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Cyan, Inc. (NYSE:CYNI)

Q3 2013 Results Earnings Call

October 29, 2013, 05:00 PM ET

Executives

Bonnie McBride - Vice President, Investor Relations

Mark Floyd - Chairman and Chief Executive Officer

Michael Hatfield - President

Mike Zellner - Chief Financial Officer and Vice President

Analysts

Ashwin Kesireddy – JPMorgan

George Notter - Jefferies & Company

Simona Jankowski - Goldman Sachs

Brent Bracelin - Pacific Crest Securities

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by for the Cyan 2013 Third Quarter Earnings Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is also being recorded today, October 29, 2013.

I would now like to turn the conference over to our host, Bonnie McBride.

Bonnie McBride

Thank you and thank you everyone for joining us today for Cyan’s Third Quarter 2013 Earnings Call. By now you should have received a copy of yesterday's earnings release. If you have not please visit our website at cyaninc.com where you’ll find our release as well as my contact information in case you need anything following this call.

Joining us today from management are Mark Floyd, our Chief Executive Officer, Mike Zellner, Cyan's Chief Financial Officer and Mike Hatfield, our President and Founder.

During the course of today's conference call we will make forward-looking statements regarding a number of topics. These include forecasts of future financial results and business performance, the market and prospective customers for the company's products, product plans and future capital expenditures, trends affecting gross margins, operating expenses and operating results for future periods and other matters.

Forward-looking statements include those in which use the terms believe, anticipate, expect and target. These statements are just predictions and actual results or events may differ materially. We refer you to the documents the company files from time-to-time with the SEC. These documents contain important factors that could cause company’s actual results to differ materially from those contained in our forward-looking statements.

Please also note that we will be discussing certain non-GAAP financial results. Our GAAP results and reconciliations of non-GAAP to the most comparable GAAP measures can be found in our earnings release and in the IR section of our website.

Before we begin I would also want to let you that the information we are providing represents our views of the matters discussed as of today October 29, 2013. Except to the extent that we have a legal duty to update, we do not expect to update our disclosure even if circumstances change.

I would now turn the call over to you, Mark.

Mark A. Floyd

Thank you, Bonnie and thank you all for joining us today. We appreciate having the opportunity to share our perspective on our business, to update you on how we are progressing for the long term business model and to give you an understanding of our future expectations. Before I review the third quarter I would like to make a few comments on the guidance we provide today in our press release.

First, I want to reiterate that the fundamental soundness of Cyan’s strategy to capitalize on transition away from hardware-defined networks to networks leveraging SDN and NFV remain unchanged. Further as you will hear in my comments on the quarter and specifically with regard to the progress we’ve made toward penetrating the Tier 1 market we believe we are executing on this strategy and we’ll emerge a leader in the space.

That said and as you know telecom space is historically lumpy. This can be particularly true towards the end of the year as capital budgets are largely exhausted with spending earlier in the year. The economic uncertainty being driven by the debt ceiling crisis and the lack of federal budget has exacerbated the situation, driving increasingly cautious order patterns among our customers.

Finally revenue from our largest customer, Windstream which reached a new record in the third quarter will be substantially down compared to prior quarters. Collectively these factors are causing a near term impact on our outlook.

Turning now to the results for the third quarter, we are pleased to report record revenue of $37.7 million, reflecting a 31% increase over the third quarter of 2012 and 19% growth over the second quarter of this year. During the quarter we continued to see early progress with the transformation, hardware driven networks to software driven networks. The first example of our partnership with Colt a leading pan-European carrier which operates 20 datacenters and connects to 19,000 buildings in 39 major European cities. Colt is launching the next generation based on Cyan's Blue Planet SDN software and Z-series platforms.

Our Blue Planet SDN software allows Colt to automate processes that were manual, reduce provisioning times and time to revenue and manage Ethernet transport and carrier Ethernet services end to end across an MPLS core in a multi-vendor network. Combination of Cyan's Blue Planet software and Z-series platforms will allow Colt to scale its metro network resources and provides a foundation for future SDN and NFV-based applications and services. This evolution to a software defined network along with a packet optical infrastructure allows Colt to deliver critical managed IT services, cloud services and communication solutions that provide a superior customer experience.

