Cray's (CRAY) CEO Peter Ungaro on Q2 2016 Results - Earnings Call Transcript

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Cray Inc. (NASDAQ:CRAY) Q2 2016 Earnings Conference Call August 2, 2016 4:30 PM ET

Executives

Paul Hiemstra - Investor Relations, Corporate Treasurer

Peter Ungaro - President, CEO

Brian Henry - EVP, CFO

Analysts

Chad Bennett - Craig-Hallum

Richard Kugele - Needham & Company

Joan Tong - Sidoti & Company

Aaron Rakers - Stifel, Nicolaus & Company

Operator

Good afternoon. My name is Nicole and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2016 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [Operator Instructions]. Thank you.

Mr. Paul Hiemstra, you may begin your conference.

Paul Hiemstra

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

Today's press release is available on the Investor Relations section of our Web site at www.cray.com. This call is being broadcast live on the Internet and recorded for replay purposes. A telephonic replay will be available shortly after the call. You can access it by dialing 1-855-859-2056. International callers can dial 1-404-537-3406. You must then enter the access code 56308193. A replay will also be available in the Investor Relations section of the Cray Web site for 180 days.

I would like to remind each of you that today's conference call will contain forward-looking statements that are based on our current expectations. Forward-looking statements include statements about our financial guidance and expected future operating results, our product development, sales and delivery plans, our ability to expand and penetrate our addressable market and other statements that are not historical facts. These statements are only predictions and actual results may materially vary from those projected. Please refer to Cray's earnings press release dated today and quarterly report on Form 10-Q for the period ended June 30, 2016. As well as Cray's documents filed with the SEC from time to time concerning factors that could affect the company and these forward-looking statements.

Our presentation includes certain non-GAAP financial measures in an effort to provide additional information to investors. Non-GAAP measures, other than non-GAAP outlook have been reconciled to their related GAAP measures in accordance with SEC rules. Our non-GAAP measures adjust for certain non-cash, unusual and infrequent items included in our GAAP results. Typical adjusting items include stock-based compensation, amortization of purchased and other intangibles and purchase accounting adjustments. We also adjust our book tax provision for certain items, including the impact of non-cash items, such as benefits principally related to our net operating loss. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures and a discussion of our non-GAAP outlook in our earnings press release, which is posted on our Web site and which is included with a related 8-K furnished to the SEC.

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

Peter Ungaro

Thanks, Paul, and thank you all for joining the call today. I want to start by addressing the update we made to our guidance today, and walk you through some highlights from our second-quarter performance. Then I will turn it over to Brian, to discuss our financial results and outlook. I will wrap-up by discussing our plans for the rest of the year and then open the call for Q&A.

First off, I want to provide you with some perspective regarding the change we made to our outlook. Clearly, I am very disappointed, we needed to make this change, but I remain as confident as ever in our business and our strategy. I do not believe that there's been any change in the strength of our products and solutions, our competitive position, or in our ability to take additional market share and grow the new markets over time.

That being said, I want to provide you some perspective around the shift in our expectations for the year. Several factors contributed here. Some of which represent the realization of risks we discussed on our last earnings call and one of which arises from a recent and unanticipated event.

First, we saw some -- we saw a significant impact from delays and third-party components, as well as the level and timing of new orders. And these were the risks that were discussed on our last call. We’re still working through various issues with the processors and the delays caused by this extended process that put added risk and pressure on our delivery and acceptance schedules for the year.

Additionally, this has impacted our ability to work with prospective customers on new opportunities that would leverage these processors, which is delay getting the new orders we had expected to win by this point of the year. Further impacting our order flow has been what now appears to be an overall slowdown in the supercomputing market were Cray compete, especially at the high-end and as well in our targeted commercial markets.

In hindsight, we thought what might have been the beginnings of this in the first quarter this year where we previously indicated weak order activity. That orders then improved a bit at the beginning of the second quarter only to slow down again in the latter half of the second quarter through today. The exact drivers for this slowdown have been difficult to pin down, but we're hearing a similar perspective from multiple sources in the market. So the market seems to be going through a far slower period this year than anticipated.

