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Cray (NASDAQ:CRAY)

Q3 2012 Earnings Call

November 09, 2012 8:00 am ET

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

Glenn Hanus - Needham & Company, LLC, Research Division

Operator

Good morning. My name is Tanisha, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Cray Quarter 3 Earnings Conference Call. [Operator Instructions]

Mr. Paul Hiemstra, you may begin your conference.

Paul Hiemstra

Good morning. 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 conference ID 65020258. The 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 planned acquisition of Appro and the expected benefits of the potential acquisition, 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 highlights of our third quarter results and take you through the acquisition we announced this morning, then I'll turn it over to Brian, who will take us through our financial performance and outlook. And I'll wrap up by discussing our plans for the rest of the year and open up the call for Q&A.

We built momentum in the quarter, highlighted by several exciting wins worldwide in our high-end supercomputing business and continued advancements on our large system installations. Our results were in line with our expectations, and we made good progress in each of our growth initiatives.

On the product side of our business, we were selected to deliver a next-generation system to the Swiss National Supercomputing Centre, also known as CSCS. We just launched this system Thursday as the Cray XC30, which was previously codenamed Cascade. As you can tell from our announcement and the positive reaction we received, we expect the XC30 to be very successful in the marketplace. It brings new hardware and software technologies together in a way that is more flexible than anything else on the market, continuing along our adaptive supercomputing vision that we laid out a number of years ago.

We're also very excited to be a couple of months ahead of our original development plans for the XC30, and we'll be shipping early systems later this year instead of in the first quarter of 2013. That's great news as we already have over $100 million in XC orders to fill.

Sticking with our market-leading high-end systems, we recently announced that Indiana University plans to replace its Big Red system with one new Cray XK7 supercomputers that we just announced last week. Their system is expected to be one of the fastest university-owned and funded supercomputers in the U.S. when it is put into production next year.

In our technical enterprise initiative, which we used to call Midrange, we had a number of wins at new Cray customers, including Texas A&M and at the University of Miami where they will use an XE6m to study hydrocarbon research from the Gulf of Mexico. We installed and received acceptance on several other systems, including at the Stevens Institute in New Jersey; and a naval research laboratory in California; and internationally at the Saha Institute of India; the Centre for Analysis, Scientific Computing and Applications in the Netherlands; and at a government customer outside of the U.S. In addition, during the last few months, we secured a number of new contracts from various government customers for systems and services spanning each of our business units.

Our Big Data graph analytics team, YarcData, made good progress on several fronts. We were awarded a new contract to deliver a uRiKA graph appliance to Oak Ridge National Laboratory, which they plan to use for a healthcare fraud detection program. And the Pittsburgh Supercomputing Center deployed a new uRiKA system called Sherlock to be used in a wide range of projects, including life sciences, virtual network analysis and cybersecurity.

We're also extremely excited that Gartner published a research report on YarcData highlighting that the big data market is much more than relational databases and dedupe, validating specifically that the uRiKA appliance is a solution to previously infeasible graph discovery problems. This report adds to a number of positive reviews we received from key influencers in the big data marketplace.

On the product development side, we recently announced the uRiKA fall 2012 release. This upgrade boosts functionality and performance on complex graph analytic inquiries. We're making this system even easier to use and adopt within the enterprise environment. This release transitions us from early customers into production-ready systems.

In our storage and data management group, I'm very excited about the expansion of our team with the addition of several engineers from SystemFabricWorks, the leader in storage interconnect solutions and software. This is a key addition for us as it expands the depth of talent in our storage team. It also is a great fit given their strong experience consulting on many high-end storage and InfiniBand implementations with major HPC vendors and customers. We've known this team for a long time, as we partnered with them in the past, and we couldn't be more excited to welcome them into the Cray family.

And finally, in R&D, we're in the final stages of testing our early prototype system for DARPA as part of their HPCS development program. We have one final DARPA milestone that we plan to complete over the next few weeks. And as you can expect with our announcement of the XC30, we're getting close to finishing it off because the XC30 is what we've been developing as part of that R&D program.

I now want to change gears and give you some context behind our announcement this morning that we signed an agreement to acquire Appro International, and our strategy going forward.

