery appliance that scales to unprecedented levels of performance, enabling the discovery of unknown or hidden relationships within large, complex data sets.

In the third quarter, we secured another important worldwide financial services organization as a Urika customer to use the system for compliance and risk management. A leading electronics company is adopting Urika to analyze relationships across their customers, products and social media channels to understand, influence their behavior.

And in an interesting twist and a first for Cray, we added a professional major league sports team as a customer who's using Urika to run analytics on their games, players and winning strategies. Every win is exciting, but this one is especially fun, given my personal love of sports. It's exciting to see these continued convergence of commercial enterprises in a variety of industries putting high-performance analytics to use.

Our fall software release for Urika delivers more streamlined integration with the existing enterprise ecosystem of business intelligence and visualization tools.

Just 2 weeks ago, we significantly expanded our research and development team in Europe with the addition of an engineering team, including the founders from Gnodal Limited. Gnodal was a recognized leader in high-performance networking.

We also acquired the key intellectual property. This acquisition, while strategically significant, was not material from a financial perspective. The team is already off and running in support of some of the -- our key projects in Europe. They will also play an important part in developing our future product roadmap in supercomputing. I'm very excited to welcome this impressive team to Cray.

Finally, staying on the topic of personnel additions, we've made 2 other key hires over the last few months that I'd like to highlight. In August, John Josephakis joined us as Vice President of Worldwide Sales. John has a long history in high-performance computing and storage markets, having worked with one of our main storage partners, DataDirect Networks as their Head of Sales for a number of years. And just this month, Kent Winchell joined our CTO office. Kent joins us from IBM's Worldwide Deep Computing division where he was a distinguished engineer and the CTO of their High Performance Computing group. I've known both these guys for quite a while, and I'm excited to welcome both John and Kent to Cray as each of them brings unique knowledge and skills to our team.

With that, I'll turn it over to Brian to take you through the numbers and the outlook.

Brian C. Henry

Thanks, Pete, and good afternoon, everyone. As we begin with our fourth quarter 2012 release, we are continuing to report certain non-GAAP measures, which adjust for selected noncash, unusual and infrequent items included in our GAAP results.

Before I get to our outlook, let me first take you through our third quarter financial results. For the quarter, revenue was $54.4 million, and our non-GAAP net loss was $13.5 million or $0.35 per share. Product revenue was $31.7 million, and service revenue was $22.6 million.

Our non-GAAP operating loss for the third quarter of 2013 was $15.1 million or about $2.5 million less than our GAAP operating loss.

For the third quarter, total reported gross profit margin was 38% and non-GAAP was 39%. GAAP-reported product margin was 26% and service margin was 53%. Service margin was slightly higher than we expect going forward, due in part to lower incentive-based compensation in the quarter due to our operating loss. On the other hand, Q3 product margin was lower than our typical targets.

Non-GAAP operating expenses for the quarter totaled $36.2 million compared to $23.6 million in Q3 of 2012. Operating expenses increased in the third quarter this year, primarily as a result of our acquisition of Appro during the fourth quarter of 2012, investments in R&D related to big data and our continued sales force expansion.

Our third quarter operating results included $2.9 million for depreciation, noncash pretax items excluded for non-GAAP purposes for the third quarter were $0.7 million for amortization of intangibles and purchase accounting adjustments and $1.8 million for stock compensation.

As expected, cash declined during the third quarter as we grew our inventory in anticipation of a large fourth quarter. Total cash and investments at the end of the third quarter were $140 million, down from $253 million at the end of the second quarter.

As usual, our cash balances are highly volatile and subject to a number of factors, including the timing of customer installations, individual contract variations, timing of customer acceptances and collections.

As discussed in the past, we view networking capital as a better measure of our financial position than cash and investments on their own because it includes an important element of our business, our inventory balances. As a reminder, we typically do -- don't buy inventory until a contract is highly anticipated, thus higher levels of inventory on our balance sheet indicates we are expecting strong results in upcoming periods.

Our networking capital at the end of the third quarter was $275 million compared to $285 million at the end of the last quarter. We expect networking capital will continue to be much less volatile than our cash and investment balances over the coming quarters.

Inventory at the end of September was a substantial $206 million compared to $126 million at the end of the last quarter with about $70 million or 34% out of customer sites and in the acceptance process. This percentage has grown substantially since the end of the quarter.

