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Cyan Inc. (NYSE:CYNI)

Q1 2014 Earnings Conference Call

May 06, 2014, 5:00 PM ET

Executives

Maria Riley - Investor Relations

Mark Floyd - Chairman and Chief Executive Officer

Jeffrey Ross - Chief Financial Officer

Michael Hatfield - President and Co-Founder

Analysts

Scott Thompson - FBR Capital Markets

Ashwin Kesireddy - JPMorgan

Simona Jankowski - Goldman Sachs

Operator

Good day, ladies and gentlemen. Welcome to the Cyan Inc.'s first quarter 2014 earnings conference call. (Operator Instructions) And I would now like to turn the conference over to Maria Riley, Investor Relations. Please go ahead.

Maria Riley

Thank you, and thank you everyone for joining us today for Cyan's first quarter 2014 financial results conference call. I am joined today by Mark Floyd, Cyan's Chief Executive Officer; Jeff Ross, Cyan's Chief Financial Officer; and Michael Hatfield, Cyan's President and Founder.

Shortly after the market closed today, Cyan issued a press release announcing the results for its first quarter ended March 31, 2014. If you would like a copy of today's press release, you may access it online at the company's website, www.cyaninc.com.

During the course of today's conference call, management will make forward-looking statements regarding a number of topics. These may include forecasts of financial results and business performance, including trends affecting gross margins and operating expenses, future markets and prospective customers for our products, expectations regarding our existing customer demand for our product, future cash requirement and resources and other matters.

Forward-looking statements include those in which we 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 reports on Forms 10-K, 10-Q and 8-K that we file with the SEC from time-to-time, including our Form 10-K that we filed for the year ended December 31, 2013. These documents contain important factors that could cause the company's actual results to differ materially from those contained in our forward-looking statements.

Please also note that we will discuss certain non-GAAP financial results. Our non-GAAP results and reconciliations of non-GAAP to the most comparable GAAP measures can be found in our financial results press release on our website. This information we are providing represents our views of the matters discussed as of today May 6, 2014. Except to the extent we have a duty to update, we do not expect to update our guidance even if circumstances change.

Before I turn the call over to Mark, I would like to note that management will present at the JP Morgan Conference in Boston on May 19, 2014. We hope to see many of you there.

With that, I will now turn the call over to Mark Floyd.

Mark Floyd

Thank you, Maria, and thank you all for joining us. Before we get into the specifics of the quarter, I would like to welcome Jeff Ross, our new CFO to the Cyan team.

Jeff brings to Cyan over 25 years of financial leadership, including CFO positions at Velti and Sybase. He's a strong addition to our management team, and we look forward to his contributions, as we execute against our strategic growth initiatives.

Turning to our first quarter, we delivered $19 million in revenue, above our $16 million to $18 million guidance. International revenue grew 22% sequentially.

We are pleased with customer diversification we saw in the quarter. We had four 10% or greater customers, representing the U.S., Europe, Asia, and the Web 2.0 markets. The Windstream revenue for the quarter was modest and represented less than 10% of revenue.

We continue to make solid progress on our Tier 1 carrier initiatives. We are in trials with four Tier 1 carriers, focused on SDN and NFV functionality of our Blue Planet platform. In two of these trials, we passed important milestones and advanced to the next stage of evaluation.

We believe that vendor selection announcements for major SDN and NFV initiatives will start to happen this year. If we were selected, we would not expect significant revenue from these initiatives this year.

Our Blue Planet SDN and NFV software platform continue to gain industry attention in the quarter. In March, Blue Planet won the NetEvents Innovation award for the best NFV solutions for carriers. This marks Blue Planet's third award since December, which we believe is indicative of the industries continued recognition of our leadership in this rapidly developing space.

Also during the quarter, ETSI, the standards body facilitating the rapidly increasing interest in NFV and network virtualization approved two parts, in which Cyan's Blue Planet SDN platform is the orchestration system. An approved ETSI PoC must be sponsored by an ETSI service provider member. Cyan was able to demonstrate one of these PoCs in the first quarter.

Specifically, at Mobile World Congress, we collaborated with Intel, Red Hat and Connectem to demonstrate an open multi-vendor NFV infrastructure. In just 15 minutes, our Blue Planet orchestrated the network and virtual resources needed to turn on a virtual evolved packet core in a data center.