First, a little bit about the company. As one of the leaders in HPC supercomputing, we've known Appro for quite a while as we've partnered with them on a couple of solutions. And they have been making waves recently with their rapid growth, becoming the #3 vendor across the top 100 supercomputers in the world, after IBM and us. They're well known for having very strong relationships with their mostly U.S.-based customers across both government and commercial businesses. The Appro team has done an excellent job of building a proven product portfolio. They build among the most advanced, scalable industry-standard clusters in the world, featuring their unique ACE management software. They've grown their revenue base over the past few years with strong performance across multiple industries and product sets.

We saw this acquisition as an opportunity to do several important things. First, we've been talking for quite a while about our 2 main goals: to be the leader in the supercomputing market and to grow profitably both our top and bottom line. This acquisition allows us to execute against both these goals faster than we could do on our own. By leveraging Cray's brand and worldwide sales and service organizations, we expect to attack a larger percentage of the supercomputing market. Over time, we believe we can grow Appro's revenue, both in the U.S. and internationally, faster than they would've been able to do on their own and contribute to Cray's growth across multiple market segments.

Second, Appro helps us fill out our product portfolio with a more flexible offering in the technical enterprise and high-end supercomputing market, giving us a strong solution for customers who want different technology options. In fact, with this acquisition, we now have a Cray system offering for over 80% of the $4.3 billion supercomputing market. And with a full suite of market-leading HPC solutions, we now have something to offer nearly every supercomputer user in the world, a position I'm very excited to be in going forward.

Third, this acquisition will help us accelerate the growth of our current offerings especially across storage and service. The storage business is growing fast, and Appro systems represents an ideal opportunity to deliver an integrated compute-and-storage offering to a broader set of customers and further accelerate our growth.

And finally, teaming with Appro gives us new options to expand our offerings in Big Data, both alongside our uRiKA graph analytics appliance and as part of a broader portfolio of solutions in the future as the big data market is large and growing rapidly and a good portion of it is built on the model of industry-standard hardware leveraging a variety of software applications. Cray brings our unique ability to integrate HPC technologies into Big Data solutions to give customers a strong value proposition, as we've shown with our uRiKA appliance. We believe we can leverage our technology in this rapidly evolving market, and with this acquisition, we have even more opportunities to drive growth into the future.

We plan to create a separate business unit called cluster solutions where we'll focus on growing our business in this fast-paced cluster market. Daniel Kim, the founder and CEO of Appro, will be General Manager of this business unit, reporting to me. After completing the transaction, we expect to add about 90 Appro employees to the Cray ranks, the vast majority of Appro's current employees. I'm looking forward to having Daniel and the excellent Appro team join our team at Cray.

With that, let me hand it off to Brian to take you through our numbers and outlook.

Brian C. Henry

Thanks, Pete, and good morning, everyone. I'm going to walk through our financial results for the quarter and then discuss our outlook, including the impact we expect to see going forward from our acquisition we announced today.

Our third quarter results were in line with our expectations. Revenue for the quarter was $36 million. Year-to-date and first 9 months of the year, our revenue increased 37% over last year to $232 million. Back to the third quarter, product revenue was $18 million and service revenue was $17 million. We reported a net loss for the quarter of $5.2 million or $0.14 per share. Total gross margin for the third quarter was a very -- very strong at 48%, resulting from product margin of 43% and service margin of 54%.

Operating expenses for the quarter were $25 million compared to $29 million in the prior year period. For the quarter, we incurred non-cash costs of $2 million for depreciation and amortization and $1.8 million associated with incentive-based compensation. And for the 9 months ended with -- ended September 30, these non-cash items were $6.1 million and $4.2 million, respectively.

Our gross margins and operating expenses for the quarter and year-to-date benefited from a partial reduction of our year-to-date incentive-based compensation accrual due to our reported loss in the third quarter.

We also recorded a tax benefit of 34% of pretax income for the 9-month income. For the first 9 months of the year, our tax rate was 4%, with the lower rate resulting from minimal taxes applied to the $139 million pretax gain we recorded from the asset sale to Intel in the second quarter of this year.

Total cash and investments increased again in the third quarter as we finished the quarter with a total -- with total balances of $283 million, an increase of $60 million over the second quarter.

Our inventory continued to build during the third quarter, primarily driven by large installations expected to be completed in the next few months. We finished the quarter with $169 million in total inventory, more than 75% or $131 million of which was out at customer sites and in the acceptance process.