I would now like to take a moment to discuss our outlook. While we have secured all the customer contracts necessary to meet our 2013 expectations, a wide range of results remains possible. A significant portion of our expected fourth quarter revenue is dependent on several large systems, which are currently anticipated to be accepted late in the fourth quarter. These acceptances are complex with hurdles to overcome. In addition, a number of them have compressed time lines due to the U.S. government shutdown.

Assuming successful acceptance of these systems, we expect revenue to be approximately $520 million for the year.

We expect overall gross profit margin for the year to be in the mid-30% range. Note that the non-GAAP adjusting items are expected to have a positive increase to our gross margin of slightly less than 1% for the year.

Total GAAP operating expenses for 2013 are expected to be in the range of $160 million.

Non-GAAP operating expenses would be lower as a majority of the $10 million plus in total non-GAAP adjustments reduce operating expenses. The non-GAAP expenses are principally stock compensation and amortization of intangibles.

Other income and expense are expected to be in the neutral to modestly positive range for the year, mostly dependent on foreign currency fluctuations.

Based on this outlook, we expect to be profitable on a GAAP and non-GAAP basis for 2013.

We expect to record an income tax benefit for 2013 as a result of the partial release of our valuation allowance against deferred tax assets in the second quarter. The GAAP tax provision remains dependent on a number of variables, including the level and geographic distribution of taxable income.

A significant portion of our 2013 tax obligation is expected to be offset by previous net operating losses, and thus, will not require cash disbursements. Our non-GAAP tax or effective cash tax rate is anticipated to be about 7% to 10%.

For 2013, share count, when profitable, should be about 40 million and modestly higher in 2014, but this is dependent on a number of factors, including our share price.

For 2014, while it is very early in our planning process, and based on our current 2013 outlook, we anticipate revenue to be in the $600 million range for the year. Revenue is expected to ramp quarterly with a significant weighting to the fourth quarter of the year. Non-GAAP gross margin for 2014 is anticipated to be in the mid-30% range. And total non-GAAP operating expenses are anticipated to be about $175 million with the difference from GAAP mostly due to stock compensation.

Based on this outlook, we expect to be profitable on both a GAAP and non-GAAP basis for next year.

Our non-GAAP tax rate for 2014 is expected to be about 10% though it is dependent on several variables.

For 2014, we expect stock-based compensation to be a couple of million higher than the $7 million expected in 2013, and intangible asset amortization and purchase price adjustments are expected to be somewhat over $2 million.

As we have discussed in the past, we are currently making significant investments toward our growth initiatives, specifically in big data, storage and analytics.

Our Storage business has begun to pay for itself on the growth we experienced in 2013 and we expect to see continued positive return from this investment in 2014.

In big data analytics, we expect to invest a sizable amount again in 2014 toward this opportunity, impacting our earnings in the range of $20 million.

big data is a growing -- market is growing rapidly and presents a compelling opportunity to leverage our supercomputing technology to build a strong position in this market.

We're very excited about the opportunities these investments enable. We will continue to watch them closely and make adjustments along the way based on our analysis of the risk-return potential.

We expect our cash and investment balances will fluctuate next quarter, but ultimately be significantly higher at the end of the first quarter of 2014 compared to this quarter following the collections associated with large systems we're currently delivering.

As I mentioned, we expect networking capital will continue to be much less volatile than our cash and investment balances over the coming quarters.

In summary, we had our -- had a good first 9 months of the year, highlighted by strong customer contract flow and expect a strong fourth quarter. For 2014, we're in position to deliver strong growth again.

With that, I'll turn it back over to Pete.

Peter J. Ungaro

Thanks, Brian. Let me wrap up by giving you some perspective on what's in store for the remainder of the year and as we head into 2014.

We have 3 focus areas. The first is to continue to drive strong revenue growth. This starts with delivering our top line goal of $520 million for 2013, but also includes winning new business and building momentum in our growth initiatives for 2014 and beyond. For this year, we expect that at $520 million, more than 15% of our total revenue will come from commercial customers. And based on this outlook, we're expecting over $300 million in revenue in the fourth quarter, which will be a new record for Cray in a single quarter; and at $520 million for the year, a new annual record as well.

