Cyan's Management Presents at JP Morgan Small/ Mid Cap Conference (Transcript)

| About: Ciena Corporation (CIEN)

Cyan Inc. (CYNI) JP Morgan Small/ Mid Cap Conference December 10, 2013 12:00 PM ET


Steve West - CTO

Mike Zellner - VP and CFO


Ashwin Kesireddy - JPMorgan

Ashwin Kesireddy - JPMorgan

Hello everybody, my name is Ashwin Kesireddy. I’m one of the associates on Rod Halls team. Our team covers wire line/wireless communication equipment and data networking stocks. I would like to welcome you all, both in this room, as well as on the webcast for this fireside chat with Cyan. Today, we are very pleased to have with us Steve West and Mike Zellner of Cyan. Steve is the CTO and Mike is the CFO. Welcome both, Steve and Mike.

Before we get started, the way we normally do these presentations is give few minutes to our presenters to talk about the company. I will chime in with few questions and then we will open up to the audience for more questions. Before we get started, I would like to note that Cyan is one of the stocks we cover. We have an overweight rating on this stock. We believe Cyan’s Blue Planet software will be very attractive, not only to tier 1 service providers but also to datacenter customers. In addition we think Cyan’s Z-series packet-optical boxes will be very attractive solutions to service providers thinking about next generation network architecture.

In general we are positive that optical vendors will see better times with a margin front as well, as they bring more intelligence down to their optical layer from data layer. With that – and for people who are not familiar with their story I would like to handover to Steve and Mike to start to give us an overview of the company and bring us all up to speed with the story here.

Steve West

Thanks very much for attending this session. What I would like to do today is just run through some of the concepts that we believe underpin a significant change in our networks or operated by carriers and how the impact of various technology changes is creating a generational change in the way networks are built and operated. We have of course to go through the traditional forward-looking statements announcement that I am sure you are all familiar with.

We have a series of changes going on in networking today, related to the economics of delivering capacity to end users. And these changes are creating an imperative for network operators to reduce their costs but also to find new sources of revenue. The changes really revolve around a demand for much higher capacity services. Also the nature of these services is changing dramatically and the network operators require to provide much more guaranteed delivery of service than has been the case in the earlier internet era. Another aspect is that it’s important to reduce OpEx. And in this new environment there is a reality that moving faster, being more agile results in lower operating cost. This is this construct of faster being the new cheaper.

What Cyan does is address both of these dynamics by providing integrated converged packet-optical hardware that delivers packet services of a high capacity optical infrastructure. We also provide the software that integrates the different components of these solutions, both within each network element, but more importantly across the networking domains from the end user all the way into the datacenter.

The key ingredients here are the use of virtualization to support network as a service, but also to provide the tools that allow the operators of these networks to manage the transition, to bring their workforce up to speed through the use of virtualization technologies. The company has had a fantastic track record over the last several years of significant growth, both in revenues as well as in the number of customers that we serve and we are now expanding into new verticals, as well as targeting customers in Asia and in Europe.

The strategic change is driven CEO down within large carriers with a need to drive new revenue at reduced TCO. We’re seeing a series of market verticals taking advantage of this approach. First of all the optical infrastructure for wireless networks has been an investment area for the last several years with everyone accessing everything anywhere anytime. What has happened is the wireless backhaul infrastructure has been transformed from the earlier T-1 environment to one that is now based on Carrier Ethernet over high capacity optical aggregation networks

The second area is the web scale optical capacity area, where increasingly content is hosted within datacenters, and this drives the need for high capacity datacenter access, as well as for high capacity interconnect between datacenter locations, and ultimately we believe towards a new environment moving from the internet to an inter-cloud environment with collaboration between these cloud services.

The net sum of this is, there is a network as a service environment where increasingly the operators of businesses and enterprises want to be in control of their network infrastructure and be able to run virtual networks across the shared infrastructure, both at the carrier Ethernet and at the optical networking level.

What we have is a change towards consolidation of the different technology silos. We have a whole range of technologies that up until now have been managed independently by different teams within the different silos also the carrier environment. Also the specialized equipment vendors have targeted each of these categories indecently. What we see here is an opportunity to integrate across these different technologies and this integration challenge is an opportunity that we believe has tremendous potential to reduce costs, both at the CapEx and at the OpEx level. Cyan targets this integration and orchestration opportunity through our SDN solutions.