I would now like to take -- like to move to our outlook. A wide range of results remains possible for the fourth quarter and full year 2012. While many variables may impact our results, the most significant is the timing of the acceptances of Blue Waters and the Titan supercomputers, which together could represent roughly $180 million in product revenue. These are 2 of the largest systems ever built, and both are on a tight time line due to previous delays of third-party components. Assuming acceptance of these systems occurs in 2012, as currently planned, we anticipate total revenue to be in the range of $450 million for the year.

Our gross margins for 2012 are expected 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 quite profitable for 2012, independent of the $139 million pretax gain from the asset sale to Intel in the second quarter.

The impact of our planned acquisition of Appro is not included in the 2012 outlook as it is not yet closed and the potential impact will be influenced by the timing of the close, amongst other things.

The fourth quarter will be fully taxed for accounting purposes. We currently expect our 2012 effective income tax rate to be in the range of 5% to 8%, but it is dependent on a number of variables. Due to our substantial net operating loss carryforwards, our actual cash tax rate for the year is expected to be about 4%.

For 2013, while it is still early in our planning cycle, based on our current outlook for 2012 and assuming completion of the Appro acquisition as planned, we expect slight revenue growth, as compared to 2012. More than 2/3 of the revenue for the year is expected to be recognized in the second half of 2013, with the fourth quarter anticipated to be by far the largest of the year.

Gross margins for the year, including Appro, are anticipated to be in the mid-30% range. We currently expect total operating expenses for 2013 to increase significantly over -- year-to-year, as I want to give you some additional perspective on that. As I mentioned, we currently expect our 2012 operating expenses to command at about $120 million.

As we look towards next year, there are a few primary areas that are driving our expenses higher. First, with the DARPA program expected to come to close in the fourth quarter of this year, we will have fewer R&D credits next year, likely resulting in about $10 million in higher R&D costs. Second, assuming a timely close, the Appro acquisition is expected to add about $15 million in expenses when integrated into our business. This excludes potential purchase price adjustments. And third, our combined incremental investments in storage and Big Data initiatives are expected to add about $5 million to $10 million next year. We currently expect to invest more than $15 million in YarcData on its own in 2013. Taken together, the net of these items, it -- is that we currently anticipate our operating expenses to exceed $150 million for 2013. Many factors will impact our total investment, including the level of revenue realized and decisions we make periodically as we monitor each of the new initiatives and our core business.

Based on this outlook, we expect to be profitable for 2013. We expect our effective tax rate for 2013 to be about 40%, but it is dependent on a number of variables, including the level of income and the geographic distribution of revenue. Our actual cash rate -- tax rate for 2013 is expected to be in the range of 10%, though, and this is also dependent on several variables.

In periods when we are profitable, shares outstanding for the diluted per share calculations are expected to be about 38.5 million but will vary with the level of options exercised and the stock price. In periods of losses, this is expected to be somewhat over 37 million shares.

Other income and expenses are expected to be slightly positive in 2013 and can be impacted by foreign currency fluctuations. Cash is expected to fluctuate over the next few quarters as our balances are dependent on the timing of product deliveries, customer acceptances, various contract milestones and cash collections. We anticipate our cash and investment balances to decrease in the fourth quarter of 2012 due to the timing of collections and the Appro acquisition but ultimately, following the large acceptances, to be somewhat higher than our Q3 levels in the first part of 2013. As always, actual results for any period are subject to large fluctuations, given the nature of our business.

Now I want to talk a bit about the Appro in the acquisition.

Appro revenue has been growing nicely over the past few years. While it is very early for us to forecast exactly what Appro's business will add to ours in 2013, we are expecting them to contribute at least $60 million of revenue for the year, which was considered in our 2013 outlook, with gross margins lower than the -- Cray's typical margins.

We agreed to pay $25 million in cash at closing, which assumes that Appro delivers $3.5 million in net working capital without debt. The $25 million purchase price will be adjusted down if the value of the working capital is below $3.5 million. Assuming Appro's future contribution is in line with our expectation, we expect the impact of the acquisition to be accretive, from an EBITDA basis, in 2013. The initial tax and accounting treatment of the transaction is not expected to be determined until the end of the year.