An example of this is from industry analysts IDC who just recently reduced their growth expectations for the supercomputing market. In the highest end of the supercomputing market, were we focus, we believe that our addressable market is down year-over-year. We are not sure how long this slowdown will last, but at this point we believe it will continue through the rest of the year and possibly into 2017. We don't see this as a longer-term trend, but it is clearly impacting our current view.

Second, we very recently experienced an electrical smoke event caused by a manufacturing facility power component at the smaller of our two facilities in Chippewa Falls, Wisconsin. This event caused smoke which damaged five relatively smaller customer systems that were being tested and prep for shipping, and for which we expected to achieve acceptances before the end of the year including some in the third quarter.

Some of these systems were key pieces of larger customer solutions. And as a result, their impact to our overall revenue outlook was more significant than just the value of the revenue type to those systems themselves. This event just happened and we're still evaluating the full extent of the impact, as well as our recovery plan. But I want to note that the majority of the loss is expected to be covered by insurance.

However, it's likely to have a significant impact on our results for the year, as the components for these systems will need to be reordered, rebuilt, tested, and will ultimately be delivered much later than originally anticipated. At this point in our analysis of the situation, we believe that the impact on 2016 is likely to be more than $20 million, but potentially as much as $60 million in revenue.

We fully expect that any revenue impacted by this issue will not be lost, but would be recognized in 2017. While it is difficult to quantify the precise financial impact of these three issues on an individual basis, each of them is significant and ultimately has driven us to revise our outlook for 2016.

Now I'd like to shift my comments to the second quarter, which was highlighted by product launches in each of our focus areas of compute, storage, and analytics. These new products offer customers the most performance solutions we have ever built. Our revenue for the quarter was in line with the target we previously laid out driven by significant customer acceptances in Europe and the U.S.

Gross margins for the quarter were particularly strong at 36% and we picked up some significant wins spending each of our three focus areas. In supercomputing, we have two primary offerings, our XC and CS product lines. The XC40 is our most scalable and advanced supercomputer and the CS400 and CS-Storm are our highly flexible clusters.

We installed several systems at different sites around the world during the second quarter. In the U.K., we significantly expanded and upgraded the two Cray XC systems at the European Center for Medium-Range Weather Forecasts or ECMWF. We made significant progress along our plans out at the Department of Energy's National Energy Research Scientific Computing Center, in Berkeley, California, known as NERSC.

With the first phase of the labs new system now accepted, we’re in the final stages of delivering additional equipment to expand the system to ultimately serve as the labs next-generation supercomputer, named Cori, which we expect to complete later this year. We also installed a major storage upgrade expanding this next M-file [ph] system to more than 28 petabytes of capacity and integrating our data work storage offering. Later, nonvolatile storage would sits between the compute memory and the parallel file system to dramatically improve application performance.

In clusters, we installed our first Intel Omni-Path interconnect based solution at the Alfred Wegener Institute, in Germany. We also continue to make good progress with commercial customers as the Center for Modeling & Simulation in the United Kingdom selected a Cray CS400. Its first Cray system. The center is made up of a consortium of manufacturing companies, including Airbus, BAE Systems, Rolls Royce, MBDA, and Williams Formula One.

In big data analytics, we launched our new analytics platform, the Urika-GX. We’ve been very pleased with the interest generated through the launch and since then. We have wins with the Urika-GX at both Oak Ridge and Argonne National Laboratories. Argonne is placing the Urika in its leadership computing facility, where they’re putting the system to work on important problems in both material and life sciences.

We also secured a large analytics order from an international government customer for multiple Urika-GX's as well as the machine learning solution leveraging our CS-Storm cluster system. This is among our largest analytics orders in our history. Just last month, we teamed up with Deloitte to build a new high-speed cyber security threat analytics service built on the Urika-GX. This subscription-based service offered by Deloitte is currently in production at several customers and leverages the Urika-GX to provide high-frequency insights into a customer cyber risk profile. Overall, I'm very pleased with the progress we made in the quarter in analytics and the momentum we're starting to build.

With that, I will turn it over to Brian to take you through the numbers.

Brian Henry

Thanks, Pete. Before I get to the updated 2016 outlook, let me take you through our second quarter financial results.