What this involves is integration of the hardware platforms but with improved control. So in the past, the different pieces of equipment, be they DWDM, Ethernet Switching, SONET Platform, OTNs, IP routers, have been managed by different teams within the different carrier environments, so very complex environment that then required a legacy OSS to title together and into an ERP solution. We believe that this is changing because of high capacity integrated circuits, allowing for much more density in the deployment of these applications, resulting in converged hardware platforms, what we call packet-optical transport platforms.

The other side of this is the software that’s required to coordinate across these different functions, as they change to these more cost effective hardware environments and this is known as software-defined networks. What software-defined networks do is to allow for more innovation of the application level, where applications can get access to all the data across all platforms at all technology levels. It also allows for innovation and the addition of new applications that can drive new opportunities for our customers. Equally important, it opens the market up to several new classes of hardware that operate at a much lower cost level and allows for collaboration across different domains within the overall end-to-end service delivery environment.

This will be a change that impacts the entire value chain and what we believe is that it’s a generational opportunity for a company like Cyan to take advantage of the changes in the demand for services, but more importantly in the underlying technology that enables the delivery of these services. This extends across the networking hardware, as well as the software areas.

The hardware solution that Cyan delivers is what we call the Z-Series that integrates both packet and optical capabilities into a compliant and converged hardware platform. The value of this is that the operator of the network can deploy fewer boxes and that the coordination between the packet and optical functions happens transparently and automatically.

The transition to integrated solutions is enabled by higher density silicon and also more modern optical componentry. So within one chassis we can accommodate all of the functions that would previously have required several different boxes from several different vendors. Cyan has a range of hardware platforms that offer different size for different locations in the network.

Now changing over to a virtualized environment like this where the functions are all merged into one hardware platform requires a change in the way we would manage these solutions from a software perspective. Basically it’s taking the software out of the individual nodes and floating them up into a datacenter like compute environment. By doing this, you get access to all of the state, all of the configuration information from a software perspective and this enables the generation of new software applications.

The key attribute of this new change is the ability to really rapidly turn up end-to-end services and to do so in a more optimized fashion, where we coordinate better between the packet and optical layers. Cyan produces a range of different software tools and one of the aspects that the integration of the software allows is much superior visualization of how these networks operate and this is the key requirement.

As the operators transform their business, they have to retrain their staff and workforces and by having superior visualization, we enable this transition almost allow the operators of these solutions to learn on the job as they configure new applications. One of the key technologies we deployed is 3D visualization, which allows us for operators to understand the interlayer relationships between the packets and optical technologies and more about that as we proceed this morning.

We call the overall framework Blue Planet. It's our platform environment that supports the control, not only between the layers with the ability to add additional applications; it also supports integration of the end-to-end service delivery from the customer’s premise into the datacenter and across the core network.

What I want to do now is just go through a few simple case studies that illustrate where Cyan solutions are deployed and how they impact our customer’s business. This is an example of a physical network deployed in the United States for LTE backhaul. What you see is a whole series of nodes that are interconnected with fiber. Top of the fiber we may run DWDM and carrier Ethernet solutions. Ultimately at the highest layer the services you can see are all backhauled to mobile switching centers on the right hand side of this chart.

What you see then is a multi-layer environment, encompassing the use of packet services, Ethernet aggregation, OTN, DWDM and physical fiber. Clearly it's important to be able to understand how these services are delivered end-to-end across each of these network technology layers. What you see here is a screen capture from our management solution and it shows how that end-do-end services is actually orchestrated across multiple modes and multiple different transport technologies.

This results in a much more dynamic environment for these network operators. They have been able to adopt the wireless infrastructure based on changing demands as users move around in a wireless environment. And this is a solution that is widely deployed in the United States and with the increase roll out of LTE globally, we anticipate further demand for these types of solutions around the world.

Another example is the use of a multi-vendor solution by Colt, a Pan European purveyor of Carrier Ethernet services. In this example Colt is using multiple different equipment vendors to orchestrate the end-to-end delivery of services. At the customer premise, there are devices called Network Interface Devices, NIDs that are interconnected using Ethernet rings. Cyan then provides the aggregation equipment that then is used consolidate all of these customers’ demands to share the optical infrastructure at both the OTN and DWDM levels.

