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Cray Inc. (NASDAQ:CRAY)

Q4 2013 Results Earnings Conference Call

February 13, 2014, 04:30 PM ET

Executives

Paul Hiemstra - Corporate Treasurer and Investor Relations

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

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

Analysts

Alex Kurtz – Sterne Agee

Chad Bennett- Craig-Hallum

Glenn Hanus - Needham & Co.

Sid Parakh - McAdams Wright Ragen, Inc.

Operator

Good afternoon. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2013 Full Year and Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Paul Hiemstra, Corporate Treasurer and Investor Relations contact you may begin your conference.

Paul Hiemstra

Thank you. 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 58707088. 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. I'm going to start with some comments on our 2013 fourth quarter and full year 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 2014 and then open up the call for Q&A.

As we announced in January, we had a great fourth quarter and full year. We posted record revenue for the second year in a row as well as solid profitability. We had good growth across our business completing the acceptance of more super computers during the fourth quarter than we have in any previous quarter in our company's history. We also grew our big data revenue and put ourselves in position to continue to drive growth in this fast growing market.

I want to give you an update on how we did against our three major focused areas for the year. The first was to deliver on our outlook of $520 million in revenue. We came in ahead of this target at over $525 million, driving 25% year-over-year growth, well over twice the blended growth rate of the markets we serve. This is led by the strength in our supercomputing business, which includes our XC30 and CS300 system.

The XC30 is our most advanced supercomputer able to deliver extreme scalability and sustained performance to users in a variety of data intensive computing application. The CS300 is our cluster supercomputer which provides flexible configuration options in an integrated energy efficient and modular platform.

To give you some context on our growth in 2013, if we look back to 2012, that year we completed the acceptance of the largest system in our company's history and one of the most powerful supercomputers in the world, the Blue Water System at the University of Illinois. This system contributed more than a $140 million in product revenue or over a third of our total revenue for the year.

Contrast that to 2013 where our single largest system came in at less than $60 million in revenue or only about 11% of our total revenue. So despite not having a megadeal in 2013, we were still able to grow our high end supercomputing revenue, which speaks to the competitiveness of our systems and the work we are doing with the broader set of customers around the world.

We completed the installation of several large supercomputers during this past quarter, including XC30 systems at the Swiss National Supercomputing Center, at the U.S. Department of Energy and National Energy Research Scientific Computing Center, and at the U.K. National Supercomputer Facility.

Europe was a particular highlight for us in 2013 as it was the first year that we crossed a $100 million mark in revenue for any of our geographies outside of the U.S. We also positioned ourselves well for continued strong growth in that region. I’d like to add that we grew in each of our four geographies in 2013.

We had a number of new supercomputer wins in Q4 including several government and commercial orders for both our XC30 and CS300 systems. In November, we were awarded a contract to upgrade the XC30 at the University of Stuttgart’s High Performance Computing Center; their existing XC30 known as Hermit will we expanded to more than seven petaflops of compute power and an additional two petabytes of storage.

Increasing the amount of commercial customers also continues to be a focus area for us as it further expands on markets and diversifies our revenue base. In 2013, more than 15% of our total revenue came from commercial customers. We have seen strength in several commercial markets, including the energy segment, manufacturing and financial services.

We also strengthened our supercomputing product roadmap with the completion of two significant development projects, supporting the latest generation Intel Xeon Ivy Bridge processors and integrating new accelerators into our CS300 and XC30 systems with both the Intel Xeon E5 and NVIDIA's GPUs.

We also enhanced our industry-leading OpenACC 2.0 compatible Cray compiler, which is designed to make users of these accelerators more productive. And as we announced in November, our CS300 is now available with this unique Cray compiler, providing our customers with an integrated user experience across our supercomputer lineup.

The second major focus area for 2014 was to continue to grow our presence in the big data storage and analytics market. In storage and data management, we had a great year, finishing with over $63 million in revenue, 27% year-over-year growth. Our storage business was led by our Sonexion Lustre storage system, which can scale up to the highest performance levels in the world.