The second example is our progress of Blue Planet deployments. We have now deployed our Blue Planet SDN platform in over 1,000 networks, up from 85 at the end of the last quarter. We believe that Blue Planet is the leading SDN platform for carrier and network operators and is the foundation for future sales of new Cyan and third party software applications. Additionally our Blue Planet SDN platform was named the Best New Telecom Product by Light Reading at its annual Leading Light's event in October. The Leading Light's program recognizes innovative companies and products that signal the direction of technology advances and have demonstrated significant traction in the market.

The third example is our progress with major Tier 1 carriers. Winning Tier 1 carriers is a key objective for Cyan. Last quarter I discussed that we had started to engage with multiple Tier 1 carriers. Since then we have made good progress. We are now in the labs of four Tier 1 carriers and in a meaningful discussion with several others. For carriers and other network operators, SDN and NFV have a potential to increase long-term competitiveness and revitalize their business models. The result, that carriers are bidding [inaudible] faster than normal and evaluating deployments of software-defined networks and network function virtualization.

Potential benefits driving this accelerated pace includes significant lower CapEx spending as SDN and NFV reduce hardware complexity, substantially reduced operating cost through increased levels of automation and software control and the ability to build elastic non-static networks that offer quicker provisioning times, support new applications and services and deliver better overall customer experience.

We are putting substantial resource behind our Tier-1 efforts and are confident we have the right strategy and the best technology. Given the size of these customers and the related sales cycles, even at an accelerate place for Tier-1s capturing their business is a long term effort and assuming success this business will not likely result meaningful revenue until late 2014 or 2015.

Turning to our go-to-market strategy we have several major accomplishments to discuss. As I discussed last quarter our international expansion effort is moving more slowly than what we would have liked. During the third quarter however we made significant progress. Revenue from international markets reached record levels and was 13% for the quarter compared to 5% for the second quarter. We continued to expand our international reach and now have the direct sales presence in 15 countries outside of North America.

Complementing our direct sales we added five new international channel partners in the third quarter bringing the total to 22. We also added our first premier level partner in Latin America, CLAdirect. During the quarter we received a significant order from GlobalConnect, a Danish service provider to provide high bandwidth capacity for major sporting events connecting stadiums to the studios to a nationwide Ethernet transport network for HD TV distribution.

Additionally the parent company of Westdale, Grupo Televisa wants Cyan to provide mission critical connections to their global headquarters in Mexico City. Finally as we’ve previously discussed Colt is large and significant opportunity for Cyan and we are proud to highlight this win as an example of our growing international traction.

In North America we continue to expand our footprint into the enterprise and datacenter market, including follow-on sales to one of the largest Internet franchises in the world. This particular customer continues to build out new metros into Cyan technology including our 100 giga solutions. This reflects the continued success of our LAN and expand strategy. We see more multiple opportunities in the enterprise and data center markets. Economic contingency and software control are becoming important architectural elements in helping these companies to grow and operate their networks.

From a partnership perspective, six new companies recently joined Cyan Blue Orbit Ecosystem. Blue Orbit is a Group of SDN and NFV-focused companies partnering together to test and deliver multi-vendor solutions that are truly deployable in networks today. Aided by Cyan earlier this year Blue Orbit numbers now include Accedian, Arista, Boundary, Canonical, Connectem, Embrane, Mellanox, Metaswitch, [Omnicron], Overture, Pica8, RAD, Red HAT and Ryu. The difference between the Blue Orbit and other industry groups is that the testing is more specific customer engagement.

As a result we believe Blue Orbit will be instrumental in leading and perhaps accelerating the adoption of SDN and NFV technologies. For example with our Blue Orbit partners Cyan recently demonstrated multi-vendor NFV orchestration. As many of you know NFV is the fastest moving interface in the SDN And network virtualization field. And while some companies have come out with NFV orchestration, it is usually developed as a vendor specific vertically integrated solution. True to the tenets of SDN and NFV Cyan is demonstrating this technology at lab trials as a multivendor approach.

We most recently we approved our NFVO interoperated with Metaswitches virtual router reflector technology, open source virtual DNS and connect virtual Evolved Packet Core technology.

At this time I like to turn the call over to Mike to walk you through our financial performance. I will then provide guidance and conclude with some commentary on our outlook. Mike.