We then also hand off those aggregated services into the core network to provide end-to-end service between any location, in any city in Europe and any other location across the European network that Colt operates. So from a hardware perspective we provide the packet optical aggregation equipment that you see in blue, but more importantly it's our software that orchestrates the service from end-to-end, allowing Colt to turn up services in a matter of hours as opposed to competitors that might take weeks or even months to turn up comparable services.

A huge area of change in our networks is the compelling economics of datacenters, and this requires that the datacenters are first of all accessible by users of the services in the datacenter but equally important to provide high capacity interconnect between datacenter locations. What we have found over the course of the last several years is a significant increase in the number of locations that are using datacenter type architectures and that even within large metro there may be several different datacenters requiring massive capacity interconnect.

And Cyan solutions have been deployed to deliver Ethernet and DWDM interconnectivity between these datacenter locations, but more importantly it's the Cyan software that enables these new web 2.0 type operators to manage these networks with very small operation style, reducing their OpEx and also improving their responsiveness to changes in demand for capacity between these locations. And we anticipate that this is a growing demand market with increased rollout of datacenters across the United States and around the world.

What this leads to is the opportunity to move up the stack into function virtualization and to use these methods to not only provide connectivity at the packet and optical level, but also to provide connectivity to applications and content. What you see here is a solution that is being trialed in various Tier 1s around the world, where it’s possible to use dynamic provisioning of services across these networks and even have web based interfaces that allow the dynamic changing of capacity between access and datacenter locations.

What this really is, is service orchestration across the WAN, that you see in the center but also into datacenters and even into virtual network function type application areas on the right-hand side of the chart. We believe and anticipate that this is going to be of significant interest to carriers in the coming months. This is not something we deploy today, but it is something that we are committed to developing in the months ahead and have engagements with various different carriers.

So we believe that we have a significant opportunity in this market, first of all to grow our existing accounts with traditional WAN type connectivity but to also expand what those hardware deployments do through the use of improved software solutions in our SDN framework, by adding new functions to our software portfolio. We also have seen great success where our packet solutions provide a lower cost alternative to very expensive router ports in some of these Edge applications. Our success in the web 2.0 environment we believe is an indicator of potential for us to penetrate additional verticals and certainly we’re seeing increased success over the course of the last several months in Europe and in Asia.

So thank you for the attention on this part of the presentation. I want to hand it over to Mike who will present more of the financial details.

Mike Zellner

Thanks Steve. So I will go over the financials quickly and then give us some time for Q&A. So again business model highlights, based on the profile of offerings as Steve went through, a strong long-term growth profile on the revenue side, both underpinned by our offerings of course, as well as what’s going on generally in the telecommunication space. New geographies, we’ve primarily been in North America centric but that’s expanding for us. Our offerings are very applicable right across the globe and we’ve made efforts to get the infrastructure in place to do that. I will share a little bit more with you on that in a moment.

Demonstrated repeat buying, we have a chart that you recall land that [ph] expand then I will kind of demonstrate how customers come back for more once they start in a very specific area of their network, expanding margin profile as the software piece of the solution really begins to spin up. Then that causes our overall company margins to have the weighted average benefit of that. And then we continue to invest, to make sure that we can take advantage of this large opportunity in front of us. This gives you a sense of the revenue trends over the past couple of three years. You can see continued growth that way in each quarter, that’s demonstrated here.

Doing the same on an annual basis after our last quarter were basically the same as we were for that entire year in 2012, so again demonstrating growth from the annual perspective as well. This is the land that [ph] expand chart that I mentioned. This shows how our customers come back for more and we have an extensive profile of where that has happened for us. This is the top, I don’t know, 25 - 26 customers.

You can see what will typically happen is the customer will come in and they’ll engage us for one area of their network. We will provide both our software and our hardware solutions. They will see the benefit of that and then they will come back more and expand in other parts of their network. And you can see that, of the top 30 customers there, the profile of spend is 9.5 times of that initial purchase. That’s the point at the bars down there on the bottom. So repeat business is a very significant part of the story.