For the quarter, revenue was a $100 million in line with our target we laid out on the last call, and as anticipated, we reported a net loss. Product revenue was $69 million and service revenue was $31 million. While the majority of my comments are going to focus on our quarterly results, we encourage investors to focus on our results over several quarters as the variability in any given quarter is typically very large given the nature of our business.

Total gross profit for both GAAP and non-GAAP in the second quarter was 36% with product margin coming in at 34% and service margin at 41%. Product margin was higher than we expect for the full-year.

GAAP operating expenses for the second quarter were $52 million compared to $40 million in the second quarter of 2015. Non-GAAP operating expenses for the second quarter of 2016 were $49 million compared to $37 million in the prior year quarter. The principal difference between the GAAP and non-GAAP numbers was driven by $2.6 million in share-based compensation in the second quarter.

The increase in operating expenses in the quarter was driven by higher employee expenses and $4.4 million lower R&D credits compared to the second quarter of 2015. As anticipated, we also incurred a $2.3 million expense for an early lease termination fee during the second quarter for the upcoming move of our St. Paul facility. This fee was fully covered by our future landlord as a lease incentive. For accounting purposes, this benefit will be reflected over the life of the lease.

Non-GAAP net loss for the quarter was $11.4 million or $0.29 per share. Our GAAP net loss was $3.1 million. In addition to the $2.3 million early lease termination fee, I mentioned, our second quarter GAAP operating results also included $3.2 million for depreciation, $2.8 million for stock compensation, and $200,000 for amortization.

Shifting to the balance sheet. Total cash investments and restricted cash at the end of the second quarter was $224 million, a decrease of $96 million compared to the first quarter, primarily driven by increasing inventory for systems in this delivery or system deliveries in the second half of the year.

Inventory was up $75 million in the quarter to $197 million with 24% or $47 million in finished goods, all of which was out at customer sites and then the acceptance process. Our cash balances tend to be extremely volatile due to multiple factors, including inventory purchases and accounts receivable fluctuations. And as such, we encourage investors to focus on working capital, which decrease more modestly in the quarter than cash to $381 million compared to $418 million at the end of the first quarter. Part of the decrease in working capital was driven by a multiyear customer sales type lease receivable, which shifted $22 million to long-term assets in the second quarter.

I would now like to take a moment to discuss our outlook. For 2016, a wide range of results remains possible. We decreased our revenue guidance and now expect revenue to be in the range of $650 million. This decrease was driven by three factors, Pete laid out. The level and timing of new orders, the delays of key third-party components, and the related impact of those delays, as well as a very recent electrical smoke event caused by a manufacturing facility power component that will delay our ability to complete some customer contracts in 2016.

Revenue for the third quarter is now expected to be about $80 million and was also impacted by the electrical smoke event. As is typical, the anticipated revenue is highly dependent on the timing of a couple large acceptances. Based on this outlook, we expect just over half of the revenue for the year will be recognized in the fourth quarter.

For the year, overall non-GAAP gross margin is now anticipated to be in the range of 34%, slightly higher than our previous guidance. This is driven primarily by product mix. I want to note that our GAAP and non-GAAP gross margin results are expected to be relatively close going forward.

Total non-GAAP operating expenses for the year are expected to be in the range of $200 million, $5 million lower than our previous outlook. This number includes the $2.3 million early lease termination fee I mentioned earlier. Adjusting items from GAAP are predominantly driven by stock compensation and are expected to total about $13 million for 2016. With about $1 million of that going to cost of sales.

Share count on a fully diluted basis went profitable. It should be about $41 million to $42 million for 2016. Though it is dependent on a number of factors, including our share price. Given our updated outlook for 2016, our effective GAAP tax rate is now expected to be about 6% and our non-GAAP tax rate is expected to be about 30%, but both are subject to significant variability.

This higher non-GAAP tax rate is the reverse of what you would normally expect and largely driven by our level of expected profitability and new geographic distribution of income. This tax estimate is highly dependent on a number of variables including the distribution of income and the impact of newly adopted accounting standard for share-based compensation, which will likely lead to add or lead to added volatility in our effective tax rate.