Just this month, we also signed a new contract to deliver a standalone Sonexion to an energy company in South America. This storage system was sold independently of a Cray Supercomputer and is based on our standalone offering to Sonexion, which we call Cray Cluster Connect or C3 for short, representing another step in expanding our storage solution to customers worldwide.

We launched a new storage offering during the fourth quarter called Tiered Adaptive Storage, or TAS, allowing us to address the higher vertical storage management markets across big data and supercomputing. This solution allows customers to transparently manage and access data across their storage hierarchy, including solid state drives, disk and tape archives. TAS is equally well suited for storage for active or archival data.

In big data analytics while still small from a revenue perspective our YarcData team tripled the number of Urika customers in 2013. During the fourth quarter we added new customers in our life sciences, cyber security, telecom and the electronics market segment.

A leading life sciences company recently chose Urika as the development environment for their data discovery strategy. They intend to Urika for a number use cases including transitional research, cohort selection for clinical trials and as a means to quickly bring the proprietary data together with public data to augment their research initiatives.

And finally our third major focus area for 2013 was to build a significant cluster supercomputing business. This was centered around our acquisition of Appro International in late 2012. We have three goals for the Appro business. First was to integrate our two teams and extend Appro's reach by enabling the worldwide distribution of big cluster supercomputers.

We have accomplished this goal with the last remaining integration cap being manufactured. We're already up in running in the new manufacturing facility in Chippewa Falls, Wisconsin to this product and expect this transition to be fully completed early in the second quarter.

Second was to grow this business with our traditional Cray customers. While we definitely achieved this goal we weren't able to hit our overall cluster revenue target for the year coming up about $10 million short mostly due to a single large contract impacted by sequestration. That said, I believe we'll be ahead of our growth targets as we exit our second year of this acquisition at the end of 2014.

And third was to leverage this product to serve as a broader platform for a supercomputing and big data technologies to drive further differentiation into the markets. We had a clear win on this goal and we already announced extending our unique XC30 compiler for use with our CS300. And we have a couple of exciting tricks up our sleeve in this area planned for later this year.

Overall, I am quite proud of our success with this acquisition and Q4 was another great proof point with acceptances in new orders in each of our major geographies and across a number of industry verticals including government, manufacturing, higher education and financial services. All-in-all we ended 2013 on a strong note and built a strong solid momentum for 2014 which I’ll discuss in a minute after Brian takes you through the numbers and the outlook.

Brian C. Henry

Thanks, Pete, and good afternoon, everyone. Before I get into the 2014 outlook let me first take you through our financial results for the period ending December 31st. I am going to start with our fourth quarter results of most of my comments will be for the full year which is really the best way to look at our company.

For the fourth quarter revenue was $307 million and both GAAP and non-GAAP gross margin was 37%. Non-GAAP quarterly operating expenses were $49 million compared to $35 million in the prior year quarter.

I’ll discuss the change when I discuss our full year operating expenses. Also note that we’ve recorded significant incentive-based compensation in the fourth quarter for both years. Finally GAAP net income was $51 million or $1.27 per share for the quarter and non-GAAP net income was $59 million or a $1.48 per share.

Now shifting to our full year results, revenue for 2013 was $525.7 million an increase of 25% over 2012. Product revenue grew substantially for the second year in a row to $436 million compared to $354 million in 2012. This was primarily driven by our supercomputing business and growth in storage.

Service revenue for the year was $89 million a 33% increase over 2012. Service revenue increased primarily due to growing maintenance revenue resulting from our larger install bases systems. GAAP net income for 2013 was $32 million or $0.81 per share and benefited from a partial reduction in the valuation allowance held against our U.S. deferred tax assets. Non-GAAP net income for the year was $30 million or $0.76 per share.

Total non-GAAP gross profit margin for the year was 36%, the same as it was in 2012. On a GAAP basis for the year total gross profit margin was 35%, product margin was 32%, down 3% from 2012 driven in part by a higher mix of our revenue from our cluster supercomputers.

