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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

Glenn Hanus - Needham & Company, LLC, Research Division

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

Cray (CRAY) Q2 2012 Earnings Call July 31, 2012 4:30 PM ET

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Cray Reports Second Quarter 2012 Financial Results Conference Call. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today, Tuesday, July 31, 2012, at 1:30 p.m. Pacific Time. I'll turn the call over to Paul Hiemstra, Director of Treasury and Investor Relations.

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. This call is being broadcast live on the Internet and recorded for replay purposes. A replay will be available shortly after the call. You can access the replay by dialing 1 (855) 859-2056. You must then enter the access code 14743057. A replay will also be available in the Investor Relations section of the Cray website for 180 days at www.cray.com.

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 planned customer acceptances, our product development and new product introduction 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 vary materially 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.

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

We had a great quarter, with solid revenue and gross margin results. Along with some big wins, we also completed the asset sale for an interconnect hardware development program to Intel for $140 million. And even if you'd back out the gain we recorded from that transaction, we were still solidly profitable for the quarter and even stronger for the first half.

We had a good quarter on the product side of our business with a couple of large acceptances and a number of new orders. The big news of the -- for the quarter was our first ever petascale supercomputer installed on a large commercial customer. It was an especially nice win for us as it included both an extremely large XE6 system, as well as our Sonexion storage solution. While we can't name the customer, we can tell you that they're in the energy segment and they're using the system to do a new form of high-end subsurface imaging, which we believe will be an important application area in this vertical over the next few years. This is also our latest win in the commercial HPC market, and we're excited to continue to seek for the use of supercomputers being deployed in various commercial sectors, a great time for us and our industry.

As I mentioned, we also had a strong run of new orders for our high-end systems over the past few months, both domestically and around the world. Even more importantly, we now closed all the deals we needed to reach our current 2012 outlook. And something I'm very proud of over the last month or so, we signed a number of contracts totaling over $70 million, all which feature our next-generation Cascade supercomputer, getting us off to a good start as we look into 2013 and our next generation of products.

Let me tell you about a couple of these recent wins. On the U.S. front, we were awarded a new contract to deliver a Cascade supercomputer and a Sonexion storage system to the Department of Energy's National Energy Research Scientific Computing Center, also known as NERSC. NERSC is part of the large Berkeley National Laboratory and they serve over 4,000 users working on a wide array of scientific research disciplines to improve our country's competitiveness and natural resource sustainability.

Also in the quarter, we were awarded a new contract by the Department of Defense's High-Performance Computing Monetization Program to perform a significant upgrade to the program's 3 existing XE6 systems, and combine them into a single petascale supercomputer. We'll be doubling the number of process reports in each of the 3 systems by upgrading them to the latest AMD Opteron technology.

In Europe, we were awarded a new contract to deliver one of our next-generation Cascade supercomputers to the Finnish IT Center for Science. It's a multiyear, multiphase contract with the majority of the system being delivered in 2014. And just this month in Australia, we're awarded a contract to deliver a Cascade supercomputer with Sonexion storage to the Pawsey Centre in Perth. This is a notable win as one of the uses of this system will be to support the data-intensive science that will be carried out by the Australian Square Kilometer Array Project. The amount of data ultimately generated by this project will be so fast that researchers must analyze it in real-time, a process which required massive amounts of computing power.

We also made good progress in each of our initiatives during the quarter. In our technical enterprise or midrange supercomputing initiative, we had a number of wins, including at the Stevens Institute in New Jersey, the City University of New York and in a large commercial manufacturing customer.

As part of our new Department of Defense contract that I mentioned, we will also be delivering a new XE6m supercomputer to the Naval Research Laboratory in Monterey, California to be used by the organization's Marine Meteorology division.

During the quarter, we also installed a technical enterprise system at [indiscernible] in Brazil, Media Swiss in Switzerland, and the Arctic Region Supercomputing Center in Alaska.

YarcData, our subsidiary focused on Big Data, made strides in the development of 2 new graph analytic solutions for the EUREKA appliance. The first is in our life sciences segment where EUREKA can now be used to enable much higher productivity in the drug discovery process by helping researchers find non-obvious interactions between cancer-associated proteins through the analysis of very large sets of data from research literature, public databases and experimental sources, all in real-time.