As Brian mentioned, we now have all the business we need in order to achieve our outlook for 2013, so the focus has shifted to building, delivering and installing all of the systems necessary to deliver on that target. We have a number of large systems that we currently expect to get accepted in the fourth quarter. Some of the schedules for these systems have experienced delays, and as a result, their acceptance time lines have been compressed. While we still expect to get these systems accepted by year end, it is likely going to come down to the wire on at least a few of them. However, as is typical, if a system doesn't get accepted by year end and the revenue shifts out of the quarter, we would expect it to get accepted and recognized in the following quarter. It doesn't go away. It just shifts out and becomes additional revenue in that future period.

As many of you know, this is part of the business of delivering large supercomputers that require customer-driven acceptances to achieve revenue recognition.

I also want to note that while the U.S. government shutdown resulted in some of our Q4 acceptance time lines being constricted, at this point, we haven't lost any deals or had any contracts pulled back as a result of it. We're continuing to monitor the situation closely with each of our customers, but at this point we remain confident in our plans with these customers, both in the short term and especially in the longer term.

We're off to a good start for 2014 as we've already secured a number of large contracts for next year with several key XC30 wins in the last few quarters in the Europe, U.S. and Asia Pacific regions.

Our second goal for the rest of the year is to continue to grow our presence in the big data storage and analytics market. We see strong momentum here and we expect that to continue into 2014.

In Storage and Data Management, we made another major step forward this past week with the launch of a completely new storage offering called Tiered Adaptive Storage, or TAS, broadening our portfolio solutions behind -- beyond high-speed Lustre file systems. TAS is an open-storage solution for big data and supercomputing, which enables our customers to manage their data across 4 tiers of storage and also addresses hierarchical storage management and archive requirements.

As data continues to explode in size, the need to access, manage and preserve data continues to increase in complexity and demand. By deploying a Cray TAS resolution, customers will be able to more effectively manage large persistent data and also easily manage data between various active and archive tiers.

In tandem with our TAS release, we also announced a strategic investment in Versity Software, Inc., a private software company with unique specialization in archival storage software. By partnering with Versity, we're able to offer industry-leading virtualization technologies to manage and optimize customer data across multiple storage tiers, scaling to a virtually unlimited archive size. We're excited about this new offering and our growing partnership with Versity.

In big data analytics, YarcData continues to target 4 main verticals. We're continuing to focus on proving the success of our early installations and working to acquire new customers. Urika offers customers an ability to do data discovery at a scale and speed that is truly unique in the industry today, and we've been amazed with the wide variety of use cases customers are bringing to Urika.

Our third goal for the year is to build a significant cluster supercomputing business. This is about making our Appro acquisition pay off for us in the marketplace. We've completed nearly every piece of our integration and expect that the last one, manufacturing, will be fully transitioned in the first half of 2014. We've also expanded our opportunity by working with new and traditional customers to grow the business. We made good progress here and have a number of new opportunities that we're working on, some of them very significant. We expect to see strong revenue growth in 2014.

And finally, we're continuing to explore leveraging our supercomputing technologies to bring further differentiation to our cluster offerings.

Let me wrap up my comments by saying that while we have a lot of work left to do over the next 7 weeks, we put ourselves in the best position possible to achieve our outlook for the year, and I'm confident in our team's ability to execute on our plans.

As we shift our focus to 2014 and beyond, we've already secured a number of large orders for next year, a great place to be at this point, and we're continuing to work on other opportunities that we hope to announce over the coming quarters.

The string of large wins we've been awarded over the last few quarters demonstrates the competitiveness of our products and we're investing to expand this competitive advantage even further.

We're positioned to have a great 2013 and to deliver continued growth and profitability in 2014.

With that, I'd now like to turn the call over to the operator to begin the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Chad Bennett from Craig-Hallum.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

So on the acceptance delays, I guess, so it sounds like the government shutdown did impact you from an acceptance standpoint. Should we assume that those systems were shipped in at customer sites and you had all the components that you needed for them -- for those systems and it was just merely a sign-off issue? Is that the way we should interpret it?