The transaction is also not expected to require a Hart-Scott-Rodino review or approval, and as a result, it is anticipated to close relatively soon, possibly within a few days or weeks.

In conclusion, I believe this transaction represents an attractive opportunity to increase market share, grow our business profitably and increase shareholder value over time, with limited risk.

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

Peter J. Ungaro

Thanks, Brian. These last 12 months have been pretty amazing. We built 2 of the fastest supercomputers in the world, installed 1 of the largest supercomputers ever at a commercial company, successfully launched 3 new initiatives in the fast-growing markets, completed a very successful monetization of technology in a future R&D program to Intel, just agreed to acquire the #3 provider at the high end of the supercomputing market, and we're bringing to market our largest R&D effort we've ever done, in the new XC30. It's exciting to think about how far we've come in a year.

I'd also like to clarify that revenue for the first 9 months of the year increased 61% over last year. So we're in great shape year-to-date.

Now with about 7 weeks left, we have 3 main focus areas for the rest of 2012: first, getting our 2 largest installations accepted; second, winning new business and building momentum in our growth initiatives; and third, completing and beginning the integration of our acquisition of Appro. Let me take you through each of these.

The first one is all about finishing the acceptances built into our plan. As we've been discussing throughout the year, key to this is the acceptance of the Blue Waters system at the University of Illinois and the Titan supercomputer at Oak Ridge National Laboratory, both of which are critical for us to achieve our outlook for the year. I was just at the Blue Waters site with the team last week, and I'm happy to report that we're continuing to make good progress there and now have completed the installation of both this system and the Titan system, which is exactly where we expected to be in the time line we laid out for you last quarter.

We've begun the acceptance process at both sites now, a very involved process that we expect to take the rest of the year to complete. It's extremely exciting, as these are 2 of the fastest supercomputers on the planet, and we're hard at work as we currently expect both of these acceptances to occur very late in the year. If we run into unexpected delays or other issues between now and the end of the year, it could cause one or both of these acceptances to shift into 2013.

Our second focus area is winning new business and building momentum behind our 3 growth initiatives. We secured all the deals we need in order to achieve our 2012 outlook, and we're off to a good start for 2013, with several key XC30s, XE6 and XK7 wins in the past 6 months. We're continuing to see strong momentum here, and we expect that to continue into next year.

Outside of the unusual bump in revenue the Blue Waters systems bring us, I'm confident that we'll continue to profitably grow the high-end supercomputing business year-over-year. And we're well positioned with our new XC30 supercomputer.

On the initiative front, our goal remains to ramp the combination of these 3 solution areas to over 10% of our total revenue for 2012 and position them to grow faster than our core business in 2013 and beyond. For our initiatives, we are internally targeting 3x to 6x the growth rate of our core business, which we expect -- typically expect to be in the low double digits. In fact, if everything plays out like we hope it to, we should achieve 15% of our total 2012 revenue with our initiatives, well ahead of our 10% target. As you can imagine, I'm very pleased with the track we're on, and we have a goal of growing the percentage of total revenue coming from our growth initiatives in the future.

Our technical enterprise initiative is to -- continuing to drive product revenue in the under-$3 million price range. Expect to see us extend our XC family into this market in mid 2013, which puts us in a good position to continue to increase our growth in this segment into the future.

From a revenue perspective, the -- our biggest of the 3 initiatives is storage, and we're getting our next-generation Sonexion systems ready for market. And as you've seen recently, many of our new wins have included Sonexion. We've doubled our share of the Cray attached storage opportunity this year, and a big step for us over the next few quarters will to bring -- be to bring our cluster-attached Sonexion solution to market where we can connect Sonexion to non-Cray systems.

And in Big Data, our YarcData team is working to discover and refine new repeatable solutions for the uRiKA graph analytics appliance. We're excited to add some new uRiKA customers over the past few months. And with the growing pipeline, we expect to continue to steadily ramp this business going forward.

Our third focus area for the rest of the year is to complete the acquisition of Appro and begin the integration process of our businesses. Our target here is to grow our revenue in the supercomputing and big data markets, but fast integration is important to getting off to a good start.

Now, clearly, when you do the math on our current 2013 outlook, you will see that, even when you normalize this year by taking out the Intel transaction, we expect our operating income to come down some next year compared to 2012. I want to give you a few things to think about from that perspective.