Mike Zellner

Thank you Mark and good afternoon everyone. First let me remind you that unless otherwise noted, the financial results and guidance that I will be reviewing are non-GAAP. Our non-GAAP results exclude the effect of stock-based compensation expense. GAAP and non-GAAP results as well as non-GAAP to GAAP reconciliations are included in today's press release as well as on the Investor Relations sections of our website.

As Mark noted revenue for the quarter was inline with our expectation at $37.7 million and represented an increase of approximately 31% over the $28.8 million reported for the third quarter last year. Third quarter revenue was up $6 million or 19% sequentially. Windstream comprised 50% revenues for the quarter, Year-to-date, Windstream has represented 45% of our total revenue, which is consistent with their contribution in the first nine months of last year where they 47% of total revenue.

For the third quarter gross margin was 40.2%, compared to 39.1% for the same period last year and 43.5% last quarter. The sequential decrease in gross margin was driven primarily by additional deployment to new customers, which typical involves a lower margin product mix as initial deployments are generally comprised of thinly constituted chassis. As a rapidly growing company focused on footprint expansion, we expect to be adding a significant number of chassis in any different period. We have stated in the past that timing, size and relative mix of divisions as compared with [inaudible] is expected to decline our gross margins sequentially quarter-to-quarter. As [it] becomes a significant portion of our revenue we expect less fluctuations in gross margin. Our three to five year gross margin target model of 56% to 60% remains unchanged.

Total operating expenses increased to $21.5 million for the third quarter up from $12.9 million for the same period last year and from $20.3 million last quarter. Operating expenses in the third quarter were slightly lower than we anticipated primarily as a result of slower than anticipated hiring. While this yielded near term saving, it doesn't change our attention to continue the investment resources needed to grow our business. As a percentage of revenue, operating expenses were 57%, up from 45% for the same period last year but down from 64% last quarter. We expect our operating expense to increase in absolute dollars as we grow the business. We are and will remain selective in our hiring practices.

Net loss for the quarter were $6.4 million or $0.40 per share based on 46.3 million basic weighted average shares outstanding. This compares with a net loss of $6.6 million or $0.24 per share last quarter. The net loss for Q2 was based on a weighted average outstanding share count of 27.4 million shares. As a reminder the outstanding shares used in the calculation reflect the full quarter of our previously outstanding preferred stock and converted common stock. As a result of timing of our IPO, the full common stock count was only included was part of Q2.

Turning now to the balance sheet, in Q3 we launched a lease financing program for Windstream resulting in $3.3 million of short term and $6.5 million of long term lease receivables on our balance sheet at September 30. This lease receivables have weighted average term of three years and are secured by the underlying lease asset. We expect to sell this lease instruments to third-party financing organizations at par value. Additionally, our intent is to continue to partner with third party finance organization to have them offer lease financing option to our customers.

Cash, cash equivalents and marketable securities at quarter end were $77 million as compared to $92.9 million on June 30. Cash used in operations of $13.3 million would have been $3.5 million excluding the lease program previously mentioned. An additional $1.5 million was invested in capital equipment. DSOs at the end of Q3 were 47, down from 57 in the prior quarter.

The decline in DSOs were primarily the result of the impact of lease receivables, which are not included in accounts. Excluding this impact DSOs would have been 63. We ended the quarter with $15.7 million in inventory, an increase of $2.7 million from June 30. Inventory turns have remained flat at six. Inventory remains well managed as we continue to strike the appropriate balance between responsiveness to customers needs and efficient working capital management.

Deferred revenue was $20.8 million at December 30, down 2.4 million for the balance at June 30. Deferred revenue consists primarily of ship and built hardware awaiting customer acceptance. The remainder consist of software along with support and maintenance revenues that is recognized ratably over the related contractual period.

Before turning the call back to Mark to provide guidance for Q4 I wanted to remind you that our IPO [lot] has expired on November 4th. This means that trading for cumulative lots of shares can begin on the fifth.

At this point I would like to turn the call back over to Mark.

Mark A. Floyd

Thank you, Mike. As I mentioned on the outset of the call we see a mixed economic environment and other factors effecting our near term outlook. As a result we are estimating our fourth quarter revenue to be between $30 million and $33 million. We expect our non-GAAP net loss of $9 million to $11 million and the net loss per share to range from $0.19 to $0.24. At these revenue levels Cyan has projected to grow 33% for the full year of 2013.