Service margin for the year increased substantially to 52% compared to 43% in 2012, driven by the strong demand for Sonexion storage revenue grew 27% in 2013 to $63.9 million. Gross margin from storage came in at a strong 40%. Non-GAAP operating expenses for 2013 totaled a $155 million compared to $116 million in 2012.

This increase was due to several factors including increase investments in big data, storage and analytics and a $20 million less in R&D co-funding credits along with additional operating expenses that resulted from our acquisition of Appro.

Total cash and investments at the end of the year were 2$20 million, an $80 million increase from the end of the third quarter. Non-current assets included $14 million in cash which was restricted at the end of the year. These funds are associated with the customer prepayment for system anticipated for delivery in the second half of 2015 at which point the restriction is expected to be released.

Working capital at the end of 2013 was $335 million, increasing significantly compared to the $275 million at the end of the third quarter and $283 million at the end of 2012. Working capital tends to be less volatile and we believe is a better measure to track then simply cash and investments on the roll.

Inventory at December 31st was $95 million with about $25 million out of customer sites and in the acceptance process. As a reminder we largely build to order.

I would now like to take a moment to discuss our outlook for 2014. While a wide range of results remains possible we expect revenue to grow to about $600 million for the year service revenue is expected to grow 5% to 10% in 2014 with gross margin for service somewhat lower than in 2013.

We expect revenue to ramp quarterly this year with about $50 million in the first quarter and roughly 50% of the annual total coming in the fourth quarter. Overall non-GAAP gross margin for 2014 is anticipated to remain in the mid 30% range. Total non-GAAP operating expenses are expected to be in the range of a $175 million for the year, non-GAAP adjusted items includes items excluded for reconciliation purposes totaled about $9 million in stock compensation and somewhat over $2 million in amortization of intangibles.

About 75% of these items impact our operating expenses and about 25% impacts gross profit. As we indicated on the last earnings call we are continuing to make significant investments to drive growth specifically in Big Data Analytics. In storage we are growing nicely and that business is already profitable. In Big Data Analytics we are continuing to make investments ahead of revenue growth and for 2014 we expect that the investment to net out to a total of about $20 million.

We continue to evaluate these investments in the context of the opportunities they enable us to pursue mainly the high growth big data market. Interest and other income and expenses are expected to be in a neutral range for 2014. Based on this outlook we expect to be profitable on a GAAP and non-GAAP basis for 2014.

Our reported effective income tax for the year is expected to be about 40% but is dependent on number of variables including the distribution of taxable income and on the impact from changes in through the valuation allowance to hold against our deferred tax assets.

However the larger majority of our income taxes for 2014 are expected to be offset by previous net operating losses. Based on this outlook our effective cash tax rate is anticipated to be about 10% for 2014. Share count when profitable should be about 40 to 41 million shares but is dependent on a number of factors including our share price. We expect cash and investments to fluctuate significantly quarter to quarter while working capital should be less volatile.

In summary 2013 was another strong year highlighted by continued strength in our high end supercomputing business and growing traction in our Big Data Storage and Analytics Groups. I am pleased with our continued ability to grow, even more excited as we’ve been able to grow in a way that diversifies our revenue. In this diversification by products , by customers and geographies. With that I’ll turn it back over to Pete.

Peter J. Ungaro

Thanks Brian. Let me wrap up by taking you through our three major focus areas for 2014. The first is to keep the company on a strong growth path in our three selected markets; Supercomputing, Big Data Storage and Data Analytics.

According to market analysts the supercomputer market is growing into 7% to 8% range our targeted storage market is growing in the 10% to 12% range and the big data analytic market is growing at about 40% each on an annual basis. Our goal is to grow two times faster than the growth rates in each of these markets.

We have multiple offerings in each of these segments which we believe give us the opportunity to do just that and potentially more. With the growing pipeline across each of our solutions we are off to a fast start in 2014. In fact just last week we were awarded multiple contracts totaling well over $100 million, which we expect to complete during 2014.