First and foremost, replacing $150 million in product revenue from our single Blue Waters transaction is a huge hurdle in and of itself. We don't have a single deal of that size planned for 2013. What we're working toward is making up for that lost revenue with a combination of organic growth and new Appro revenue, and we do see some upside here. And second, we're continuing to invest ahead of profitability in a couple of areas, majority of which is being driven by our investment in the big data market. This is a sizable investment, as Brian mentioned. But what we are seeing here is a significant opportunity that, if it hits, will substantially change the fundamentals of our company, both on the top and bottom lines.

Our initial customer and prospect engagements give us confidence that this business opportunity is real and potentially extremely valuable. We feel good about the progress we've made so far, but we're not certain how or when this business will become a material contributor to our results. We're monitoring this closely, and if the opportunity doesn't materialize as expected, we'll look at throttling back on the investment. And conversely, of course, if things pick up quickly for us, you may see us putting our foot down on the gas a bit more to take advantage of the opportunity.

The way I like to think about our company right now is in 2 distinct but closely related businesses. The first is our core HPC systems business, along with its complementary services. This business is in great shape and continuing to grow at a strong pace. We're gaining market share and continuing to expand our presence across each of the markets we're attacking, all while maintaining solid profitability. On the other hand, we have an opportunity in Big Data to develop an incredibly powerful, unique set of solutions that we can deliver into a large, rapidly expanding market, fundamentally reshaping our company.

As we've talked about before, our strategy is to leverage our incredible supercomputing R&D, intellectual property and technologies into the HPC and Big Data server and storage markets, combining unique technology with fast-growing market segments where performance matters to customers. We're excited about the opportunity and progress we've made so far.

Our acquisition of Appro continues along this strategy, enabling us to grow faster, leverage our existing sales and service infrastructure and brand and broaden our product portfolio, ultimately allowing us to add more value for our customers, expand our leadership position in the supercomputing market and accelerate our effort in Big Data. Adding both the teams from SystemFabricWorks and Appro to our family will make Cray a stronger player in our target market segments. I couldn't be more excited about our future.

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.

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

I guess, I'll start off on Appro and try to dig in there a little bit. I guess, first of all, what is the growth rate of that business? Or what should we expect it to be? And then secondly, I think it's largely a service-orientated business, from what I understand and based on probably what you said about gross margins. I guess -- are they -- do they have any differentiation on the product side of the business and specifically in their software stack, in the ability to manage clusters, that gives you a little bit of technology along with the deal? Or any elaboration there would be helpful.

Peter J. Ungaro

All right, Chad. Some great questions. As you know, they're a private company. We haven't closed the transaction yet so we can't disclose all their financials, but I can tell you that they have been growing pretty nicely over the past few years. And as Brian said, we expect them to contribute at least $60 million to our business this next year, in 2013, which is -- it would be continued growth for them. They're actually not a service-related business. Really, the majority of all their revenue, Chad, is in clustered solutions, so industry-standard clusters in the high end of the HPC market, really in the supercomputing market space. And that's been a big part of their focus. They do have a great product, though. They have a number of really solid engineers there. And in particular, they have a system management package that they call ACE, Appro Cluster Engine, that we've evaluated to be very, very strong in the cluster market. So I feel like we're not only getting a great team and a nice addition to our product business that's very complementary with our XC30 and all the other systems that we have, but we're also getting some great differentiated software.

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

Okay, so the logic here is we want to take more share in the high end of the supercomputing market?

Peter J. Ungaro

The logic here, really, Chad, is a couple of things. One, definitely, we believe that we can grow in the supercomputing market, and this gives us a platform to do that between our current solutions and Appro. Bringing those things together, we can address over 80% of that market. That's $4.3 billion. By the way, Chad, that market grew 25% last year, so that's a good market to try and gain some more share in. The second thing is, as we've started our growth initiatives around technical enterprise and storage and Big Data, we really see that we can bring some of those technologies into Appro, give them some increased differentiation by leveraging some Cray technologies over time and helping them to really expand their business along with ours. It's, for instance, adding storage solutions into their business. They do very, very little storage today. We'd be able to take everything that we've been doing within our storage business and bring that to their business and, I think, incrementally grow both sides of the equation. And thirdly, it gives us a platform for some more efforts that we're -- that we've been working on in Big Data overall. So I think that we can grow nicely with them and provide us a growth opportunity that's bigger than we had in our -- by ourselves. And it also takes advantage of the efforts that we've been working on in our new initiatives over the past few years to grow that. It helps speed those along, too.