Looking out to next year our initial expectation is that we will continue to grow in 2014 at roughly the same rate as we were estimating for 2013 or approximately 33% year-over-year. The estimated 2014 growth rate does not include any new Tier 1 customer wins. If we are successful with our efforts and the Tier 1 move quickly to implement next generation technology than we believe that our 2014 growth rate could be higher.

We recognize that our near term guidance is disappointing to all of us. I want to reiterate again that nothing fundamental has changed and I feel very confident about our business. Our installed base of 100 customers having deployed our Blue Planet solution as well as our demonstrated ability to win new customers puts us in a unique position to leverage future opportunities.

In addition we are making enormous progress with entering Tier 1 accounts and see tremendous upside potential for the long-term. With that I would like to open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Rod Hall with JPMorgan. Please go ahead.

Ashwin Kesireddy – JPMorgan

Hey guys this is Ashwin Kesireddy on Behalf of Rod Hall. I guess my first question is actually on visibility for 2014. Obviously you’re guiding for 33% growth rate. Just wanted to ask what better visibility do you have now when compared to when you went public few months ago? Can you talk about any big deals that we should be aware of, also when do you expect revenue from Colt or when do you expect to recognize revenue from Colt?

Mark A. Floyd

That’s a great question so Colt, we started recognizing revenue from Colt in a very small fashion right now but we think that's a 2014 revenue play for us as they start building out their networks. When you think about 2014 the way we looked at it in our fourth quarter and while our guidance is slow because Windstream we expect to be substantially lower in the fourth quarter than in prior quarters. We expect them to come back strong in 2014 as much as they were in 2013 so we are planning for Windstream to be relatively flat in 2014.

But if you look at other customer base, all of our other customers were up 50% year-over-year and we actually think that trend could even accelerate in 2014. And again as per my comments a second ago these are our existing customers and customers that we feel very close that we’re going to win, not including any new major Tier 1.

Operator

Our next question comes from the line of George Notter with Jefferies & Company. Please go ahead.

George Notter - Jefferies & Company

Hi, thanks. I wanted to ask about the guidance as well. So if I look into Q4, if I think about the kind of numbers that were originally contemplated here. I think they did include in assumption that Windstream would slow down. So I guess I am wondering where exactly the decline in expectation comes from? Is it indeed Windstream or are there other accounts that you are kind of thinking about as filling in that hole in Q4, or did similar of those opportunities in fact push out. I guess I am just trying to really understand the puts and takes on the guide for Q4.

Mike Zellner

Sure George. You know the number one thing is that Windstream we feel will be very light in Q4 per my comments. And then the second major factor is that if you remember on the call last quarter I talked about our international business not being as much as what we wanted or hoped it to be, even though in the third quarter it was 13% of revenue, we anticipated EBITDA in the third quarter that it would have been higher and therefore we had anticipate the fourth quarter to be again higher on our international piece and that piece is just moving little bit slower for us and the accounts are there.

We see some light of sight on some very nice ones but it's just those are the two major factors and the third to a lesser degree, though it was important is that some of our customers are looking at the economic situation right now and the uncertainty and are just kind of holding a little bit tight, little bit longer on before they start placing orders.

George Notter - Jefferies & Company

Got it and then -- I am sorry. So the international deals that were slipping out in timing is that Colt specifically is it a multitude of deals and how broad-based is this push up that you are seeing? And is there something, yeah systemic to the offering here or to the SDN story or what is it that’s driving those push outs intuitively?

Mark A. Floyd

Yeah, it has nothing to do with SDN. In fact what’s interesting is excitement of SDN is there. What I think is happing is as you build your product along in different carriers and different networks and different requirements and responsibilities to give you a perfect example like Intel STP that’s one of the key things that we need for the Asian market and that’s going to be available in 2014, not in the fourth quarter and we have a lot of customers in that region that are waiting for that functionality. But I think all in all it's just slower than what we expected.

George Notter - Jefferies & Company

Got it. So just to be clear so Windstream is, it sounds like roughly in line with what you are expecting in Q4 in the majority of the decline and assumption for Q4 is -- are these international pieces, is that accurate?