We announced two of these deals on Tuesday as we won contracts totaling over $40 million to provide the Department of defense high performance computing modernization program with three XC30 supercomputers and two Sonexion storage systems.

We will be delivering our most advanced supercomputers in storage to the Air Force Research Lab in Ohio and the Navy Supercomputing Centre in Mississippi. In addition to securing new contracts, we plan to continue to execute on our product development roadmap for the year. One of our big efforts here is to deliver new XC30 and CS300 systems based on the next generation of Intel Xeon processors.

There processors are expected to be a major step up in performance and we are working closely with Intel to remain on track to deliver systems with these new Xeons during the second half of the year.

Our second major focus area for the year is to continue to establish a stronger presence in the big data storage and analytics market. As I mentioned earlier our Sonexion storage appliance and our TAS hierarchical storage solutions provide customers with a unique scalable offering that solves them of their toughest storage problems. We have a number of complex Sonexion installations planned this year, including at the European center for Medium Range weather forecast and several installations in energy sector.

As data continues to explode in size the need to access, manage and preserve it, continues to increase in both complexity and demand. Sonexion handles our customer's need to have extremely fast data movement to and from their largest system and by deploying the TAS solution customers will be able to more effective manage their large precision data between various active and archived tiers. Both of our storage solutions can be deployed on their own or together and each can be integrated with a Cray Supercomputer or a non-Cray cluster system.

In big data analytics we make good progress with our Urika appliance in 2013 and we expect it to continue to gain traction in 2014. We are continuing to target four primary market verticals but we are also seeing early success with customers outside these verticals, demonstrating the breath of the Urika solution, to address large scale data discovery across multiple disciplines.

In addition we have enabled both of our supercomputing platform to use Hadoop to manage scientific big data and we are planning to announce the second analytics appliance in the first half of this year. With these steps I believe we have an opportunity to grow even faster in the analytics market in 2014.

In conclusion I am very pleased with what we accomplished in 2013 and our strengthening position in the market. We are in strong competitive position right now and we are in a great place to continue to grow and execute on our goal for 2014. With that I'd now like to turn the call over the operator to begin the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Alex Kurtz from Sterne Agee. Your line is now open.

Peter J. Ungaro

Hey, Alex

Alex Kurtz – Sterne Agee

Hey, Peter, hey guys. Thanks for taking the question. Just two quick ones here. First on the visibility Peter, I think in the past you've talked historically about being able to see certain amount of revenue, this time of the year, can you give us an update on that? And then the second question is related to all the changes at IBM, you have the Blue Gene opportunities and the Lenovo opportunities, how should investors think about what's been assumed in your guidance for '14 and how that may help the '15 fiscal '15 outlook?

Peter J. Ungaro

Sure, Alex two great questions. On the visibility front as we sit here today we can see the remainder of this year better than we could last year. So when I look at our contracts that we have in front of us as well as our pipeline and where we are in relation to those things I feel really good about where we sit right now at the start of this year.

So our visibility is even better this year at this point in time than it was last year at this point in time. So I think that’s a good sign overall and gives us a lot of confidence to step out and continue to grow.

As you mentioned one of the most interesting things that has happened over the last quarter is our largest competitor, which is IBM announced that they are selling X86 Server business to Lenovo. This is a big deal for the entire HPC market. If you look at the top 500 list 77% of IBM systems on that list are actually X86 based systems that are going to move over to Lenovo. So that clearly opens up some opportunities within the market that I am sure that not only us but other companies in the market place are very focused on.

So that’s an exciting change for us that we hope to be able to capitalize on over the next couple of year.

Alex Kurtz – Sterne Agee

Right, the other thing is you have not presumed in your guidance for the year left.

Peter J. Ungaro

Now definitely not Alex I mean we as we came out with our guidance even before this Lenovo deal was announced and we are holding our guidance right now, so not in our guidance for this year.

Alex Kurtz – Sterne Agee

Thank you.