Based on this outlook, we expect to be profitable on a GAAP and non-GAAP basis for 2016. Despite the reduction in our guidance for 2016 and our lack of visibility for 2017, I continue to believe that we are in a strong competitive position with significant opportunities to drive continued growth, especially as we expand further into the commercial markets overtime.

With that, I will turn it back over to Pete?

Peter Ungaro

Thanks, Brian. And to clarify our GAAP net loss $13.1 million for the second quarter. We have three main goals for the rest of the year. First, is to deliver on our outlook. Second, to win new business and third is continuing to push into our target commercial markets.

For 2016, we still have a lot of work left to do in order to deliver on a revised outlook. Both in terms of executing against the orders we’ve already received as well as to sign new contracts for this year. We have three new processors to integrate this year. The latest Intel Xeon processor known as Broadwell as well as Intel's new Xeon Phi processor known as Knights Landing and the Nvidia P100 Pascal GPUs.

We’ve installed and achieved acceptances on numerous Broadwell based systems. And at this point, we're not seeing any major issues with these processors. Although we're still working through the minor ones as we enable them across all our product line.

On Knights landing we're continuing to work through technical issues that could impact performance and further impact timing, especially as we scale up to large systems. However, while we continue to work with Intel and their partners to resolve these remaining issues, we began shipping these processors in our XC and CS supercomputers and have been for a couple of months now.

Some of the sites integrating the Knights landing processors include at NERSC, at Los Alamos and Sandia national labs, and at Argonne National Laboratory. To give you a better perspective on this, we now ship more than a 100 cabinets of Knights Landing base systems. On the Nvidia Pascal GPUs we have the GPUs in-house and are working through ongoing test and scaling into larger systems.

We expect to begin receiving these processors and volume shortly, and we plan to begin shipping them to customers for significant deliveries later in the year. We're still behind our original integration schedule here. Ultimately, we expect to work through the remaining issues on each of these processors to achieve the anticipated acceptances before the end of the year.

Our second main focus for the year is to win new business. As I mentioned earlier, the market appears to be going through a pause right now, which we believe is temporary. Our expectations for longer-term market growth remain intact. It is important to know that our win rates remain strong, giving us continued optimism that we will return to strong growth in the future. However, it is difficult to tell when that will occur.

As is normal for this time a year, it is too early to give any view on 2017 that we currently have less visibility than its typical. While we are confident market conditions will improve, we don't just know when the market is going to wrap out of this slower period and lead to stronger deal flow. So for now our planning for 2017 will be on the conservative side.

Our third main focus area is to continue to grow our revenue from commercial customers, with a strategic goal of driving a third of our business from the commercial markets over time. We continue to add commercial companies to our customer list and new activity remains high. However, conversion of this activity to orders and the revenue and revenue has been slower-than-expected coming into the year.

We focus on four primary commercial market segments, energy, manufacturing, financial services, and life sciences. Energy is our largest and with the drop in the price of oil over the past year, you may remember we have reduced our expectations for this segment going into 2016. At this point, it is looking like the energy vertical is going to come in significantly lower than even our lowered expectations for the year.

Our manufacturing and financial services segments are down as well. We expect revenue from life sciences to grow at this point. However, it is by far our smallest commercial segment. Despite the slower commercial performance, we remain confident in our ability to push further into the commercial markets. As the explosion of data continues to drive companies to look for new ways to leverage that data into actionable business decisions. Our systems remain uniquely positioned to add strategic value across these growing markets.

Let me wrap up by saying that while I’m disappointed, we needed to revise our outlook, I’m confident in our leadership position in the market, our strategy to drive growth and expand on our competitive position, and our ability to drive growth into the future.

With that, I now like to turn the call over to the operator to begin the Q&A. Operator, we may start the Q&A please.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Chad Bennett.

Chad Bennett

Hey, guys. Thanks for taking my question.

Peter Ungaro

Hi, Ben.

Chad Bennett

Pete, I know I was hopping on and off in other call, but I know each of these issues, three issues are significant. But is there any way to give us an idea of how much of the delta between the guidance is true slippage versus just lower order growth or orders below expectations. And any indication of kind of what slips into next year? Thanks.