Peter J. Ungaro

So Chad, just to be clear about that, we don't believe that the government shutdown had an impact in our third quarter. The impact was not due to the government shutdown. There were 2 systems, particularly -- 2 large systems that didn't get accepted. One passed its acceptance test and was going through approvals and just didn't get through the approval and sign-off process in time to make the quarter. The system was in production, but just didn't get the approvals that it needed. The second system was performing really above our expectations on nearly all of the acceptance criteria. And as we were getting through the final stages of the acceptance process, we just hit some delays, which can happen from time-to-time, especially when you're building some systems at the scale that we build them at, and it just ended up taking a little bit longer than expected and it pushed beyond the quarter end. As I mentioned, we expect to get both of these done by the end of the year. So they're in our plan for the $520 million overall.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. But they haven't been accepted yet?

Peter J. Ungaro

They have not been accepted at this time.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. So how should we -- I guess, maybe a question for Brian. Is there any way to get an update for the inventory at customer sites metric where it is today?

Brian C. Henry

From what I said in my comments, it was substantially more than it was at the end of September, as we speak currently, and we're well positioned to have all the inventory where we need to by the end of the year. It gets down more to working through the acceptance processes.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Yes, I guess what I'm getting at is have we -- to reiterate the guidance in the ramp that you have, we have to basically have -- unless I don't understand acceptance time lines, we got to basically have 90% of the products shipped by today and basically almost shipped, installed at the customer site. So is it fair to say that the vast majority of product revenue in the December quarter has been shipped at this point?

Brian C. Henry

I would say yes. I mean, not everything is shipped and we still have a few to go, but virtually all of -- has been shipped now.

Peter J. Ungaro

I would mention one other point, Chad, in that 15% of our revenue this year, if we -- hitting the $520 million number will come from commercial customers and we found commercial customers have typically different acceptance process than our more traditional government or higher education customers have. And sometimes we can get through those quicker than we have traditionally gotten through them in, for instance, a large government facility.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. And then just on the component side, there's obviously been a lot of press or stories regarding the DRAM and memory situation related to the Hynix plant fire in early September. Can you talk about the relative impact, if any, on you guys and how you're dealing with that?

Brian C. Henry

Well, it certainly caused us to scramble around this quarter when that happened. I think where we ended up is we've gotten the memory that we need to make the shipments that we intended for the quarter. And so we feel good about that. Perhaps because there's 3 vendors and perhaps because of the fire, the firming up of the memory prices occurred in the fourth quarter and moved higher than it has been, and so we've had a modest impact on our gross margin because of the memory cost in the fourth quarter and we'll have some of that carry over to next year. We think the supply and demand will be much better in balance -- in memory really after the Christmas season.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. A couple of more for me. Pete, have you changed your thoughts on -- or Brian, for that matter, on where we end up in terms of the growth segments of the business: the storage biz, the big data biz and Appro at the end of this year. And then, obviously, you gave a first look on next year, kind of how we should think about the different pieces growing or representing as a percentage of revenue next year?

Peter J. Ungaro

Yes, Chad, great question. So maybe one by one. We are really seeing nice momentum, I would say, across storage and analytics this year. I mentioned on the last call -- last quarter's call that in our Appro acquisition, for clusters, we're a little bit behind our track this year because one of the big programs really got hit by sequestration. So we expect this year that we'll be a little bit behind our plan in our cluster business and really tracking nicely in both our storage and analytics business around the big data site. As we've looked into next year, we really have the same goals that we had. We wanted these businesses to grow faster than the general marketplace. We'd like our storage business to grow twice as fast as the general storage market, so kind of targeting somewhere around 25% growth in that business. And in analytics, we want to double that business every year because it's coming from a pretty small number and I feel really good about doing that. Urika's been very strong every quarter. We brought on more customers in that business. And next year, we'll also bring on a second analytics offering that, I think, is going to really help that business out. So I feel really good about where that's going overall. The Appro acquisitions, our cluster systems, I do expect those -- that business to grow quite a bit faster than the market next year. I think it's definitely going to be on a good pace for the year. And it should work very nicely with our XC30 high-end supercomputer to really flush out that marketplace. So I see all 3 of those businesses contributing strongly to our year next year, probably as a percentage of revenue being much higher -- a higher percentage than they were this year for us overall. But we haven't broken all that down for you guys.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay, good enough. One last one for me. On the -- Pete, again, as you look into next year, on the supercomputing or HPC side of the business, are there a couple -- without naming names, are there a couple of large procurements or orders out there that you have good visibility on that gives you the confidence in that business heading into next year? Or is there any way to talk about, I don't know, what you cut if off at, $80 million or $100 million-plus deals, where you either won them or you think you're in a good position to win to give you a kind of visibility into it?