The legacy approach is normally lengthy and very expensive. Telefónica and Sprint sponsored this demonstration, which was hosted by Intel.

In February, we further extended our market leadership with enhancements to our product portfolio. First, we added new service automation features to our Blue Planet platform. The highlight was the rollout of our new Carrier Ethernet 2.0 API, which multiple customers are already utilizing to automate the provisioning of Ethernet services.

API has provided an open programmability, customer's need to enable SDN platforms like Blue Planet to interoperate with their existing business, operational and provisioning systems. This is the first API Cyan has introduced with more to follow in the quarters ahead.

We also introduced several new important enhancements for our Z-Series Packet-Optical Transport Platform. These advancements focused on how Cyan Z-Series can groom, aggregate and transport 100-gig traffic and feed new 100-gig backbones currently being built by operators around the world, specifically these include a new 96-channel ROADM that allows us to drive up to 10 terabytes of data on a single fiber.

A new 10 gig to a 100 gig muxponder that allows our system to efficiently aggregate and groom traffic into a 100 gig waves and most significantly, a first of its kind, a 100 Gig-E packet optical switching module. Other 100 Gig-E solutions on the market only transport Ethernet services. Our 100 Gig-E module natively supports packet services and provides a unique and more cost effective alternative to incumbent routing and switching solutions.

Just the first of the year, the industry and market has picked up momentum and dialogue has changed. Industry leaders are no longer asking whether the transition to software-controlled networks and NFV might happen in wide area networks. Instead discussion to shift it to WAN networks will be transformed with many industry leaders having acknowledged that the conventional hardware defined approach to carry infrastructure is too complex, expensive, static and hinders their ability to introduce new revenue generating services.

While you were at Mobile World Congress in Barcelona or the Open Networking Summit in Santa Clara, the message from network operators is clear. They want open and extendable networks, software functionality that is separate from hardware, the ability to mange and provision their network assets globally with software, the ability to integrate program and write the business operational and other support systems. Importantly, they plan on using new innovative partners and NFV and SDN technologies to help deliver this functionality.

These customer impairments are addressed by our Blue Planet platform. Being first-to-market has given us the opportunity to actively engage with network operators, help create and fine tune the most important first-use cases, and learn valuable insights on how these systems need to perform and operate.

This knowledge is allowing us to deepen our customer relationships. We're helping a number with activities designed to drive revenue and monetize their investment in Cyan. These programs are establishing Cyan as more of a partner than just a vendor. We think this approach will help our customers expand their markets and revenue opportunities and create pull-through for our hardware and software platforms.

We are aggressively advocating the value position of Blue Planet around the world through customer deployments, trials and PoCs. Ultimately, we believe Cyan has a unique first-mover advantage in helping customers orchestrate both network and virtualized resources across multi-domain and multi-vendor networks.

With that I would like to turn the call over to Jeff who will walk you through our financial performance.

Jeffrey Ross

Thanks, Mark, and good afternoon to everybody on the line. First, let me say that I am very pleased to be part of the Cyan team. I believe that this is an exciting time for the company and the industry. And I am looking forward to the journey as we strive to capitalize on the market opportunities at hand and to grow our business.

With the exception of revenues, the financial results and guidance we will discuss today are all non-GAAP. Our GAAP and non-GAAP results as well as non-GAAP to GAAP reconciliations are included in today's press release.

In the first quarter, we achieved revenue of $19 million, above the guidance we provided in February. This compares with $20.9 million in the fourth quarter of 2013 and $26.3 million in the first quarter of 2013.

International revenue in the first quarter grew to $4.2 million or 22% of total revenue. This was up 22% when compared with the fourth quarter of 2013 and up considerably when compared with the $263,000 of international revenue reported in the first quarter of 2013.

For the first quarter, gross margin was 39.3% compared with 41.6% for the same period last period and 40.7% for the fourth quarter of 2013. ASPs were within our historical range. The downward pressure on our gross margin was primarily attributable to the overall smaller revenue scale, which resulted in a higher percentage impact from a relatively consistent manufacturing overhead cost.