Our second new solution area is in cyber security, where EUREKA can help enable much more sophisticated threat detection by discovering hidden relationships between any number and scale of data sources such as network security logs, DNS, blacklist, firewall, the whois lookup directory and open source reporting. These 2 new solutions really begin to demonstrate our continued progress in strengthening our EUREKA value proposition in the big data market.

We also added a number of new members to our YarcData team during the quarter, including Kiran Narsu, who's our new global financial services segment leader. Kiran joins us from Oracle where he was a Vice President of Sales for Analytical Applications as part of their financial services global business unit. He's a great example of the exceptional talent that we've been able to assemble in our YarcData team.

In our Storage and Data Management group, we continued shipping our Sonexion 1300 solutions to customers across the government, academic and energy market segments. Sonexion is our high-performance integrated data storage solution featuring the Lustre parallel filesystem, and delivering market-leading performance and scalability. Wev'e now delivered over 50 petabytes in total storage capacity this year alone.

We're also building out our storage expertise, including adding industry veteran, Larry Genovesi, who's one of the cofounders and past CTO of Terascala, the original Lustre appliance company. Larry brings a strong background in HPC storage and data-intensive computing, especially with commercial customers, and we're excited to have him on board working as part of our CTO office.

Finally, I'm pleased to report that we continue to make good progress on our future development efforts as we passed 2 different milestones totaling $15 million on our DARPA R&D program related to the development of our next-generation Cascade supercomputer. We had originally planned for the second of those milestones to be completed early in the fourth quarter, so we're tracking a couple months ahead of schedule. That milestone was primarily focused on the development of our next-generation Aries interconnect, which is progressing nicely. All in all, this was a pretty great quarter for the company.

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. Before I get to the 2012 outlook, let me walk you through our second quarter financial results. We had another great quarter and first half of the year. Revenue grew 82% in the first 6 months of 2012 compared to the prior year, to just over $196 million. And for the first half of the year, excluding the $139 million pretax gain from the asset sales to Intel, operating income was $20.8 million.

Revenue for the second quarter was $84.2 million compared to $67.9 million in the second quarter of 2011. Product revenue for the quarter was $68.5 million, and service revenue was $15.7 million.

Net income for the quarter was $147 million or $3.91 diluted earnings per share, including the $139 million pretax gain from the asset sale. Excluding the gain, operating income for the quarter was very solid at over $12 million.

Total gross margin for the second quarter was 41%, resulting from product margin of 42% and service margin of 35%. Total operating expenses for the quarter were $22 million compared to $29 million in the prior-year period. As Pete noted, we benefited from $15 million in R&D co-funding credits this quarter.

Our second quarter and first half results were impacted by higher accrued incentive compensation due to our strong operating results, as well as increased spending toward our growth initiatives, particularly YarcData.

For the second quarter, depreciation and amortization expense was $2.1 million and noncash stock compensation expense was $1.2 million. As for the 6 months of the year, these were $4 million and $2.4 million, respectively. Excluding these noncash items and the gain from the asset sale, our adjusted EBITDA was more than $27 million for the first half of the year, a strong 6 months no matter how you measure it.

Our effective tax rate for the first half of the year was 5% and benefited from the recognition of a capital loss of about $80 million, and the partial release of a valuation allowance provided against deferred tax assets. The $80 million capital loss resulted from an acquisition we made in 2004. We still have about $105 million in potential future cash benefits for deferred tax assets. The deferred tax asset balance primarily resulted from net operating loss carryforwards that were generated in previous periods.

Cash increased substantially in the second quarter, driven primarily by the proceeds from the asset sale, and we finished the quarter with total cash balances of $223 million. This was an increase of $111 million since March 31, 2012. However, to get the whole picture of the increased strength of our balance sheet, I think it helps to point out that our working capital actually increased by $168 million during the quarter to $315 million.

We continue to build inventory during the second quarter in anticipation of installations currently in progress. Inventory at customer sites and in the acceptance process at quarter end was $104 million, representing about 80% of the $132 million in total inventory on June 30.

I would now like to move to our outlook. A wide range of results remains possible for 2012. While many variables may impact our results, one significant item is the timing of a single plan customer acceptance for Blue Waters -- for the Blue Waters system at the University of Illinois, also referred to as NCSA. This acceptance represents approximately $150 million in product revenue that Pete will discuss further in a moment. Assuming acceptance of this system occurs in 2012, as currently planned, we continue to anticipate total revenue to be in the range of $430 million to $450 million for the year.