Mark A. Floyd

Let me be very clear. Windstream's going to substantially down than what we thought in Q4 and so that is the major part of the fourth quarter guidance. We do know they will be back in 2014 and I am not going to comment on their CapEx spending but I think you can talk to those guys and you’ll see the correlation. But from the international view point it's just taking us longer, George it's just taking us longer.

George Notter - Jefferies & Company

Got it, okay. And then the other question you mentioned you had four Tier-1s when you were in the labs and I think your discussions with others you mentioned. But what’s the perspective there? I mean certainly they are longer term sales cycles, I mean are they in labs, in locations, where these are just kind of features oriented laboratories, where the nature of what they do is to just test the technologies that are out there, is it tire kicking in that sense or are these really situations where you’ve got customers that are looking to operation wise something on a time frame they are legitimate opportunities?

Mark A. Floyd

I will tell you George and I’ve been in this business 30 years, I’ve never seen the Tier-1s move as fast as they are in looking at this SDN technology, period. It is amazing to me. So the answer to your question I think it's a combination of those two. In fact what I find interesting is that we have -- we are in conversation with multi Tier-1s and it's -- and they are all at the same time, which you know it usually doesn’t work that way. So when we look at our opportunities right now in the third quarter, I mean the second quarter when I talked about going forward we were not in the labs of any those Tier 1s.

So in three months we have entered four tier 1 labs and I would say it's a combination of what you described. They are looking at it from a future view point but they are looking at from a immediate view point as well. Because they see SDN as not just one product, it's not just one functionality, it's something that you can bring in your labs today and that you can expand on it over time with the NFV functionality and other applications.

So it's not going to be one of these pioneering things where oh, it works now, it's big enough to stick in the lab, I believe it's going to be one of these things that will get into a network and will work in continued progress. Mike do you have any comments on there?

Michael Hatfield

George, it's Mike Hatfield, the other thing that I would say is that the announcement that AT&T made about the domain 2.0 and their strong initiative around that, I think that helped crystallize a lot of the interest and they made it very clear they are expecting this type of technology to be meaningful in terms of their overall spin that how they go about it. So I think we're just seeing an acceleration of this and it's not just saying around, they are really trying to figure out exactly how they go to deploy this as new deployments next year.

George Notter - Jefferies & Company

Got it. Great. Thank you.

Mark A. Floyd

Thank you.

Operator

Our next question comes from the line of Simona Jankowski with Goldman Sachs. Please go ahead.

Simona Jankowski - Goldman Sachs

Hi. I just wanted to ask you about the quarter you, just reported. So Windstream was obviously quite strong and international was up nicely. But if I strip out both of those, I basically back into your North America revenues declining about 24% sequentially and I just wanted to see if that matched your expectations and if not what drove the decline?

Mike Zellner

Simona, hi it's Mike, we can go through the detail afterwards if you want but there was a decline, it was a 6% decline for customers outside of Windstream. Mark do you have something to add as well?

Mark A. Floyd

Yeah but Simona if you look at it on the year-to-date our other customer base is up 50% year-over-year and we -- at anyone time in our business it's going to be lumpy where customers mid-quarter and then they hold tight or the quarter goes or whatever. So we've actually expanded the number of customers and I think and I predicted that our new customers, our other customers should I say outside of Windstream and international partly international being a summer but it continue to grow at 50% or higher rates. So we feel pretty comfortable with our North American business.

Simona Jankowski - Goldman Sachs

Right. Just to be clear the 6% decline that's just for revenue outside of Windstream but I also take out the international piece of that, it implies that the remaining North American customers declined 24%. I mean that just seems like a pretty significant decline. Can you just down narrow it down a little bit to the sources of decline?

Mark A. Floyd

It's quarter-to-quarter, Simona, we got customers coming in and out. We -- I will just be very clear we have not lost one customer and our business continues to grow and I think it's just a matter of quarter-to-quarter fluctuations with their purchasing but we don't see any issues with that.

Simona Jankowski - Goldman Sachs

And then as far as the datacenter or Web 2.0 customer funnel that you had been pursuing, can you update us on how that's going and if the one datacenter customer you had if they were up or down in the quarter sequentially?