Opportunities for gross margin expansion; on the hardware side, we initially ship a chassis and maybe a couple of line cards and as customers come back and fill in those chassis with higher margin packet-optical, packets, specifically types of line cards that allows us to grow our margins on the hardware side. Generally speaking we think we can get our hardware margins aside from software, maybe to the mid to high 40s. The software side of the equation is where our margins can sort of increase dramatically from that and I think of it as a flywheel. We start with software, it’s a subscription type of model. It starts slow. And then both in terms of it rolling out over time as well as expanding throughout our customers networks, that becomes a larger piece of the revenue pie over time and we get the impact on margins that way.

These are our Q3 results that compares it both to last quarter sequentially as well as a year ago. So you can get the sense there. I will note our margins in Q3 ticked down a bit from Q2, and this happened to be a relatively – a quarter where we had relatively a larger number of initial customers, that their profile of the deployment is a chassis and a couple of line cards which is a lower margin profile, setting it up for higher margin going forward. We also have an annual adjustment for a very large customer in pricing that typically hits in Q3. So that impacted it as well. But again you can see the progress and growth on the revenue side that way. And our overall target that we’re headed for, we’ve given a three to five year profile is our gross margins to be between 56% and 60%, definitely be a component of software into that and our operating margins between 15% and 20%.

So again, a very, very large market that’s being disrupted by ourselves and others frankly; software driven approach that aligns well with the industry’s move to software defined networks. The carrier models are really, really challenged, that Steve went through. Bandwidth requirements are growing like never before and revenue side of things are flat to slightly up. But we can serve customers outside of the carrier space as well, enterprise, content providers, et cetera. We have a strong track record of repeat business and revenue growth and margin expansion opportunities are significant for us.

So with that, I think we can open it up to questions.

Question-And-Answer Session

Ashwin Kesireddy - JPMorgan

Great, thanks for your presentation. I guess my first question is on Windstream, which is obviously your largest customer. Mike maybe this is for you. How sensitive do you think is Windstream to economic uncertainties? For example the sequestration issue, tax rated issues? Are they more long term focused then we’ll continue to invest despite this short term uncertainties? It would be interesting to know what their spending behavior is. Also are you having any 2014 conversation with them?

Mike Zellner

So, Windstream is a great customer. They’re not immune to the economic realities like anybody else there. They’re affected by those of course. But they’re a great customer. We expect -- we have ongoing discussions with them as you might imagine, multiple times per quarter frankly and 2014 comes into that just like everything else. They have talked about, for the most part being through their investment in terms of wireless backhaul, which is an area that we support them. There are other areas that they are moving forward with, that we also support them with, business Ethernet deployments to their customers and so on.

So again, they’re a great customer. Expect them to stay that way. We’ll see where it goes. I think we talked about assuming that they’re sort of flattish from a revenue standpoint on a dollar basis year-on-year. We’ll see, it’s still early days. But the relationship is great and again very, very good customer.

Ashwin Kesireddy - JPMorgan

Okay, again on Windstream. How much of your revenue do you think is relaying to the stimulus related spending?

Mike Zellner

In terms of -- again we’re deployed right -- that’s specifically related to Windstream. Yes. They took advantage of some stimulus dollars, I’m quite sure, but our involvement with them is not tied to that specifically. We will continue to be a significant supplier to theirs going forward as they grow their business.

Ashwin Kesireddy - JPMorgan

Okay, just on your 2014 outlook. The big downside shift in the expected growth in 2014, is that mostly because of Windstream? Can you provide more color on why your growth expectations changed so much from the IPO?

Mike Zellner

Well, again, we’ve talked about and it’s just early days; we’re not going to spend too much time here talking about 2014 but we did talk about feeling like it would be a growth profile that was similar to what we’ll see this year, 30% to 33%. We’re still, as you might imagine, in the middle of working through all the details of our planning process for next year. So I don’t feel like I can shed a bunch more light on it than that, but we do feel like a profile of growth in the low 30s is very doable and that’s our expectation.

Ashwin Kesireddy - JPMorgan

Okay, thanks. Moving on to Colt, obviously a great customer a huge customer in Europe. How should we think about the pace of deployments at Colt? Does Colt give you better visibility than rest of the Telecos you deal with? Or is it the same story there?