Peter J. Ungaro

We don't really see many $100 million deals next year. I mean, one of the things that, I think, really differed in 2013 versus 2012 is that, while we grew our business, we also didn't have another $100 million kind of plus deal to get us there. So our business really diversified this year quite a bit over where it had been in the past, which is, I think, a really healthy thing for our business overall. And as we look at 2014, I see 2014 playing out very similar to 2013. No real huge single deals probably, but a number of sizable ones. So a number in the, let's say, more like $40 million, $50 kind of million category versus the $100 million to $150 million category.

Operator

And your next question comes from the line of Alex Kurtz from Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

So Peter, first on the second pushed deal. Was that political or technical delay in that deal?

Peter J. Ungaro

It was technical, Alex.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Okay. If -- Brian, if we're just going back and thinking about the amount of revenue that -- the amount of inventory you had to ship to book the government business, would you say that if you were to exclude the commercial business, that's maybe 90% of the government business that you need to close, that inventory has been shipped and in place?

Brian C. Henry

I would say, on the government business, we have shipped virtually all of the inventory that we need for acceptances this year. There may be some of the smaller CCS systems yet to go and we have one medium-sized one that's supposed to ship if it hasn't already shipped that's a CCS system.

Peter J. Ungaro

Our CS300 machines.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

Okay. So the commercial business then is just a matter of transactions, right, Peter, and that can happen a lot quicker?

Peter J. Ungaro

We do have acceptance tests with most of them because they're still relatively large machines, but they tend to be shorter and more focused.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

So if we just go back to the guidance for the year, Peter and Brian, given that you have an increased compression here at the end of the year, what gives you the confidence about maintaining the guidance? Why not give yourselves a little bit of margin for error here and lower the guidance for 2013? I think everyone on the call will be pretty disappointed if we come back 3 months from now and you guys missed because you didn't take a little bit more conservatism in this fourth quarter here?

Peter J. Ungaro

Well, I mean, that's certainly a discussion that we had. But when we look at each deal, I mean, we really look at it system-by-system. There's not that many of them. It's a good double-digit number, but when we look at them one by one, we really see the ability that, if we look at our time lines, we have the ability to hit each one. Because they're all different in size and different in scope, it's very hard to think about where to play that out at, but we feel confident in our number overall, Alex. I feel like if we didn't feel we were going to get to $520 million, we would not say $520 million. We are definitely targeting that number and I feel we're -- well, I don't feel, we are on track for that as we sit here today.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

All right. Can you talk about the Urika pipeline, Peter? Just the number of transactions that you're working outside of the government vertical?

Peter J. Ungaro

Yes, so we had -- we have 3 commercial customer transactions here in this last quarter that we talked about and -- on the call. So we had another financial services customer, which we're getting some nice traction in that industry now; electronics company; and then, of course, the sports, the major league sport team. So every quarter, we seem to be continuing our growth in the government segment, so that's been going very good and adding in a couple more commercial customers. So I feel like the business, as we see it, is going nicely. What surprised us a bit, Alex, is that we're seeing things across a number of verticals. So not just the 4 that we originally targeted, but a number of verticals. But the use cases are around the same. So we're seeing our use cases starting to be transferable vertical-to-vertical, which is really nice. I would say that probably the poster child for that is our cyber security use case, which we've seeing interest in across virtually every vertical that we work in.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

And just last question here, guys. Looking into 2014, just thinking about where the leverage is, if you were to drive upside from the $600 million number, is leverage in the model operating leverage just going to come from better margin mix? Or are you able to cap the OpEx growth if you're to show revenue upside? I know it's early, but just thinking from a framework perspective, how to think about all that non-GAAP OpEx next year?

Brian C. Henry

Well, I think, generally, the operating expenses are less variable and so they're likely to -- with revenue growth to be moved less than what gross margins would be and that's the largest part of the leverage that we have.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

So the $175 million is not necessarily a fixed number, but it's pretty close to what your operating model looks like maybe some incremental sales marketing commission dollars if you were to be above $600 million?

Brian C. Henry

Yes, we're -- it's still preliminary, so we're not totally locked down. But I would say, generally, we come up with a plan and the movement in expenses are less significant than they are -- than other areas.