Revenue for the third quarter is expected to be $30 million. With this level of revenue, and without significant co-funding in the third quarter, we anticipate a loss for the quarter. We expect this loss to be somewhat reduced by the requirement to partially reduce the incentive-based compensation accrued in the first half of the year.

Back to the year, overall gross margins are anticipated to be in the 35% range and total operating expenses are expected to be about $120 million. Based on this outlook, we expect to be solidly profitable for 2012. This is independent of the $139 million pretax gain from the asset sale. We currently expect our 2012 effective income tax rate to be about 5% to 8%, but it is dependent on a number of variables. Our actual cash tax rate for the year is expected to be 5% or less of pretax income.

For the year, shares outstanding for the diluted earnings per share calculation are expected to be in the 37.5 million to 38 million range, but will vary with the level of option exercises and stock -- and the stock price. Other income and expenses are expected to be in the neutral range for 2012, mostly dependent on foreign currency fluctuations.

Cash is expected to fluctuate in the second half of 2012 as our quarter-end balances are dependent on a number of variables. We anticipate that our cash balances to increase in the third quarter of 2012 and, ultimately, following the large acceptances to be significantly higher in the first part of 2013. As always, actual results for any future period are subject to large fluctuations given the nature of our business.

In summary, we had an excellent first half of 2012 with strong profitable results. As we shift into the second half of the year, we are focused on building on our competitive momentum.

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

Peter J. Ungaro

Thanks, Brian. We have 3 main focus areas for the rest of the year: first, executing on our delivering acceptance plans; second is winning new business and building momentum on our new initiatives; and third, tracking to our ongoing product development plan. Let me take you through each of these.

The first one is all about executing on our delivery installation and acceptance plans. Key to this is the acceptance of the Blue Waters system at the University of Illinois, which, as Brian mentioned, is critical for us to achieve our outlook for the year. We're making good progress here as we now deliver the majority of the system to the customer's data center. This is the largest system we've ever built, and with everything that needs to come together, we currently expect the acceptance to come down to very late in the year.

As we discussed last quarter, we've already taken some delays, including an integral third-party component, and as a result, the schedule is very tight. We currently expect to receive this key component in the September, October time frame, which has caused quite a bit of compaction in the schedule. An unexpected delay or other issue could cause the acceptance process to shift into 2013.

Of course, as we've been discussing throughout the year, we also have another large acceptance expected for the fourth quarter with the Titan upgrade at Oak Ridge. It is important to note we do expect any acceptance delay to really only be a shift in timing. If one of our system acceptances slipped from 2012, it won't go away. Instead, we would expect it to complete in early 2013.

Our second focus area is winning new business and building momentum behind each of our 3 new initiatives. As I mentioned earlier, we now secured all the deals we need in order to achieve our outlook for this year, and we're off to a good start for 2013 with the recent Cascade wins I mentioned earlier. On the initiative front, our goal is to begin to ramp the combination of these 3 solution areas to over 10% of our total revenue for 2012, and position them to go at a faster pace than our core business in 2013 and beyond.

We continue to close new customers each quarter with our technical enterprise midrange systems, bringing our leadership to create supercomputing technology into the $200,000 to $3 million price range. We're continuing to expand our Cray Linux Environment, especially our Cluster Compatibility Mode, which allows customers to run third-party ISP applications right out-of-the-box. It -- our latest update to the software allows applications to run faster and scale to even higher levels. We have additional updates planned here which will continue to expand the performance and capability of our offerings in the technical enterprise space.

In storage, as I mentioned, we're shipping the Sonexion 1300 to a broad number of customers and, as you can see, many of our new wins have included Sonexion. A big step for us this quarter will be to bring Cluster attached to Sonexion solution to market, where we can connect Sonexion to non-Cray systems. This is an important step to expanding our TAM in the HPC storage marketplace.

And in Big Data, our YarcData subsidiary is working to discover and refine new opportunities for our EUREKA graph analytic appliance. Our pipeline continues to grow, and, as I mentioned earlier, we're building out solutions in our key vertical markets and adding some great talents to our team here.