Peter J. Ungaro

The other thing you mentioned was Blue Gene, just a follow up on that you know from what we’d be hearing in the market place is that there is no direct follow on to the Blue Gene products in the market. That obviously been a pretty successful platform for IBM also and so this again opening up some opportunity we believe for us in the market place overall. So I mentioned that we are pretty excited about our competitive position right now in the market and clearly those two things changing with our most in our largest competitor that is pretty exciting for us. We just have to see over the next few years how much we can turn that into increased growth.

Alex Kurtz – Sterne Agee

Thanks guys.

Operator

Your next question comes from the line of Chad Bennett with Craig-Hallum. Your line is now open.

Peter J. Ungaro

Hi Chad.

Chad Bennett- Craig-Hallum

Hey guys. So just digging a little bit more into the IBM opportunity I guess. Is there a way to think about the relative opportunity between XC30 and the cluster product in the X86 sale I would imagine may be it benefits the cluster products more but any further color there?

Peter J. Ungaro

Yeah so if you look at their IBM lined up with X86 products without a doubt this cluster CS300 product line is the most similar to that product in the way it's architected and what it brings to the market. As we found there is a lot of those companies that look at cluster that announced they will look at the XC30. So I think it's actually going to benefit both line overall at least as a potential to benefit both lines overall. So may be a little bit more weighted to the CS300 Chad but both volumes we get benefit from it.

Chad Bennett- Craig-Hallum

Okay. And then did you -- maybe I missed it Brian but did you give a revenue number in ’13 for the big data segment?

Brian C. Henry

No in SEC 10-K filed today there is an area on it is called other and it's included in their net total areas 14, but the data analytics piece of that is little bit less than half.

Chad Bennett- Craig-Hallum

Okay.

Peter J. Ungaro

As we mentioned Chad the big thing for us in the analytics side was `Urika that would be weaker is that we tripled our customer accounts in that space last year so nice progress on the customer front.

Chad Bennett- Craig-Hallum

And are those customers -- is it a mix bag between kind of license up front license sales versus subscription or is it just…?

Peter J. Ungaro

Yeah great question. So what we are finding is that a number of our customers as they kind of do early test that of the product and bring it into they are doing that on a short term subscription basis. But as they put that in our they make a bigger commitment to that product and we see them going towards the purchase. So we see interesting thing as both we think customers actually both different agreements, one more for proof-of-concept or a test that as an opportunity but most of our customers we're seeing are thinking about going into production with the machine and building a larger environment around it are looking at a purchase. So, both have been important to enable this business, but I think more of a revenue will be on the purchase side of things as you go forward.

Chad Bennett- Craig-Hallum

Okay. And then last on for me. Pete the big data appliance that you are announced or releasing in the first half of this year, will that have broader appeal than the graph appliance, the Urika appliance that you have now and can you provide any color in terms of may be how broadly the appeal or quickly that could ramp with the models different behind it?

Peter J. Ungaro

I don't want to mention too much about the product, we haven't announced it yet and I will tell you I am pretty excited about the product overall. But give us a couple of more months. I mentioned we are going to do it here in the first half of this year, so give us a couple of months to roll that out to you. But I will tell you that it definitely is go after a broader part of the market. As we got into the analytics we wanted to find a place that we could apply computing technology in a very unique way and carve out a kind of unique spot in the market. And we are really proud of our team and our data and our ability to do that.

We have some great reports from Gartner and IDC a number of different analyst about our ability to do that. So, I feel like that was a great spot for us to start. But as we look at this market place, we see the potential growth behind this market, we wanted to come with something that's complementary to what we doing with Urika but also attacking a much broader piece of the big data market analytics overall and that's what we're targeting at.

Chad Bennett- Craig-Hallum

Okay. Thanks. Nice job on the quarter and the year guys again.

Peter J. Ungaro

Thanks Chad.

Operator

Your next come from the line Glenn Hanus from Needham. Your line is now open.