Peter Ungaro

Sure, Chad. I appreciate that call -- that question. The way that I frame it is very difficult as I mentioned in my comments. It's very difficult to give a financial view of each of these three areas independently. Although the one that we can more clearly view is that the electrical issue that we had. Where we know between $20 million to $60 million of revenue is going to ship out of this year into next year. So that’s a clear view of the outline. The remainder of the impact is really a combination of the other two factors and they’re very tied together. For instance, a lot of the delays in processors slowed down customer buying decisions, so which technology they would pick and so on. So it is very difficult for us to kind of itemize those two out. But in general, I think you can clearly view that the one that we're associated with this recent event we had in our manufacturing facility are going to move into 2017.

Chad Bennett

Okay. And then, I was a little bit surprised and maybe it’s a function you're on track for what you are delivering this year, that you held gross margin guidance. But on that slipped revenue, how should we think about gross margins considering the potential penalties are at or whatnot?

Brian Henry

I mean we are not given any guidance on future gross margins on the site. I don’t think you should expect it to be any broadly different other than these would be all systems rather than a mixture of systems and service.

Peter Ungaro

Yes, I think the gross margin strategy we saw from last quarter went up by about a point and that’s really mix. As our product revenue with the revised outlook came down a little bit. We’ve a leadership in mix that's bringing that margin up a little bit. We think our current belief is all of the other implications like penalties or other things for some the delay that we will be able to handle within that shift.

Chad Bennett

Okay. Thanks, guys.

Peter Ungaro

Yes, thank you, Chad.

Operator

Our next question is from Alex Kurtz from Pacific Crest Securities.

Alex Kurtz

Hey, guys. Can you hear me okay?

Peter Ungaro

Yes. Hi, Alex.

Alex Kurtz

Hey, Pete. So, just to clarify on Chad's question around the penalties. So, when you do eventually recognize some of this delayed revenue, it sounds like the gross margin impact from the penalties to be pretty de minimis. Is that correct?

Peter Ungaro

Yes, it's difficult to project exactly, but as our current view is that’s how we would look at it.

Alex Kurtz

Okay. I'm a little -- I’m a little bit confused about you guys shipping some of your KNL processors to some of your big projects that you outlined. Well, then on the flipside we know obviously a lot of revenues is shifting out. So are you planning on recognizing most of the KNL revenue from your top three projects that you’ve outlined before this year or is there now going to be a little bit of a split between the years on those big project for KNL?

Peter Ungaro

Yes, so Alex, when we built up the revised outlook. Of course you look at all of the things that we're trying to do in this year and everything has odds of happy, different odds are happening this year versus next year. So, we kind of jump all of that into account, but we're thinking that the majority of those KNL shipments we're going to be able to work through that and get those done by the end of the year. As we came up with our target, so that was really a huge part of our thinking this year, which really been delayed is that we kind of run out of wrong way of fixing these problems and we can bring on additional customers and such as kind of all the schedules are moving to the right with this year and so that's been -- that's a significant impact to us. But the current outlook does require that we resolve the issues that we have for these kind of early big customer and get those accepted.

Alex Kurtz

Okay. So when we think about the change in guidance today, it doesn’t sound like its necessarily pertaining to the big KNL projects. It sounds like it's kind of related to other vendors and other issues. Is that the right way to think about it?

Peter Ungaro

I think that it's definitely -- there is different odds of everything happening in the year. But I think generally the way that you said it is correct, that the big -- the bigger contract that we have are really built into our current outlook. What really happened for us is that when we look at where we were sitting a quarter ago, when we mentioned these two things we had a couple of other things going on. So, when we looked at the technology risk that we had across all three processors, our hope was -- and our belief at that time was that we were going to work through those in kind of result those over the course of the next quarter. And what happened is we continue to dig into that, that’s we found more problems in that time as expanded and we kind of ran out of runway there. And as we're looking at the new orders that we had to get, there is a number of those that we really started to have them. We felt we're very significant discussions with customers early in the second quarter that kind of fizzled out over the last few months, some of which were tied to them not being able to choose which technology they want. Some of which just were delayed in their ordering process overall rat. So we still believe that we're in good shape to get through these problems, but at the end of the year versus getting through them with enough time to bring on additional customers that we were assuming we’re going to be able to do when we had our views last quarter.