Steve West

Sure. I think the engagement with Colt is just beginning. So I think it’s clear that we are in the early stages of that engagement from a deployment perspective. What I can say is that the relationship with Colt has been extremely positive. We work very closely with them on this new architecture that they’ve been championing over the course of the last year or so. But this change is something that is supported at the very highest levels of Colt. They are committed to this architecture. And the entire kind of business profile of Colt is really built around this carrier Ethernet delivery, as you’re aware and that we are, we believe in a very good position to benefit from growth I this market. As everyone understands, the need for these high capacity package services is increasing across the entire industry and we have great expectations that Colt will benefit from this overall demand and that as a provider to Colt we’ll be part of that story. In terms of specifics, in terms of numbers, I don’t think we can really share any of that today. I don’t think we are in a position to make any kind of pronouncements. Just in general I think we are very bullish about the relationship with Colt.

Ashwin Kesireddy - JPMorgan

I guess what I’m trying to understand is biggest risk with Colt, what do you think can change either in the microenvironment there or in the business environment which could possibly accelerate deployments there, that’s probably…

Steve West

I would argue on that one that because who Colt is, they have some very clear business imperatives related to both, the Carrier Ethernet business as well as the datacenter business and that both of these require high speed connectivity. So I can’t speak for Colt as a business. I’m assuming that they can run their business well and everything we’ve done with Colt indicated they’re a very professional and professional company. So we have no expectations that anything would get in the way of that rollout of their plan and that we do expect to benefit from their ongoing growth and success.

Mike Zellner

I just want to add one thing. We’ve talked earlier about, Steve, as he was showing the case study talked about how as a result of deploying this, the SDN strategy that we’ve helped them with, they’ll be able to turn up their, they have a big focus on business seasons and services of course and they’ll be able to turn that up very, very quickly in hours versus some period of their competitors that’s very much longer. So will that allow them to win market share? I guess we’ll see. It’s their business. That’s certainly their strategy and on the surface you would think that it would help in that regard. We’ll see going forward.

Steve West

And to add to that this concept of fast being the new cheaper, I think is an important one. If you have an organization that takes 60 to 90 days to turn up the service, it doesn’t take 60 to 90 days because they’re sitting around doing nothing. People actually doing that work, and cost them a lot of money. If you can automate these turn ups and reduce the time to market, you really have an impact on your cost of doing business. But more importantly if you can turn up the service more quickly, you’re more compelling as a supplier. So, I think if you require a high speed service and you go to one carrier and they say 90 days or 60 days and you go to Colt and they say you can have it in a week or two; clearly that’s a very compelling case for going with Colt. And I think most of the, just initial turn up having an environment which is software controlled allows that carrier to be able to respond more to customer’s changes in demand. Sometimes in this highly rapidly evolving market, you can’t really predict the way people used during the old days. You don’t have an idea of what you’re going to require in terms of bandwidth requirements in a year or two in every location. So having a more agile environment is going to be important for Colt, and we believe that’s going to put them in a great position and we’re delighted to be part of the ecosystem to help them achieve those objectives.

Ashwin Kesireddy - JPMorgan

Mike, maybe this is for you. Can you comment on the visibility in your business, various business segments, maybe outside Colt and Windstream, particularly on international piece, how do you see that developing?

Mike Zellner

International is an area of significant growth for us. We put infrastructure in place to allow for that. It’s still very, very early days for us. In terms of in general, we do get some visibility. As our customers plan out their network, we’re very much part of that. So that gives us a heads up in terms the direction that they’re taking their networks and so it does give us a bit of visibility that way. It’s different with each customer, but certainly having a month or two of visibility is a realistic scenario.

In terms of tying them back to international again, of course, this is absolutely in area that we think will be significant growth for us in 2014 and beyond. As I mentioned, its early days. Colt is a great example. Again they’re success will likely impact how quickly we go with them. It certainly looks like there is lot of opportunity for them and us that way but there are others NTT and others. So, we’ll see how it will fall for us in 2014 but our expectations are that international will absolutely grow significantly for us going forward.

Ashwin Kesireddy - JPMorgan

And probably last question on this international piece; how much of your revenue is split between Europe and rest of the world and international?