Glenn Hanus - Needham & Co.

Good afternoon guys.

Peter J. Ungaro

Hi Glenn.

Glenn Hanus - Needham & Co.

So just to follow up on the IBM first, what's your sense of if there is a benefit to you is that potentially second half of 2014 benefit or should we think of that more in terms of 2015?

Peter J. Ungaro

Well, as I mentioned before, we haven't really thought about it in our '14 plans yet. I mean, but there is no doubt Glenn, we are trying to understand that and see that how that plays out for us and we definitely think was the strength of our product in the market. Even if this wasn't happening I feel like we have some upside in those products over the next couple of years, but this just adds another opportunity for us. So I am really thinking of it over the next few years not really specific '14 kind of event and that's how am thinking about it. Now we will see how that's plays out. Hopefully over the next quarter I will be able to give you a little more color on that.

Glenn Hanus - Needham & Co.

Sure. On the deal landscape you discussed in your opening remarks the revenue concentration in 2012 versus 2013 being a lot less. What is the deal landscape look like as you contemplate your guidance here for 2014?

Peter J. Ungaro

So I think 2014 from a kind of mega-deal perspective and it going to look a lot more like 2013 than 2012. So, we don't see any those huge mega-deals in the year and by the way if we don't see them by now then not likely in the year, right. So they take a while to pull together. So, we think 2014 is going to be a nice much, nice balanced year across the board for us overall. As I mentioned, we did over 15% of revenues in commercial in 2013 which is huge growth for us because couple of years ago we almost had zero percentage of our revenues in commercials. So that's been a nice growth piece overall and I also mentioned that all four of our geographies around the world grew nicely in 2013.

So I feel like we have some nice balanced strength right now across as Brian mentioned across products, across our customer base and then across geographies. So, am feeling good about how this is going to play out for us.

Glenn Hanus - Needham & Co.

And as you look into your 2014 number you are seeing the same kind of balance?

Peter J. Ungaro

Yeah I think even a little bit improved as we go forward. Because I believe that these the newer products that we're bringing to market like in the analytic space, the TAS storage solution those are just starting to come on board, right. So they will continue to kind of improve that balance overall.

Brian C. Henry

And Glenn just a piece of information that's disclosed in the 10-K, last year we had two customers that totaled 22% of our business that's a much lower concentration than we had. And there is a chance that as Pete said that it will be even more broadly distributed this year which is a great part of the diversification. Also I think we have said that all the international areas grew and all the businesses did well.

Glenn Hanus - Needham & Co.

So, as you kind of look into 2014 and into 2015 what do you see as like the biggest swing factors that we saw some upside that it would likely to come from certain regions or certain part of the HPC or where might the upside be or where might the risk be in the model?

Peter J. Ungaro

Yeah. So this is where I am most excited. So when we look at it across our businesses, when we look at supercomputing, when we look at storage and analytic, we see opportunities for upside in each of those areas. I think that each of those area has kind of given us incremental upside. When I look at it from a geographic basis I can see each of our major geographies and when we look at our pipeline that could really do something pretty amazing. I mean I mentioned that Europe was our first geography outside of the Americas to break the $100 million barrier.

Well I will tell you they had huge growth year-over-year in order to break that barrier and I see that opportunities be out there in each of our geographies to do that. So I just really feel like the company is so much more balanced while I think we've always the good technology we've been really able to balance that out nicely within these three different solution areas within bringing on board commercial customers and just a broader customer portfolio and a couple of products. So not a huge number of products, not a huge diversified product list but enough that we can get this much better diversified growth.

Glenn Hanus - Needham & Co.

On the gross margin front you mentioned Brian that service gross margin might be down a little bit, might the product margin be up some next year or this year now? And might, overall how should about the overall gross margins I heard your guidance there is probably up a tick year-on-year or flat or down or how should we think about that?