Our third focus area is to continue to execute on our product development plans. We need to complete a key upgrade to our XK6 GPU based supercomputer, which requires the same third-party component I mentioned earlier, as well as complete the development of our next-generation Cascade system which includes our new Aries interconnect. We're on track to deliver an early prototype system for DARPA later this year as part of their HPCS program, and make it available to the broader market in the first half of 2013.

We have one more DARPA milestone planned for the fourth quarter of 2012. This milestone would signify the end of the DARPA HPCS development program which Cray has been participating in since 2002. Of course, we also have updates to both Sonexion and our EUREKA software environment in our future plans.

In conclusion, we had an extremely strong first half of the year, which showed in our operating results and balance sheet, as well as in a number of new wins. We have a lot of work left to do and there's some serious hurdles we need to clear between now and the end of the year. But assuming we achieve our large acceptances, as expected, in 2012, we're well positioned to deliver on our outlook for the year. Driven by our strong HPC systems and our new growth initiatives, we're continuing to build momentum for the future.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Glenn Hanus.

Glenn Hanus - Needham & Company, LLC, Research Division

Could you just give us a little more color around the availability of the chips required? Did the schedule slip some for you over the last several months, and so now things are incrementally tighter than they were? Or is it basically unchanged from a couple months ago?

Peter J. Ungaro

Sure, Glenn. We -- as we mentioned over the past couple of quarters, we did take that delay in late 2011, and I mentioned on the call just a couple of minutes ago, we do plan to ship in the September, October time frame, which is about what we have been planning since we took the initial slip. So what I really want to get across is, is that those initial slips that we took a long time ago and we've been talking about over the last 2 quarters now, had just really compacted the schedule. And so there's a lot to do, they're very large -- both very large systems, Blue Water being the largest system we've ever built. And so it's going to cause a lot to come together, all at once, to be able to get these things done this year. So we still expect them to be done that's why we've kept them in our outlook, but we do want to be very open with everybody about the risks and about what it's going to take to bring these machines together.

Glenn Hanus - Needham & Company, LLC, Research Division

Is it a question of adequate supply? Or are there other technical issues with the chip and the technology that have to be tested or resolved?

Peter J. Ungaro

I would say both. Whenever we take delays like this, and of course, we're not as far along in our testing of the chip that we -- as we would normally be, so you never know if there's latent performance or capability, functionality issues with the chip. So all those things just compound into the schedule that needs to be done at the end of the year. So it's a little bit hard to say, Glenn, but I would say it's clearly in supply, but it also could end up being also in performance or functionality. We'll just have to see it as we get closer.

Glenn Hanus - Needham & Company, LLC, Research Division

Can you give us any update on, like, what the revenues were for the -- if you want to combine the 3 -- the new initiatives? How did they come in for the quarter in terms of contributing to revenue?

Peter J. Ungaro

Yes, we didn't break out the revenues by quarter -- in the quarter, but I would say, Glenn, we had a really good quarter in storage. Our storage initiative did very, very well in the quarter. We had some modest revenue in both our YarcData, EUREKA product, as well as in the midrange. And we're definitely on track to hit our goal of 10% of our total revenue this year. So I feel very good. We had nice progress in all 3 of our initiatives in the quarter.

Glenn Hanus - Needham & Company, LLC, Research Division

Can you give us an update on your view of -- geographically around the world, the HPC spending environment, especially in light of a lot of the macro challenges? It sounds like from some other vendors that the HPC sector has remained pretty strong.

Peter J. Ungaro

Yes. It was nice in our new wins that we announced that we announced them in every geography. So it's been really nice to have wins in AP, in Europe, as well as in the U.S. Of course, in the U.S., I think the big question mark is the government budget. I mean, we've gotten some good news recently that it looks like that we'll be able to pass a continuing resolution here over the next month, I guess, in September is the current expectation. But we have these kind of outstanding unknowns, where -- is sequestration going to happen and what's going to take place there? But as of right now, we see strong spending there and we've been able to announce a number of new wins. And we haven't seen much difference in any of the other countries either. I mean, there's certain unknowns, and clearly, a few of the countries in Europe are extremely weak but nontraditional countries where we've done a lot of business. So it really hasn't impacted us in our outlook. We've been able to hold our outlook quarter-to-quarter, and I feel good about their overall spending environment, both in government, as well as an industry.