Alex Kurtz

Okay. Just my last question and I’ll hop off here. But for the pipeline of new orders that you needed to make the year, and that sounds like where the big delta is here, the more and more I talk to you about this -- the more we talk about this. So, would you say that, that pipeline has roughly remained intact and is still -- it’s just kind of waiting on a processor decision? Or would you say that there’s been some overall change in that pipeline as far as size, whether it's in’16 or ’17? I’m just trying to understand the new order discussion. Is that a shift out or is that a rationalization down?

Peter Ungaro

Yes, that's a great question, Alex. And I think it's really important to note that I mentioned this earlier, but our win rates have remained the same. So, if you look at last year where our win rates were and this year, they are remaining the same. We’re just not getting as many paths I guess, you could say at applying those. So it's a little different in the two different segments. So if we look at the government, it's more traditional government academic segment, those have just moved out and those have slowed down a little bit. And we’ve seen that slowdown especially in North America, in the U.S. really and Europe would be the two big regions where we’ve seen that slowdown. In the commercial segment, we had a lot of downsizing. So we were initially talking to customers about some very large deals, but because of various things around the technology and their business, a lot of those deals were downsized quite substantially and kind of waiting more in a waiting and seeing about the technology pieces and how their businesses change over the next few months and next year. So, a little bit different things happening in each side of our market, but the effect I think at the end of the day is the same.

Alex Kurtz

Okay. Thank you.

Peter Ungaro

Yes. Great question.

Operator

And our next question is from Rich Kugele from Needham & Company.

Richard Kugele

Thank you. Good afternoon.

Peter Ungaro

Hi, Rich.

Richard Kugele

Hi. Well, first in terms of the Chippewa facility, I would hope that your employees sit or ride in that, if it was bad enough to affect the components, you’ve got a lot of people there, right? So I guess, just trying to understand maybe how much of your production is in that smaller of the two facilities? And then I have a follow-up.

Brian Henry

So it is the smaller of the two facilities. We didn’t happen to have a lot of systems in there at the time that the smoke event happened, and fortunate we had chipped some bigger systems out just before that. This thing really recently happened. There was nobody in the facility at the time, and it's just a smoke event that lasted not very long, but had the impact of damaging the systems that were there, and so we just have to get these rebuilt. And as Pete said, unfortunately even though the systems weren’t the biggest systems, they were linked to bigger solutions that we’re providing to customers. So we have some more significant revenue impact if we can’t get these redelivered on time with enough time to get them accepted this year, and that's why we gave you the range we did in terms of the impact. Now we suspect the facility to be up and operational within the next few weeks. It's really just a cleanup effort at this point to make sure that nothing else gets infected as we go forward.

Richard Kugele

Okay, that's helpful and good. In terms of just a clarification on Knights Landing. So Pete, are you saying that you still have issues that you’re working through on Knights Landing tied to Knights Landing projects in the $650 million, so that I mean like, I guess how much of the $650 million is based on these large projects that still have issues that you’re hoping to get customers sign off on during the year?

Peter Ungaro

Yes, Rich, you have it right. We do have issues that we’re working through in customer situations that we need to get to the $650 million. I mentioned specifically with Knights Landing, I mentioned there are three very large transactions there with NERSC, with Los Alamos and Sandia and then with Argonne Labs. So we’re still working through those and we’re expecting to -- we need to complete that and get that done to achieve the $650 million number. And so, that's a little bit of risk that's still in our $650 million outlook as we sit here today.

Richard Kugele

So is there any way to ballpark that?

Peter Ungaro

How much?

Richard Kugele

Yes.

Peter Ungaro

It's a significant number. It's over a $100 million of systems.

Richard Kugele

Okay. But that would be a push out. If worst case scenario, I mean, it's not like that's gone. It just happened.

Peter Ungaro

Yes. Definitely, definitely.

Richard Kugele

Okay. All right.

Peter Ungaro

Just like everything that was impacted by the smoke event we feel it, there’s a range that $20 million to $60 million range that we gave you, if that doesn’t happen any of those that don’t happen, they’ll be pushed out into 2017 too.

Richard Kugele

Okay. Just lastly on, and I think I’ve been asking you about this a while. But given the budget constraints on the commercial side; can you just talk about the interest level for HPC as a service, and whether perhaps that might get some of the commercial customers over the go line with a lower entry cost?