Brian C. Henry

Well the guidance is mid-30, so I think that would be best and that was non-GAAP I think that's best with in our ability to manage it right now flattish. When you look underneath it, the service is likely to be down because part of the services is what we would call engineering activities and engineering services that have had a higher margin in 2013 than is typical and that we expect going forward. And so that's why we are suggesting for the most part that overall service margins would be down a little bit. And yes there is a chance that product margins will improve and if they do that will be despite a more significant growth in the cluster supercomputing business that carries a bit lower gross margins.

Glenn Hanus - Needham & Co.

Okay. Thank you.

Operator

Your next question comes from the line of Sid Parakh with McAdams Wright and Ragen. Your line is now open.

Peter J. Ungaro

Hi, Sid.

Sid Parakh - McAdams Wright Ragen, Inc.

Hey guys, how are you.

Peter J. Ungaro

Good.

Sid Parakh - McAdams Wright Ragen, Inc.

Thanks for taking my question here. So just wanted to touch a little bit more on the big data piece here. So as you seen the product kind of evolve and you spend more time and effort on this initiative, can you talk about what customers are experiencing in terms of success with this solution? And as a result of what you are seeing happen within your customer base that's currently trying these products is your sense of the market opportunity kind of the same or bigger or maybe smaller as compared what you were thinking going in to this opportunity?

Peter J. Ungaro

Yeah that’s a great question Sid. So first of all I do want to say that there is a huge amount of hype of course around the whole big data market. And one of the things that we wanted to prove to ourselves in 2013 was we could put Urika of our customers and those customers can have some success with the platform like real success that we think they can build of further and grow and we are able to do that in 2013. I would say if I told you the major areas I would say that the whole kind of cyber security, compliance area was a big part of where we saw good customer successes in 2013 across the number of customers.

I think that we really feel that the whole kind of life sciences bio-tech space is going to be a really good opportunity for us with Urika because they have a lot of experience of this kind of this type of processing within that vertical. And so we’ve seen some nice successes and wins in that space and then we seemed a few areas around like customer churn and understanding kind of customer behavior with the products.

So one of the things that we really wanted to do was try to find some solutions that we felt that were going to be repeatable solutions for us, and you know I think 2013 went a long way to bring us into that game. We’ve kind of started that year without having those yet right so 2013 was a prove it kind of year.

When we look at the big data market overall I mean we’ve see the potential within this market so really be very, very large and very important and more importantly may be for us particularly we see the opportunity for us to apply unique technology into this space to do something that other companies -- we are not just seeing out there being done in the market today.

So I feel like it's kind of a really nice play from a market that we think is going to be growing and expanding even more and us being able to apply unique technology in there to carve out some specific areas that I think could be really, really important and meaningful on both the revenue and profit line to the company overall over the next few years. So I guess that I think it's probably even a little bit bigger than we originally thought and we just got to continue to prove to ourselves making the good steps forward and proving to ourselves that we can build up a substantial business in this area.

Sid Parakh - McAdams Wright Ragen, Inc.

Great and so just as a follow up on the same topic here. I mean is there some acquisition activity that might help you kind of move along and this initiative sooner than they are that might just simply supplement your efforts? Or you don’t fairly necessarily if don’t need for any of that and so assuming that you have all the technology in house today? So I am just curious about how you are thinking about M&A on that front?

Peter J. Ungaro

Yeah that’s a great question. When I think about it I think about kind of in two areas right, so a kind of technology and distribution. So I think on the technology side I think that we feel pretty confident that we have a good core set of base technology and that we can form partnerships with other companies to give us some of the middleware specific middleware components related to these market place that we need. So there is always I guess the opportunity to look at bringing those components in house or not and we continue to think about that.

But I think as far as our ability to build products or technologies or indicate the big data we are really trying to go more appliance light technology and we feel like we have that ability right now, and we don’t have to necessarily do something to enable us to do that. I think if I look of into the future so in the next couple of years I need a lot more about distribution.