Steve West

So, we haven’t broken it out. Overall international is about 15%, 14% of revenue. It’s today the line for exposure is European based but there is no reason to believe that that won’t shift also into Asia. It’s certainly our intent to do so. So going forward, I would say that it would be more of balanced split today. If we looked at it today, it’s a little more exposure to Europe.

Mike Zellner

We did stock in Europe ahead of Asia. So, it makes sense that that would be the case.

Ashwin Kesireddy - JPMorgan

Moving back to the presentation actually; Steve, based on your comments, in the Telco world I think everybody is used to the term services rather than applications. So, I’m assuming Colt [ph] does the same things for you. So can you give us some examples of some applications that you can turn up quickly because of SDN?

Steve West

I think the start of SDN is really about networks, actually connecting locations, providing the applications that run over those network services, the bandwidth and latency jitter profile that's required for reliable operation of the applications to delight those end users. So SDN is the infrastructure layer upon which everything we do today rests, whether it's out wireless, smart devices or whether it's our ERP systems in our businesses. They all rely increasingly on the network.

And what we believe is that the, whereas in the past the networking service market was pretty homogeneous, people wanting just best effort IP services or T1s or something like a voice service, we believe that the market moves to a much more diverse and heterogeneous mix of requirements in the future. And not only are those requirements more diverse and more heterogeneous, there's also a need to have the ability to dynamically change, because you can't predict these services. So the underlying foundation upon which all of this builds has to become much more agile and dynamic than has been the case in the past.

Now once you've got at SDN infrastructure in place, particularly once the software defined network gives access to equally agile datacenters, that's certainly the trend. As we’ve certainly seen over the last couple of years, the datacenters are becoming a lot more dynamic as well, the ability to orchestrate the entire value chain, including the WAN but also datacenter, both internal switching functions, but also the speeding up of service, the actual instantiation applications on those virtual machines, the allocation of capacity from a storage perspective, tying that all together in overall orchestration framework, we believe is a long term change that is just beginning right now, but will really drive the way people view this market in the years ahead.

And then the other aspect is what we believe is that as the compute power improves and as network performance improves, it’s going to be possible to really retire some of the hardware appliances that had been used in networking up until now and replace those more with just software applications, and that's where the application market we believe becomes quite exciting, because that's a whole ecosystem that can have significant advantages from a cost effectiveness perspective and also an agility perspective moving forward. Does that answer your question?

Ashwin Kesireddy - JPMorgan

Yes, sure thanks. I think we're running short on time so I’d like to open up to the audience for any questions for here?

Unidentified analyst


Ashwin Kesireddy - JPMorgan

Could you repeat that?

Mike Zellner

Yes, sorry, question was that I made a comment about 30% growth. I was talking about our year 2014 over 2013.

Ashwin Kesireddy - JPMorgan

I guess one last question from my side. One interesting aspect of your business is interconnecting datacenters. Is there any update to the number of datacenter customer engagements you have had so far? I think you gave 8 to 10 customers in the last conference call. Is there an update to that?

Steve West

Those were, I'm sorry, datacenter customers that we’re working with or something. So we only have one datacenter customer today where we're actually shipping gear into sort of production environments but we’re working with a number of others, but we don’t have a win that we can announce other than the one.

Ashwin Kesireddy - JPMorgan

In this initial conversations with other datacenter customers, is it more like those customers are coming to you and trying to sit down with you and plan a network or do they already have a network in mind and then they're coming to you with RFPs?

Steve West

What we've seen is a big change in the way these primarily datacenter focused businesses are viewing the network. What these organizations want is control. They don't want to have to get permission from a third party to make changes to their network infrastructure. And what we’ve seen is a significant amount of hiring by these large web scale companies, all people with more of a network background and along with those new experts is a focus in many of the issues we've discussed today, and again because these organizations are starting pretty much on a Greenfield, blank sheet of paper kind of mode, they're not tied to some of the older architectures. So they we believe in being quite aggressive in the doctrine of these methods.

Ashwin Kesireddy - JPMorgan

All right, thanks. Maybe we’re running out of time here. Thanks Steve and Mike.

Steve West

Thank you very much.

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