Glenn Hanus - Needham & Company, LLC, Research Division

And on the commercial side, do you feel -- can you leverage your big energy win into other commercial wins per -- in that vertical anytime soon?

Peter J. Ungaro

You can bet. It's a big focus for us. I mean it is super exciting to be able to have one of our largest systems that we've ever built in a very large commercial company, doing some very important work for them, and we're clearly focused on being -- we know that the work that's being done in that machine right now, the primary application is going to be a very important application in the industry over the next few years, and so we feel like we're well positioned, over time, to really do something exciting within the energy vertical market. I would say overall within commercial, Glenn, that the commercial customers have taken us a longer time to initially break into the account, and we've done that now across a handful of commercial accounts, across a few different verticals. But once we've been able to break in, we'd typically see a nice up -- a much quicker upgrade cycle and expansion of the opportunity than we do in our traditional government accounts which can be sometimes quicker to get into, but much lower on the upgrade cycle. So it's been a nice environment for us, and something we'd definitely want to extend over the next few years.

Glenn Hanus - Needham & Company, LLC, Research Division

And lastly, and then I'll leave you alone here, competing with IBM and any others you want to mention, you've named a number of new wins. What have your win rates been like versus IBM? Have you had some losses? You had a long string of wins there for a while, how are the win rates doing with IBM? And I don't know if you want to comment at all on -- InfiniBand has really been pretty strong lately in the, sort of, cluster market, I don't know if you want to comment on that as well.

Peter J. Ungaro

Sure, Glenn. So our win rates have been really strong, still. They've maintained very, very good strength. IBM just came out with their Blue Gene Q system over the past couple of quarters and they've gotten a few big wins there, mostly by their early partners that have been pretty well known for a period of time. But that system is a strong system but very narrowly focused. It's a pretty niche system, and I think we're going to compete very good against it with Cascade, as we move forward in time. Clusters are a big part of our -- the overall HPC marketplace, most of those being InfiniBand. I would say InfiniBand has done an amazing job against Ethernet. So when you're comparing -- they're taking a lot of share from the Ethernet market. It hasn't taken really a lot of share from the very high end market, but definitely, it's from the Ethernet market, and that's been going good. I would also say, on the storage side, I feel we're in a very strong competitive position there. I mentioned we've shipped over 50 petabytes of storage already this year, which is a real nice amount of storage being shipped out. And I think our Sonexion product is very well positioned there, as well as our external services offerings where we partner with both DataDirect and NetApp for certain solutions. We've been really making very, very good progress, overall, in our storage market against other offerings out there. Mostly, we're competing against other filesystems such as the IBM GPFS filesystem or the Panasas filesystem, and we're making good traction in that market, too.

Operator

[Operator Instructions] Your next question comes from the line of Chad Bennett.

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

But, I guess, I was jumping between calls and I heard the majority of your call, but I guess, following up on the prior question, Pete, you might've talked about this on the call, but are you saying that the schedule is now tighter for Blue Water deliveries, and so forth, for the back half than it was a quarter ago? And why is that?

Peter J. Ungaro

No, Chad. I mentioned that the delivery time frame has stayed the same over the last quarter. What we did is spend a little bit more time with all of you guys, just really trying to walk through what needs to happen in order for that machine to get accepted, and give some color on the overall acceptance of that. Because it's such a large system for us. I mean, without a doubt, it's about $150 million of revenue, so it's a very significant part of our overall outlook for the year. And we wanted to just give you guys more color around where that system is, what needs to happen for it to get that accepted, and give you guys a little bit more information to quantify that.

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

Okay. And I don't think this is asking anything to telling, but when would you expect to have at least a material quantity of chips from NVIDIA over the next few months here? I mean, what's the schedule at this point?

Peter J. Ungaro

As I mentioned, we're planning on getting deliveries and receiving all the chips that we need in the September, October time frame. So that's really the time frame. I would say, more or less, September through mid-October is the timeframe right now.

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

Okay. Do you -- shifting subjects, $70 million worth of orders over the last month, or month and change, can you give us any sense of where you are in '13 in terms of -- and I know you don't like to use the term backlog or look at it as backlog, but how much visibility you have today? And maybe by the time when you report the September quarter, any idea of how much visibility you would hope to have by then?