Mark A. Floyd

Sure. The one data center customer we have right now continues to expand in the metros and so we are really excited about that. We have targeted somewhere around a number of eight to 10 that we are engaged with and we are yet to close a deal with them but I feel pretty confident that we'll get some business out of this market segment for us. But the other one that we are deploying right now is continuing to expand their deployment using Cyan equipment.

Simona Jankowski - Goldman Sachs

That eight to 10 number is larger than I think you talked about previously. I think before the number was four or five. Are all of those 8 to 10 still open RFPs or have some of them have already made a selection?

Mark A. Floyd

I don't think there is any RFP, there is no one in an RFP, these are just additional engagements that we -- that had interest in our Blue Planet software and our Z series platform and the reason why the number is growing is that initially this was really targeted from North America and now we're adding some international datacenter customers as well.

Michael Hatfield

Yeah. Simona, the other thing I would add to that is that what we saw and part of that driving of that expansion in terms of number is that we are seeing a lot of these traditional data center guys, who really didn’t have a networking component to that begin to move into the networking realm. And so that accelerated pretty significantly, we have seen that over the last 60 days to 90 days in terms of that phenomenon and I think that those datacenter operators that don’t have a network components are finding that they are struggling at bit in terms of their service offerings.

Simona Jankowski - Goldman Sachs

Interesting. And then back to the Windstream expectation to be flat for next year. My understanding was that you are involved in two projects there, one of them having to do with a backhaul or fiber to the towers and then the other one having to do with business Ethernet services. And as I understand and they talked about on their call the fiber backhaul project to the towers is now winding down or largely complete. So is there another big project you’ve won for next year to make the overall revenue number there roughly flat as opposed to down significantly.

Mark A. Floyd

Well yeah Simona what was really interesting if you remember at beginning of this year I talked about Windstream being flat to slightly down compared to 2012 and this year I think Windstream will be higher than 2012. And when I look at 2014, you are 100% right in there backhaul tower application is winding down. The really good thing is that with our LAN and expense strategy we are in multiple different additional new applications within Windstream.

Michael Hatfield

Yeah what we’ve been benefiting from within Windstream is a significant expansion of their business Ethernet services as well as the residential services and so that’s been a big driver, has nothing to do with the fiber to the tower piece. So they’ve got a CapEx spend that shifts with respect to where their focus is but all of those different elements all sort of come back to some kind of Blue Planet or Packet Optical that I mentioned.

Simona Jankowski - Goldman Sachs

I see, very helpful. Thank you.

Operator

(Operator Instructions). Our next question comes from the line of Brent Bracelin with Pacific Crest Securities. Please go ahead.

Brent Bracelin - Pacific Crest Securities

Yes, thanks for taking my questions here. Wanted to talk little bit about Windstream, the assumptions for next year as you get say 33% kind of growth. Is the assumptions that the Windstream component remains flat, down how should we think about what you built into the Windstream assumption to sustain 30% plus growth next year?

Mike Zellner

Sure, Brent it is clearly we are looking at be at the equipment level of 2010.’13 this year. So when you talk about our 33% growth rate definitely our other customers excluding Windstream not including in the Tier-1’s that we are in the labs with right now.

Brent Bracelin - Pacific Crest Securities

Okay. And then obviously the new relationships there it sounds like you are financing some of the equipment that they buying from you and through leases. Do you expect that to be a big component of the funding for Windstream equipment next year as well too how should we think about the I guess the change in [inaudible] buying cost from you and now kind of through a more of a least receivable?

Mike Zellner

Sure let me answer that. We actually had a cap amount at around 10 million in day exercise about 9.8 about. We are actually going to intend to sell it off to third parties far and in fact we actually have the first tranche that we did in sort of re-tranche is that 9.8 million and the first tranche is actually already sold to a third party and we expect the others to happen directly. So that we’ll still use it but it will be in different project if you will, send it out the third parties.

Mark A. Floyd

Yeah and what’s more interesting that our business having a lease option I think a lot of our larger competitors have this option and it's pretty standard in our industry and so we just came up with one that would work with the Windstream and again our goal is to all just flow that to the third party financing and continue on.