Peter Ungaro

Yes, great question. So, we’re really super excited over the last month with the partnership that we announced with Deloitte. This is really a very interesting partnership, because we basically have a great supercomputer underneath and Deloitte has built services, practices and solution around our system and are delivering it to customers out of service. So, it is an example and hopefully one of many over time of being able for us to sell, go to market with our supercomputers in very different ways. We think at the very high-end of the market where we mostly focus, Rich, we haven’t seen erosion of that market to the cloud really most of what that's moving to the cloud has been the lower end of the market, because of the unique kind of capabilities that high-end supercomputers provide, it's not easily replicated in the cloud today. But we do think that by giving customers more choice about how they acquire supercomputer capabilities -- supercomputing capability, that can help us to grow our market over time and provide a lower kind of entry level for customers to get into leveraging supercomputers. So we’re hopeful that this is an example that really starts to take off and we’ll be continuing to look for other opportunities to do this.

Richard Kugele

Great. Please keep us updated on that. Thank you.

Peter Ungaro

Yes. Thanks, Rich.

Operator

[Operator Instructions] Our next question is from Joan Tong from Sidoti & Company.

Joan Tong

Hi. I guess, my question is related to like more longer term, Peter, I’m just trying to understand the highest, like a portion of the HPC market. What’s your view on that? Obviously IDC changed the projection. But longer term just kind of look at all the guys who bought from you guys three, four years ago and like -- and suppose to come back and update HPC. Are those still intact? Do you change kind of your view of how we see that and also your IBM; the IBM opportunities, can you give us an update?

Peter Ungaro

Yes, that's a great question, Joan. And I want to reiterate a point I made earlier which is just, I’m very confident that the market is going to come back in the future. We have a dip -- we had a big growth in the market last year. We are clearly seeing a dip in the market this year now, and we’ve kind of validated that with the number of kind of outside sights. But I clearly see the need for supercomputing with our customers and our retention of our customer base has been extremely high. Our win rates are very good. So, I’m very positive in what’s happening and what’s going to happen for the Company into the future. But it's very hard. We’re in this kind of period of very limited visibility and a lot of changes going on in the market right now. It's very hard to kind of know exactly when that's going to play out, but I feel very confident that that's going to play out over time which is why I feel good. I don’t think that there’s been any fundamental shift in the market or in the need for supercomputing technology or in the convergence of supercomputing and big data, all those themes that we’ve been talking about for quite a while. The IBM opportunity is still a valid opportunity and still is one that we’re engaged with going after and gaining ground on. So again, I feel all those key components Joan, are still there for us. And we’re in a great position to take advantage of them. But we need the market to come back for us, and we hope that that's going to happen soon.

Joan Tong

Okay. All right, I guess, my next questions is related to the tax rate, and how should we think about it longer term in terms of tax rate and non-GAAP tax rate? Actually you talk about its like 30% for the full year, and like is it going to be a going forward run rate, Brian?

Brian Henry

We’ll have an unusual set of circumstances this year that drives the rates kind of in reverse than they normally would be. The general tax rate going forward for GAAP should be 35% maybe a few percentages less driven by R&D tax credit in particular. As it relates to non-GAAP, why we have the net operating losses when we have significant earnings, the non-GAAP rate will probably be in the low double digits, high single digit range. But this year with the geographic distribution of our profitability and the overall level of profitability, along with the credits and other things that exist in the tax, we get a very unusual answer on where tax is. And I want to just emphasis that we have to estimate taxes for the year. There’s a lot of uncertainty what those estimates will be. And really relatively small changes can have a big impact. Not so much on the dollar of tax, but their rates relative to pre-tax earnings that are forward here.

Joan Tong

Okay. Thank you.

Operator

[Operator Instructions] Our next question is from Aaron Rakers from Stifel.

Aaron Rakers

Yes. Thank you for taking the questions. I’m going to take another shot at kind of the longer term expectations. Pete, I know that it's a hard question to answer around the potential whether or not it's slippage of the, what would be $115 million or $155 million the delta ex the electrical fire or electrical smoke issue, and whether or not that's a slippage into 2017, but the question is, it’s just put simplistically. If it weren’t for the slippage potential in the business would you expect your market, your revenue to grow on a year-over-year basis in 2017 at this point? I know you’ve referenced kind of a conservative view, but it’d be helpful to understand if you think actually in ’17 the market actually grows for you?