Operator

Your next question comes from the line of Glenn Hanus from Needham.

Glenn Hanus - Needham & Company, LLC, Research Division

Yes, just following up on Alex's question. Could you talk a little more about gross margin leverage in the model next year? Just help us understand where that is, how that -- where that comes from, how that works?

Brian C. Henry

Well, upside in storage, upside in the big HPC, maintenance, YarcData, those are all positive to margins. The cluster solutions team, the CS300, that is in a cluster space and much more competitive margins. So to the extent that, that grows, that -- margins don't grow as fast in dollars, and as a percent, they're lower.

Glenn Hanus - Needham & Company, LLC, Research Division

So it's more mix-oriented?

Brian C. Henry

So it is more mix. Now we do expect and what was considered in our guidance is that the cluster solutions team would have a strong year next year.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. So could you just kind of rough and tough tell us what federal is. Is it like a percent of your business here in this year and what you think it might be next year? And then just talk about what you're seeing out there in terms of federal and the visibility as you go into next year and the processes and what's been agreed to in Washington and how that's impacting your business as you look into next year and -- or not?

Peter J. Ungaro

Okay, Glenn. So federal should be around, probably, 50% to 60% of our year this year. Overall, I mentioned 15% of our year will be commercial, so then of the remainder, about 50% of the total year federal and then the rest would be kind of international, I would say, government and academia. The -- as we're talking with our customers and understanding things, there's definite unknowns out there. The first shutdown that just happened, we feel, didn't have a major impact to us. While it caused some of our schedules to tighten up, some of it really is not just delayed in timing, but customer data centers that didn't get completed on time and things like that. So it just caused some scheduled compaction. Of course, everybody's looking at what's going to happen February when the next time line comes up and we'll see what happens there. We're not really contemplating that in our outlook today. Our outlook assumes that we're going to have a good, strong full year in federal overall. But I would say, our federal business remains strong. I feel very confident in that business. I feel confident in their need to use supercomputers to really fulfill their mission. And more and more, they're really pushing to do data analytics and advanced storage architecture. So I see that as a good, strong, growing business for us, especially when you look at it over the long term, Glenn.

Operator

[Operator Instructions] Your next question comes from the line of Glenn Mattson from Sidoti & Company.

Glenn Mattson - Sidoti & Company, LLC

I wonder, what gives you the confidence in Appro coming back so strong next year? Maybe it's better attach rates? Or is there something more to it than that?

Peter J. Ungaro

Glenn, I just feel like it's a good business. We're learning how to win in the cluster market around the world. Appro, before we acquired them, was really just predominantly focused in the U.S. So we've had to learn how to scale that business up nicely around the world. We took a pretty major impact with sequestration on the biggest program that they had lacked [ph] the year before. And we feel like we've kind of replaced all of that. The first half of the year was really playing out the business that they had. And so it's really been the second half of the year where we've gotten our sales teams trained up on the product, got our pipeline moving and really started closing deals. And I see every quarter getting stronger and stronger in that business. So I feel good about it. And when I look at the pipeline, there's a lot of potential opportunity out there for this product. So it's a very large addressable market for us and I think we'll win our fair share of that.

Glenn Mattson - Sidoti & Company, LLC

Okay. Then maybe also can you talk about the strength in Europe recently? It seems like we've had pretty good order flow from there. Is that just kind of it's their turn to turn up a little bit? Or is that something -- there's just some more to that?

Peter J. Ungaro

No, I really feel Europe's been a real shining star for us. It's been a business that we've struggled in for a few years and it's really taken us a few years to rebuild Europe and push ahead. We should do -- for instance, we'll do over $100 million in Europe this year, so it's kind of our second geography that broke the $100 million category and we expect it to stay up in that range. So it's not a 1-year thing. We think that we're going to have a good, sustainable business in Europe overall. The Europe business, though, has been really driven off our core strength in supercomputing. And so one of the things we're working on for next year is to diversify that business in storage and analytics and commercial customers a little bit more like we've seen in some of our other geos.

Glenn Mattson - Sidoti & Company, LLC

Okay. And I guess, lastly, did you say what commercial will be 2014? And then, looking out, I guess, at some point, maybe this big data play ramps and maybe that will be more commercial-oriented business. So maybe can you talk about what percent commercial could get to a few years out perhaps?