And I think about as we grow the number or commercial customers that we have as we are growing different industry verticals that we have, I think there is definitely some opportunities for us to work on the distribution side of our business and I am not sure that’s going to be acquisition or partnership yet but those are something that I am really thinking about because I don’t want to slow our ability to be in this market place because of distribution. I don’t think we’ve done that so far because we are really in the prove-it-out stage of our big data analytics.

But as I think about how this may progress over the next couple of years, I think that there will be something that we will start to think about more and more.

Sid Parakh - McAdams Wright Ragen, Inc.

Okay fair enough, and last from me is, can you talk about I think as we entered 2013 you laid out the goal of having 15% of earnings come from commercial customers. So I just want to ask where you end up on that front and how much of your 2014 revenue should come from commercial accounts.

Peter J. Ungaro

So first of all for 2013 we beat the numbers. So, we got over 15% of our customers in commercial. So I really great about that and that's really good growth. You might remember, last year we did 10% of our customers so on a growing top-line plus growing percentage what's going underneath the covers is quite exciting for our business overall. We haven't really given ourselves kind of formulated specific target for 2014 but I will tell you we want to continue to grow it. So, it's a really important piece.

We want to continue to grow it both as an absolute number and as a percentage of our business overall. So kind of longer term as we see that, we want to have more and more of our business be in commercial. The interesting piece is we are doing really good in the government and academic section of our business too. So those are growing nicely also.

So just kind of as we think about it I am not sure exactly how it's going to play out as a percent of that in '14. But I feel like we are building solutions and we are getting traction in these new verticals and as we kind of picked out like first one or two customers partnership in a new vertical, we start to see other opportunities within that vertical start to flow into our pipeline which is nice. So I think it's working and am hopeful that continues to grow nicely over the next few years.

Sid Parakh - McAdams Wright Ragen, Inc.

Okay. Great. Great job guys. Thank you.

Peter J. Ungaro

Thanks, Sid.

Operator

(Operator Instructions). Your next question comes from the line of Alex Kurtz from Sterne Agee. Your line is now open.

Alex Kurtz - Sterne Agee

Yes. Guys just a real quick follow up on trading and quality. Could you just give an update on what that looks like for you guys as an opportunity? How should we think about that as far as revenue over the next couple of years?

Peter J. Ungaro

Okay. Alex, for everybody else on the call, I'll just give a quick background. So, there is two large super-computing procurements going on right now in the U.S. Department of Energy. One that's called the Trinity and one that's called Core. These are both kind of out year opportunities to kind of multi-year. Trinity is actually pretty much a just a very large platform by this out in this kind of 2016 or so timeframe and that procurement we're definitely competing for. It's one that we expect will be awarded sometime in the first half of this year and we are very hopeful for it. It's across three national laboratories, Los Alamos National Laboratory, Lawrence Berkeley National Laboratory, the NERSC center and Sandia National Laboratories. So that's that one.

Core is even longer-term and that's more -- Core is more of an R&D contract and it's kind of R&D in many different aspects of machine including the processors themselves. So Core one is a little bit less formulated about exactly how that's going to play out. That's out in the 2017, 2018 timeframe and even larger because it has R&D component on that. And that's Oak Ridge National Laboratory, Lawrence Livermore National Laboratory and Argon National Laboratory.

So we are definitely very interested in both of those deals. We will see how they play out over time. Trinity is the one that we expect over the next few months that they're going to at least start to narrow down the list and move towards the contract on. So, we are very hopeful. We will see how that plays out. No impact to our 2014 at all in either one of those.

Alex Kurtz - Sterne Agee

Thanks Peter.

Peter J. Ungaro

Yeah.

Operator

And there are no further questions at this time, I'll turn the call back over the presenters.

Peter J. Ungaro

All right. Thank you very much. I'm excited about our prospects for 2014 and what we are building for the future. Our super computing products are strong and our big data storage and analytics offering are continuing to gain momentum in the market. I believe we are well positioned to follow on a great 2013 with another strong 2014. So thanks to everybody for joining the call today and for your continued support of Cray. Have a great evening.

Operator

That concludes today's conference call and you may now disconnect.

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