Peter J. Ungaro

Yes. I mean, I think the best thing I could say from that perspective, Chad, is that we've had a great 1.5 months, so we've -- $70 million of total contract value over that time related to Cascade system. I would say we're starting to get a better picture of what that first half of '13 is starting to look like, but we're not yet where we can see the full year. And we don't have that kind of headlights right now into where we see the full year coming out. Where will we be a quarter from now? We hope to be able to give you guys a feeling of where we are if we can get ourselves comfortable with the progress we make over about the next 3 months. So it's something that we review every single quarter of how much -- we know you guys like to get headlights as far out as we can give you. It's something we talk about a lot to try to give you guys as much a guidance there. We do want to make sure we quantify for you guys the amount that we've already done here just recently, and you know we've had a couple of deals for Cascade that we booked in previous quarters, one is the -- there is this good card, and another in Japan. So we are starting to build up, I think, a nice little set of orders for the first part of the year, but we're just not yet there to give you a picture of the whole year.

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

Okay. And then can you speak to Sonexion, the competitive landscape there? Obviously, you've ramped very quickly here, both with government customers, existing customers and new commercial customers, are you seeing -- basically, is the competitive landscape what you thought it was? And the pricing and margin profile of that product being 40% -- or a little over 40%, is that holding relative to price performance?

Peter J. Ungaro

Yes. So lots of questions. Let me try and address them, Chad. So first of all, I'll just say, the Sonexion ramp is, honestly, it's exceeded our expectations. I mean, it's going very, very well. We feel really good about what we've been able to do and what the team's been able to do in storage over the past couple quarters. We do think we have a good product, and when we combine that with our other offerings where we partner with DataDirect and NetApp, we have a really nice portfolio of products to go and attack the market from. I think that the competitive landscape is about where we thought it was. I mean, I think we did a pretty good job of really understanding that market as we are breaking into it, about what the gaps were in the marketplace that we could go and attack with a solution, specifically around bringing a set of components together, optimizing a solution around those set of components, and almost, I hate to use the word, appliance sizing, but appliance sizing the storage solution at very high performance and high throughput. And so I think we've done a really good job there, overall. Most of our competition has been where customers are looking at alternative filesystems. So we're competing, for instance, our solution which is based on the Lustre filesystem against maybe a solution based on IBM's GPFS filesystem or Panasas with PanFS, although we did win deals against both of those filesystems over the last quarter. So I do feel we're making good progress on that front. And then I think the third part was around pricing. And I would say our pricing has held, I mean, we feel Sonexion does allow us to get higher margins than we were doing as we were reselling other solutions in the marketplace. So I do feel that we've been able to keep up a reasonable margin profile, much stronger margin profile than our core products, high-end supercomputers, which is important for us because we know at the end of the day, for our business model to play out and really become much more highly leveraged, we need to continue to drive to a higher gross margin. And so one of the big thing around our initiatives is building offerings that can drive to higher gross margins in our core business with high-end supercomputers.

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

Okay. Your contract manufacturing, your partner there is Xyratex, and they're obviously very bullish on the prospect of their HPC product, which is mainly you guys right now. But it seems like, well, they talk about bringing on other OEM partners for a Lustre product, HPC product. So you're going to have some competition to some extent. So when that happens, how do you look at your differentiation versus -- I'm just throwing out names maybe in HP that introduce a Lustre filesystem appliance?

Peter J. Ungaro

I feel really good about it. We've been working with them and working with high-performance storage for a very long time with our supercomputers. We've been able to acquire a lot of know-how and capability that we've wrapped around the base components that Xyratex gives us to create Sonexion. And I feel we are very differentiated from that perspective. So that actually doesn't bother me at all. More importantly for us is taking that solution outside of existing Cray accounts, and I mentioned one of the big things that we have coming up this quarter is what we call our Cluster attach solution, where we can take Sonexion and attach it to anybody's system, and that's going to really be a big step up in our addressable market for that product overall, and a big part of, I think, what's going to be in front of us as we try and grow this business even faster than we've been doing this year. So I feel very strong about our competitive position, and quite honestly, I'm much more concerned about how we compete against other filesystems then about other offerings within the Lustre space. Because if Lustre's successful, I think that's going to be great for everybody that have Lustre appliances, including Cray. And so I think that's a big part of it.