Peter J. Ungaro

Sure. It's a little early for us to be giving a percentage of commercial business for 2014. So we didn't -- we haven't really given that number. I will tell you our goal is to continue to grow commercial, though. So commercial is a big focus of ours. We see opportunity across all of our business segments in commercial and so I feel that, that's going to go good. As you mentioned, we do see big data, our big data opportunity, skewed more towards commercial than our core business. So that is going to be another opportunity. As those businesses grow faster than our core, we expected that to help our commercial business grow overall.

Operator

Your next question is a follow-up from Alex Kurtz from Sterne Agee.

Alex Kurtz - Sterne Agee & Leach Inc., Research Division

It's Sterne Agee. Peter -- more importantly, Brian, because the 10-Q is not out yet, can you just give us the non-GAAP adjustments for stock-based comp in the 3 operating lines?

Brian C. Henry

Well, if you look at the press release, it does break out the non-comp in the very back, the non-GAAP stuff by elements for both the quarter and year-to-date. So you know the large part of it, about $1.8 million was related to stock compensation and it's split up between a couple areas. Then you have some amortization that totals about $600,000. And then you have some purchase adjustments of $100,000. Those were kind of the non-GAAP adjustments above the line.

Operator

Your next question is a follow-up from Glenn Hanus from Needham.

Glenn Hanus - Needham & Company, LLC, Research Division

So it sounds like you expect the core HPC business x Appro to be growth -- growing next year?

Peter J. Ungaro

We expect all of our businesses to grow next year definitely, Glenn.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. And the tone on HPC, I mean, worldwide, I usually ask you something about this. It sounds like you're still seeing a lot of strength internationally and you commented on Europe already. So you want to comment on Asia at all?

Peter J. Ungaro

Yes, we definitely see good opportunities and a higher percentage of our pipeline coming internationally overall. So that's good. We are in a, really, I believe, a very strong competitive position with our offerings right now. I think the XC30 is a very, very strong offering in the market. Our CS300, very, very strong offering. And we're working on, as I mentioned, on the -- on my prepared comments, we're working on taking some of our supercomputing technologies over into the cluster space to really differentiate those products overall. And I couldn't be more excited about the storage offering with TAS that we just announced last week because that's a real strong piece overall of our big data storage offerings.

Glenn Hanus - Needham & Company, LLC, Research Division

Any comment on competing with IBM there in the high end and win rates and all?

Peter J. Ungaro

I don't have -- IBM's definitely still our biggest competitor, by far, overall, especially in the high end. We see them virtually every place we go. We've won probably, more than our fair share from IBM over the last few quarters. And I hope that, that's going to continue. We look at our opportunities that are in front of us for '14 and even beyond out into '15, and we feel pretty good about our business. We think that the supercomputing market's going to continue to grow and we should grow faster than that market will grow.

Operator

Your next question comes from the line of Chad Bennett from Craig-Hallum.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Just for the Agee analyst. So can you speak to linearity next year? I know you talked about significantly -- significant weighting towards the fourth quarter. But can you provide any more color? And more importantly, what's really driving that -- the weighting towards the fourth quarter? I know the last couple of years, it's been driven by, not only your product kind of road map or introduction, but also Intel's and everybody else's. What's really driving the back-end weighting?

Peter J. Ungaro

So the way we see it playing out right now is we do see kind of quarter-over-quarter growth. So we do see kind of that ramp happening quarter-over-quarter, similarly to how we saw this year as we saw it at the start of the year. The back-half weighting is really around, again, another major product introduction by Intel. And so we're -- it is going to drive a little bit of that back-half weighting, especially the fourth quarter, Q4 weighting overall. So that's -- it's a very similar driver that we've seen overall to our business. So we have each of this -- each of the kind of initiatives, our products growing, especially the ones in storage and analytics that are growing quite fast. And then on top of that, you add a new processor from Intel that's going to be out in the second half of the year and that's what's really putting that all together.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Peter J. Ungaro

Thank you. We made solid progress on our goals for the year, and we're focused on delivering the plans I laid out today. Next week starts the biggest supercomputing conference of the year, SC13, which is in Denver. You've seen some early announcements from us over the past couple of weeks, which will continue into next week as the conference kicks off. It should be an exciting show and I hope to see some of you there. Thank you all for joining the call today and for your continued support of Cray. Have a great evening.

Brian C. Henry

Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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