Peter Ungaro

Thanks, Aaron. Great question. I believe that we’re going to be able to grow faster than the market. I’ve said that we’ve proved that we can do that over the past few years, and we’ve been able to execute on that and I still believe that today. As I mentioned earlier our win rates haven’t changed. There are still very strong win rates in the market right now. And so, I believe as the market comes back, we’ll be able to come back and grow faster than that market growth. So, I feel pretty good about that. How long exactly is this going to last? That is as you know impossible to predict. We are very hopeful that it won't be an extended period. Because when we look at the drivers of the needs for supercomputing, the growth in data the needing to do analytics to get better businesses decisions, the need for building a bit more, more complex models to more accurately simulate reality and model what’s going on in the world, all those drivers are strong. And so, we really believe that as we go forward over time, the market is going to return. We’re going to be able to -- we’re well positioned to continue to grow faster than that market, and we feel really good. But we do have this kind of lack of visibility for 2017. So it's just too early to tell.

Aaron Rakers

Okay.

Brian Henry

Aaron, and one second here. I just want to make sure you’re getting it. So it's one thing, like when we have the smoke issue and we’re going to have some revenues that either are going to be this year or next year. What you’re talking about is some things that we’ve had delays of orders, right? And so the real question is, there may not just be a slip in everything else that was going to happen next year, what’s going to happen and therefore you get a big thing, this is hard to tell, and that movement could be moved out of ’17 and to ’18 or whatever. So we’re not talking about a slippage of the short fall in orders. We clearly have a pipeline and a backlog of opportunities, but we don’t have that kind of visibility that would say that, it's all made up in ’17. I just want to be pretty clear on that. Now that could -- our view could change, but that's our view today.

Aaron Rakers

Okay. And that's fair enough. And just so I can be clear. I know that you talked about downsizing in the pipeline of opportunities on the commercial side. But have you seen any changes at all in kind of the budgetary elements of the business that you do in the government or the academic side at this point, or is it purely just the orders are slower than expected and once P&L issues and that the new GPS [ph] and video are worked through that you would expect those orders to come off or have there been any kind of changes on the budgetary side?

Peter Ungaro

Yes, we haven’t -- not just in the U.S. but I’d say this is kind of globally across the government markets in Europe, in Asia Pacific also. I would say that we haven’t seen any major changes in that. I think that there is with the Brexit situation there’s a little unknown piece of that, specifically within the UK and how that may or may not impact EU based projects for the European Union. But outside of that kind of one unknown area, I would say in general Aaron we’re not seeing any weakness there, so we are hopeful. And that's part of what gives us a view that we believe that the market is going to return.

Aaron Rakers

Okay. And then the final question just to kind of gauge the commentary on the commercial side. I know you said significant, but and it would be helpful to understand how much the commercial business looks to be kind of falling short of your initial expectation for 2016.

Peter Ungaro

Well, I mentioned that we’re working across four different segments. And three of the four segments are down significantly, and all three of those are our top three in volume. So the only segment that's up is life sciences, and that's by far our smallest segment. So it's a pretty substantial change in commercial revenue for the year. Again I don’t feel that it -- I feel it's kind of the lumpiness of what we’ve kind of seen from time-to-time. I don’t feel like we’re not changing for instance Aaron, our views of trying to get a third of our revenues in commercial business over the next few years or anything. So, it's not enough that we have to change our goals in what we’re targeting at, but it is clearly a substantial impact to this year.

Aaron Rakers

Okay. Thank you.

Peter Ungaro

Thanks, Aaron.

Operator

And there are no further audio questions at this time.

Peter Ungaro

Okay. Thank you. Despite today's outlook change, we remain strong in our target markets. Our strategy is on target and believe we’re well positioned to drive growth into the future. Thank you all for joining the call today, and for your continued support of Cray. Have a great evening.

Brian Henry

Thank you.

Operator

That concludes today's conference. You may now disconnect.

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