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

Okay. A couple of questions for Brian, I think. So Brian, DARPA payments this year will be about, what, 20 -- $22 million-ish?

Brian C. Henry

Yes, right now, we're seeing a little over $20 million, we think.

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

Okay. And then when you sold off the assets, the interconnect hardware assets to Intel, I thought you talked about the savings of that essentially covering kind of what you're going to lose in DARPA next year. And I realize we've recognized some of those savings in '12. I'm just wondering where -- that $10 million number that you gave in the call of increased DARPA payments, how that factors into the cost you've shed with the Intel transaction. Are we investing more in R&D, basically, is what you're saying than maybe 3 months ago?

Brian C. Henry

So Chad, those are very good questions. I think that, when we said $10 million, that's really taking into account the reduction of a little over $20 million in credits that we'll receive from DARPA. And remember, as you said, we had over 7 months worth of benefit already in the year for the savings that we did as a result of the Intel transaction, so kind of the $10 million is the effect year-to-year of the change. Actually, in core HPC, we don't expect R&D expenses to increase on a gross level. In fact, currently, we expect them to decline things. Now we are investing, as we indicated, in some of the new opportunities and initiatives to grow the business, and so gross R&D may be offset a little bit by that. But the core R&D, gross R&D costs are going down. It's just the credits went down faster.

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

Okay. And just because you rattled off the numbers quickly: So on the increase in OpEx for '13, you talked about, I think around the growth initiatives, that increasing $5 million to $10 million, but then you kind of took out Big Data and talked about a $15 million number. Is that $15 million of incremental investment over '12 in the YarcData division? Or how should I view that?

Brian C. Henry

Okay, well that's a good clarification and question. What we were saying is we're going to invest an additional $5 million to $10 million over what we did in 2012 in these new initiatives, but we wanted to call out separately the significance of our investment in YarcData, the business transformation opportunity that we have. And we're just saying, in total, the investment in operating expenses, R&D, sales and marketing, we think, will be somewhat over $15 million in 2013. That's in total. And so it's different than a $5 million to $10 million increase.

Operator

Your next question comes from Glenn Hanus.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay, so maybe back on Appro for a minute. Can you -- you're going to operate them as a separate entity. Can you talk some about their customer base to date, where they really have gotten traction in the market and then how you are going to sort of leverage it from that standpoint and -- I assume they have a direct sales approach -- or what their sales approach has been and how you're may change that or whenever?

Peter J. Ungaro

Yes, great questions, Glenn. Let me start with your thoughts around the separate entity. So what we're doing is we're going to actually integrate portions of their current Appro business along with our core company. So a great example, as you just mentioned, is their sales team. So their outside sales team will be integrated with our sales team. We'll have one sales team that will sell all Cray products to Cray customers. So parts of their business, we're actually going to integrate. And then the core parts of their business, so think about the R&D part, the marketing parts of their business, we'll keep in a separate business unit that will focus around product management, that will focus around that product line. So kind of 2 components of that. One is the business unit that will be responsible really for the product and coming out with that. But all the other core functions of the company, including our go-to-market both from sales and service side, will be integrated with the current Cray team. So it will be a combination, I guess. They won't be a stand-alone, separate entity at Cray. Their customer base is -- one, maps to ours nicely in that they have predominantly government, higher education. But they have done a number of commercial accounts. They have a couple of customers in financial services, for instance. They have a couple of customers in life sciences. And so it helps us along the line of growing the number of segments that we saw our solutions into. You've seen us expand in that area over the last year, with some nice wins in the energy segment, for instance. Bringing this together will help us in a few more segments. The other thing is that they really are predominantly U.S.-based. We've actually partnered with them in Japan for a couple of opportunities, but other than that, really, their business is U.S.-based. And so one of the nice advantages is we'll work with them to start distributing their products worldwide, including into Europe, into the rest of Asia Pacific. And our sales teams, I'll tell you, are pretty excited about that. So we think that there's a lot of leverage here because we get to take a great product, which we believe is pretty differentiated in that cluster marketplace, and not only expand that into a broader set of U.S.-based customers but expand that internationally. And we think that there's a lot of leverage from that.