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

Okay, got it. Last one for me, and probably for Brian. Brian, I know there's a lot of kind of variability in the back half of the year. But assuming the year is what you think it is, or is what you just said it is, what would you -- where would you think cash would be exiting the year based on the guidance that you just gave?

Brian C. Henry

Well, we didn't give cash at the end of the year. And the end of the year number's, a hard one to forecast at this point. We said that we anticipated cash to increase this quarter from where we ended at the end of June. And we think regardless of the timing of the large acceptances, that in the first part of 2013, cash will be up substantially from where it is now. What it will be at the end of the year is hard to say.

Operator

[Operator Instructions] Your next question comes from the line of Steve Roberts [ph].

Unknown Analyst

Just if we get to next January and the large deal is not being accepted, what would be the likely reasons for that?

Peter J. Ungaro

I would say that the most likely reason is 1 of 2 things. Either we received the third-party component later than we expected, or that we have an issue either in that component or in just putting together the biggest system we've ever built. So it will be 1 of those 2 issues, and that's why we really wanted to say, if there is -- if we are at end of the year, and we haven't gotten it accepted, we expect to get it accepted early in 2013. It isn't that it would go away or anything like that, it's just we would get a little delayed because things aren't coming together as quickly as we can. And there's just -- there's a lot of variables that go into these very big machines that's difficult to predict exactly when they're going to get finally accepted.

Unknown Analyst

And the third-party components, we'll know by the end of October -- or you'll know if you've gotten them in time, right?

Peter J. Ungaro

Yes. I think, at the next call that we'll do at the end of the third quarter, we'll probably be able to give you guys a really good perspective of where we are on that particular component.

Unknown Analyst

Right. Okay. And then looking at that cash balance and the outlook for cash over the next year, obviously it's very positive. So what's stopping the company from, say, doing a 10 million share stock buyback? Or is that be considered seriously at this point? I mean over the last 10 years, the share count has kind of ballooned for the company, so it will be nice to see it kind of brought back in line.

Brian C. Henry

We'd look at all the options and we're focused on doing what's best for shareholders in the long run. We haven't made any decisions that we're ready to communicate at this point. We're looking at all of them, the dividends, share repurchases, acquisitions, investments, et cetera. But we're not in a position today to say which direction we're headed on other than whatever we do, it will be done prudently.

Unknown Analyst

And how would you prioritize the attractiveness of your -- of those options at this point?

Brian C. Henry

Again, I'm not going to comment on them until we announce what we're going to do if we announce it someday in the future. And that probably is not going to be just one thing, of course.

Unknown Analyst

Yes, I know. I understand. But to run the business on a daily basis, or whatever, how much do you think you would need, I mean, at this point? Like, $100 million would be a reasonable amount in excess of the -- or the additional part be excess or be -- would you need less than that?

Brian C. Henry

Well, it's a question that we think through and evaluate, and it varies with how the business evolves. So I would say in a year like this year, we're happy to have well over $100 million in cash because we've had an opportunity to have some very big sales with -- that's going to drive a lot of revenue. And if the business continues to be in -- come in large chunks and we think, on average, it will continue to be coming in large chunks, having more cash is, I think, that's for shareholders. But if things smoothes out, we're able to operate consistently with less cash, that we'll lower our expectations, our view of what we need there.

Peter J. Ungaro

I think the clear thing we really need to do is to continue to drive growth in the company. And so as we think about things that's just trying to give you some perspective there, that's very high on our priority list. And then clearly, right now, we don't have a need for all of this cash to run our business day to day, although we have $132 million of inventory sitting out there right now, most of which at customer locations. And hopefully, if we can continue to win new deals, especially large deals, that can -- that cash can really fuel our growth at the top line, too, in our core business, as well as in our initiatives. So it's just to try to give you a little bit of help around that, that's where I would guide you.

Operator

Next in queue we have the line of Russell Lyn [ph].

Unknown Analyst

Why is there just one vote for share repurchase? I'll just throw that out there. Brian, you made a comment about working capital, but I didn't quite follow. Could you repeat that?

Brian C. Henry

Sure.

Unknown Analyst

In your prepared remarks.