Brent Bracelin - Pacific Crest Securities

Sure. You bet, and I guess going back to kind of outlook for growth next year and confidence in sustained 20% growth, clearly can see how and why you can continue to expand growth outside of Windstream. I guess it’s a little less clear given a big portion of the revenue over the last couple of years for Windstream was paid for us through kind of the lot of the Stimulus funds and backhaul capabilities.

What’s the underlying belief [that what is it, core] Windstream revenue this year do you kind of actually continue to expand in to new areas or can you tell me where you are growing Windstream, help me understand how are you growing the businesses for Windstream, how it's done the last couple of years and again that has it changed next given the wind down of lot of those funds?

Mike Zellner

This is Mike. If you look at the projects they have multiple different projects that they are working on at any given time. Certainly the tower initiative for the backhaul was a significant one. And that has slowed as they don’t have [inaudible] stop they continue to need to add capacity so we’ve gone on significant wins as they’ve expanded with that and there is certainly no ceasing in the growth of broadband to the towers and certainly in all the iPads and iPhones out there are driving even more capacity than ever.

We’ve benefited as that capacity requirement grows even though they’ve built it for the towers so you’ll see that Windstream has reduced their spend in that respect with fiber because it laid fiber but we continue to benefit as they need to expand their network for just a growth that happens there. So sometimes that gets lost in terms of what’s happening in that dynamic. So yes they’ve slowed in terms of the construction to the towers but that doesn’t mean that the users of those towers are slowing their bandwidth requirement needs and growth. So we are benefiting from that.

The second component is that they have a very strong and stated initiative around all that they are doing in business Ethernet service I mean that’s been a stated in public initiative on their part and we’re in business supporting that. That continues to grow at pace as you know everybody is expanding what they are doing in that realm and we benefit from that trend.

And then finally on the residential side, clearly that’s a huge expansion opportunity that we’ve benefited some of they’ve needed to build out further capacity for the end users at their homes, all of those are drivers for us.

Brent Bracelin - Pacific Crest Securities

Okay. And then two more questions if I could here on the gross margin side I appreciate that products mix changes between chassis and line cards have different impacts on gross margins but just looking at where the source of upside came from this quarter Windstream, or one of your more mature customers I would have assumed there would have been a more favorable mix of line card capacity additions which would indirectly help margins not hurt margins was there price concessions in the quarter that kind you gave or is that the long read was there material shift towards chassis that drove and pressured margins down in the quarter?

Mark A. Floyd

So the most significant component of the movement was new customers with thinly configured chassis for sure. We did have a pricing arrangement with one large customer that also would impact it to a lesser degree. So it’s really those two items that if you will bridges the two points gross margin.

Brent Bracelin - Pacific Crest Securities

Okay, great. And then as we think about kind of the levers to expand the gross margin next year, you still have large customer concentration that looks for kind of most favored nation, pricing out of you. Did you have to change your philosophy around your ability expand gross margins next year or is that again it would be a function of products, chassis mix and then software mix?

Mark A. Floyd

There is definitely room for expansion and we’ll march towards our target of 56% to 60% share. It will be both filling out chassis as you’ve indicated it’s also the mix will begin to start getting little more software, that can be huge but it’s very, very big margin obviously so it’s a blending in it a bit of software, it's filling out of the chassis and then generally just being able to reduce cost at the same time as well.

Michael Hatfield

I think just to add on Brent when you think about Blue Planet and how we enter to a network and know by the software on a ratable basis but they will do it for a small part of their network, to test it out and to make sure everything works in their network and they start to expand. So we are going to see some, a lot of new customers, next year, a lot of these will be international customers. And so we feel pretty good that the software is going to continue to be one of the lagging rods for increase in our gross margin.

Brent Bracelin - Pacific Crest Securities

That's great, well thank you so much.

Operator

I would now like to turn the conference over to Mark Floyd for closing comments. Please go ahead.

Mark A. Floyd

Thank you. Well thank everyone for joining the call and as we stated throughout this whole call we feel very confident about our business. We are looking forward to the conferences that we will be at in the coming weeks and seeing a lot of you face to face. And with that I wish you well. Take care.

Operator

This does conclude the Cyan 2013 third quarter earnings conference call. I'd thank you for your participation. You may now disconnect.

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Source: Cyan's CEO Discusses Q3 2013 Results - Earnings Call Transcript

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