Glenn Hanus - Needham & Company, LLC, Research Division

Can you comment on just sort of why now, and the process? Was the company for sale? Or how you came together with Appro.

Peter J. Ungaro

Yes, that's a great question. So why now? It's really about -- we've been on a pretty nice roll lately. We've done really good of establishing ourselves not only in our core supercomputing market but with these new initiatives. And as we think about growing those faster and how do we keep the company on the pace that we're on right now, it was a natural for us to bring this part -- this is kind of a missing part of our puzzle that we've been laying out as part of our overall strategy, and bringing them in is a natural for us. So we've been talking with a number of different companies in this area, as you can imagine. And they really seem to be the best fit from a culture standpoint; from how they think about products; from an engineering-first perspective, not a marketing-first perspective. And so it was just a really, really good fit overall. In fact, they've been really pleased because, over the -- late last night or early this morning, we've talked to, under NDA, with a couple of our key accounts and just letting them know what we're doing here. And I would tell you that they're pretty excited, along with me. So I was pretty happy to hear the response from our customers out in the market over the last few hours, as we've been talking to them.

Glenn Hanus - Needham & Company, LLC, Research Division

Great. Shifting gears to sort of classic Cray. Let's see, you're kind of coming in at the high end of the range this year, assuming the acceptances. Is there anything we should read into that in terms of some business that you captured that maybe wasn't fully anticipated before?

Peter J. Ungaro

It's really about the -- so we really fully got all the high-end business that we were expecting to get. And then we got a little extra lift on some of the initiatives. So the initiatives are coming in strong. I mentioned we had a goal of 10% of our annual revenues. And if the year plays out like we are expecting, and as we said in our outlook, that number will be up to 15% of our total revenue this year. A lot -- so a lot of that kind of back-end lift, as our initiatives have been ramping quarter-to-quarter, we're getting a little bit more uplift from that, which is really great.

Glenn Hanus - Needham & Company, LLC, Research Division

Sorry, I -- when you said 15%, did you mean for 2013, or was it for '12?

Peter J. Ungaro

'12, yes. So that's pretty much the upside that we are hoping for in our outlook. We have the range from $430 million to $450 million. A lot of that range was really around how much can we get our initiatives ramped, in addition to some of our core business. And they've -- it's coming pretty nicely for us.

Glenn Hanus - Needham & Company, LLC, Research Division

And so then, within the 3 initiatives, can you kind of rank where you really saw the upside? Was it more in the storage, or in uRiKA, or in the Midrange?

Peter J. Ungaro

Yes, I -- yes, great question, Glenn. So storage has been our -- just a huge win for us this year. We -- literally from last year to this year, we doubled our market share of Cray attached storage, in one year. And so it's been a really, really strong play for us. That's our biggest of our 3 initiatives, from a revenue perspective, and where we also got the most uplift. Our other 2 initiatives, both our YarcData big data initiative as well as in technical enterprise, both did well also. Both contributed to that also, but the biggest piece of that was in our storage initiative.

Glenn Hanus - Needham & Company, LLC, Research Division

And then, as you think about that 15%, as we think about 2013, can you give us any color on what -- how that percentage might grow? And the -- I assume storage will still be the largest, and perhaps the other 2 might grow at some faster rate. Is there any color around that?

Peter J. Ungaro

Yes, I'm smiling, Glenn, because I knew you were going to ask me that question next. So we expect our initiatives, combined, to grow about 3x to 6x faster than our core business. So we think of our core business as growing kind of in the low double digits. Our high-end supercomputing business, those initiatives growing 3x to 6x faster than that. But a little bit different split: So our Big Data initiative, that's the smallest of the 3 right now, from a revenue perspective. I fully expect that to grow at 50% to 100%, or even more, next year on a year-over-year basis but still from a smaller number. Our storage business, probably less so growing but still growing at a good clip. So growing -- those initiatives combined, 15% of our revenue this year, growing 3x to 6x faster than our core business, that percentage should grow -- go up year-over-year. But we're not really breaking it out. We're still way too early in our process to start breaking that out for you guys, but we wanted to try and give you a little color on that to help you think about that.