Brian C. Henry

Yes, so cash in the quarter grew $111 million, but that wasn't really telling the whole story. If you looked at what happened to our working capital, and this is where it takes -- if you look at the components of it, the total networking capital, so current assets less current liabilities, when met by a huge number, $168 million, and that's a lot more than the cash we -- proceeds that we got from Intel. In the sale of the assets, it indicates a strong underlying kind of business operations and profitability there. And I didn't put the comparison, but if you compare that to the first half number, the December 31, that's even more dramatic.

Unknown Analyst

So I would probably define working capital a little bit differently. I'd take cash out of the picture and say, here are the assets that you've invested in your business. And so essentially, it's current assets less cash, minus current liabilities. And that gets me to a number north of $90 million, I think $92.5 million. That's sort of at an all-time high for you guys, and understandably because you have such a big deal in the pipeline. And -- but I guess my conclusion is, and tell me if I'm wrong here, that, that $220 million -- or what was it, $223 million of cash on the balance sheet, much of it is excess at this point because even if you grow your business, you'd be growing it from a very high working capital level today. And so you guys have a lot of excess cash. Is that a fair conclusion to come to?

Brian C. Henry

Well, first, we're not saying that the current cash levels that we have post the Intel transaction are what we need to operate the business on a day-to-day basis at all. So I don't disagree. And the working capital number I gave you, yes, it does represent the same kind of analysis you did. It just happens to include the cash in it. We're in good position right now on that. I just -- if you went back in Cray's history, and it doesn't take long to go back into Cray's history, we got down to cash for running and operating the business, we'll call it under $20 million, for certain periods of time and as late as late 2011. Now of course, we had an asset sale, we'll have to pay some taxes on that asset sale, that will pop up some number. But even in the fourth quarter of 2011, we used a lot of cash during that period of time. And I don't think it's prudent if things don't run as expected, to put shareholders at risk to cut it to tie [ph]. Now like -- as I said, if I think $220 million and above is necessary to operate the business? Absolutely not. The question is, what is the right level not to put a risk to, while we try to grow the company, shareholders in case things don't go as well as they have been for Cray over the last couple of years.

Unknown Analyst

On the other hand, your enterprise value, post this Intel deal, hasn't moved essentially. And so investors are not giving you credit for your growth and all your new initiatives. The stock price is up only because you, sort of, accumulated this extra cash. And if you show investors that you're willing to do the right thing with capital structure, then you get awarded a better multiple. And when you do have constructive uses for that cash, investors will provide that to you at a better multiple. So just keeping it on your balance sheet is not, in my opinion, the best way to manage the capital structure. And this is all from -- because what's going on with the business is great. I mean, you guys are executing at a very high level. I'm just talking about capital structure management here.

Brian C. Henry

Right. And I don't disagree with the basic ideas that you have there. I think -- but rushing to do something quickly is not the focus of what we've had, and we're focused on the long-term shareholder value, and we want some time to look through the alternatives and look at what alternatives might be better for shareholder value than doing the simple thing to do a repurchase or something of significance.

Peter J. Ungaro

I think that the main point is, we mentioned we do wanted to drive growth, that's very important. We've been able to do that organically, and we want all of our current initiatives allow us to continue to do that organically. It does require some incremental investment that we are making, as Brian mentioned, in the various businesses, especially within YarcData, which is in the Big Data market, which is I would argue probably the most exciting IT market right now of any. And I think we have a pretty exciting opportunity and solution in that space. But we want to make sure that we're looking at it the long term. There's clearly some short-term things that we can do. And we have debated them all, and we will continue to debate them, but we want to make sure that we evaluate what's going to be the right long-term play for the company, and hopefully, in that, we'll figure out what the right mix, the right balance is and then execute that plan.

Unknown Analyst

Okay. Well, if you do a stock repurchase, when the stock's $15 or $16 instead of $12.50, I'm going to say I told you so.

Brian C. Henry

Fair enough. Thanks.

Operator

[Operator Instructions] At this time, there are no questions in queue. I'll turn the call back over to you, presenters.

Peter J. Ungaro

Thank you. We had a great first half in 2012, and we're focused on delivering on our plans for the rest of the year. I'm excited about our competitive position in the market today, and I believe it's going to get even stronger as we shift toward 2013. Thanks for everyone for joining the call today and for your continued support of Cray. Have a great evening.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. You may now disconnect.

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Source: Cray Management Discusses Q2 2012 Results - Earnings Call Transcript
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