Brian C. Henry

I would note, Chad (sic) [Glenn] that if you take out the Blue Waters transaction in 2012, we expect the core HPC business to have a very good year in 2013.

Peter J. Ungaro

Yes. As I mentioned, we think that's going to be not only growing but profitable, very profitable, really, for us going forward. And the Big Data opportunity that we talked about, we think, has transformational potential for our company. So I couldn't be more excited about where we're positioned right now.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. And following up on that comment. When you're talking about uRiKA, you mentioned incremental investment there, but you sort of signal some level of uncertainty about how that might pay off whether you accelerate the investment, you decelerate the investment. Can you help us better understand the kind of the uncertainty that you're seeing? Is it sales execution-related? Is -- Are there some -- where is most of the uncertainty in your view there coming from?

Peter J. Ungaro

Yes, great, great question, Glenn. And I want to start off by saying our storage and technical enterprise initiatives for 2012, if we complete the outlook we expect, will both be profitable for us. But we're clearly investing a lot in big data because we have this transformational opportunity in front of us. I'll tell you, I'm actually not concerned right now about where we are. In fact, I'm really pleased with where we are at. We've started to do some proof-of-concepts with some new customers. Some of the early results have been very exciting for us. I think the hesitation, if you would call it that, is really that we're just really early in the process, right? We just got our fall 2012 release out. That really takes us from kind of our early customers into production-ready customers, customers that we think are going to really be able to leverage what we're doing in uRiKA more. We added a couple of new customers to the clip. I'm just -- I always smile because the machine that we did with Pittsburgh is called Sherlock. I love that name of machine, that it gives you a great visual of what this machine is all about. But it's just early, I mean, and I just don't want to -- I want to be cautious and let you guys know that, I -- on the one hand, I think we have a really exciting opportunity for us, and I will tell you, things are looking good from that direction. But I also want to be careful and just let you guys know it's early and we're going to monitor this thing not on a quarterly basis but on a weekly basis and daily basis as we go through and work with customers overall and around this product line.

Glenn Hanus - Needham & Company, LLC, Research Division

Lastly, can you just make some broader comments about the sort of health of the HPC space in light of the budgetary uncertainties coming out of Washington? What are you seeing deal-wise globally? And kind of what gives you confidence in the projections that you're making? And where do you sort of see the risks from a funding standpoint?

Peter J. Ungaro

Okay, yes, great set of questions. So first of all, I'll tell you, what gives me the most confidence is the XC30. This is a product we have been working on for a long time, and it is by far the biggest R&D project we have ever done in this company, probably going all the way back to Cray Research days. And I couldn't be more excited about how this system is playing out, some early numbers that we're getting off the machine. And if you saw any of the write-ups on it from the press since we announced that machine, they've been very, very positive overall. The HPC -- when we look at the health of that space overall, as I look at our pipe -- from a pipeline perspective, it looks really good. I mean, we're starting to see more and more opportunities in that space, a lot more in the, let's say, $5 million to $15 million range, which is really healthy overall for that space. And so that makes me feel really good. I think the one overhang on that space, as you hinted towards, Glenn, is the U.S. federal budget, what's going to happen with the cliff and all of that. I would tell you, the elections are neutral to positive for us. So how that kind of all played out, when you just think about the -- how the elections played out for the market, what happened in the House and the senate and such, that's neutral to positive. So that didn't give me any concerns from that perspective. We do have still out there, though, this fiscal cliff and the threat of sequestration. And we don't -- it's very hard to tell how that might impact the market overall. I typically think we're in pretty good shape because we're in longer-term projects that are very strategic, but I also don't want to say that that's not a potential that's out there overall. Other than that, I feel really good about where we're positioned, the new set of products that we have. At the same time that we're announcing new wins with the XC30, we're announcing new wins with our XK7. And so I feel like we're on -- in pretty good shape there overall.

Operator

No further questions at this time.

Peter J. Ungaro

Okay, thank you.

We've had good results year-to-date, and we're focused on delivering on our plans for the rest of the year. Next week starts the biggest supercomputing conference of the year, SC12, in Salt Lake City. You've seen some early announcements from us over the past 2 weeks, which will continue into next week as we show the market more new products than we've ever had at any one time, a refresh of nearly our entire product portfolio. 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, everyone.

Operator

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

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