First quarter R&D expense was $8.6 million. G&A expense was $3.8 million and sales and marketing expense was $10.2 million. This compares with fourth quarter 2013 expense of $7.3 million for R&D, $2.4 million for G&A and $10.1 million for sales and marketing. In the fourth quarter each of these expense categories included accrual benefit related to incentive compensation.

In the first quarter of 2014, growth in incentive compensation accrual benefit, we incurred a normal expense accrual. The swing from benefit to expense is the primary reason for the subsquential increase in our operating expenses. At this time, we believe that the overall operating expense level we saw in Q1 is fairly representative of our near-term run rate.

The net loss for the first quarter was $15.3 million or $0.33 per share based on $46.6 million weighted average shares outstanding. This compares with a net loss of $11.5 million or $0.25 per share in the fourth quarter of 2013.

Moving on to the balance sheet and cash flow. At March 31, 2014, our cash, cash equivalents and marketable securities totaled $46.8 million, a decrease of $17.3 million from our December 31 balance. In the quarter ended March 31, 2014, cash used in operations was $15 million. Cash used in the quarter was much higher than anticipated because of a larger than expected percentage of Q1's transactions closed late in the quarter, giving us a limited ability to collect Q1 receivables within the quarter.

Additionally, we experienced a lower utilization of our inventory than expected. Cash management is a key priority for us. Balancing the funding needs of our business to pursue significant growth opportunities against the need to maintain a sufficient runway for the company is one of my primary focus areas.

We expect cash used to be significantly lower in the second quarter than it was in the first. And with our current view at the business, we believe that we have enough cash to support our operations for at least the next 12 months.

If things developed differently than we currently anticipate, we have a number of options available to mitigate the situation. We will be monitoring our liquidity closely and we'll be prepared to take action, when and if doing so would be appropriate.

We ended the quarter with $19.2 million in inventory, a decrease of $1.5 million from December 31. Inventory turns decreased to 2.3 from 2.7 in the fourth quarter, due to lower revenue level.

Deferred revenue was $16.3 million at March 31, down from $19.1 million at December 31. Deferred revenue consists primarily of shipped and built hardware, awaiting customer acceptance. The remaining consists of software along with support and maintenance revenue that is generally recognized ratably over the related contractual period.

And with that, I would like to turn the call back to Mark for a look at our guidance.

Mark Floyd

Thank you, Jeff. We're excited about the market opportunities we see ahead, as more and more network operators look to new and innovative technologies to help them migrate from hardware controlled networks to software controlled networks. While we are very encouraged with the direction the market is moving, we are still in the early stages of this transition and it will take some time.

We are currently estimating our second quarter 2014 revenue to be between $21 million and $23 million. We expect non-GAAP net loss of $13 million to $15 million, and the net loss per share to range from $0.28 to $0.32. On a GAAP basis, we expect net loss of $16 million to $18 million, and the net loss per share to range from $0.33 to $0.37.

With that, I will turn it over to the operator to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Scott Thompson with FBR Capital Markets.

Scott Thompson - FBR Capital Markets

If we could, let's get a quick update on some of the larger customers. There is Windstream out there, they seems to be rolling out or has plans to rollout in Boston, Cleveland, New York, Chicago maybe in late '14. Can you give us an update on how well you're positioned there, not only near-term, but longer-term? And then an update on Colt expanding in the Ireland, Netherlands, Spain; and Asia-Pac revenues materializing around Colt or its partners?

Mark Floyd

So Windstream, basically, we see Windstream as they continue to build out their network, and we are in great relationship with these guys. We worked with them on engineering their new project, especially where we're sitting-in in the Metro. And we hope that the business will continue to grow and come back. But from our perspective, they are great customer of ours and we expect them to be a great customer in the future plans.

So as far as Colt, as you know, what I think is probably the first carrier that's actually rolling out our software controlled network, and we've got a great relationship with those guys. We continue to do business with them and we are rolling out across Europe with Colt.

And one of their affiliates KVH, which there is a press release this morning that went out by KVH about them building out their network based on Cyan's, not only our hardware, but also our Blue Planet as well. So those customers right there, we feel pretty good about. And have a good working relationship with that.

Scott Thompson - FBR Capital Markets

So it sounds like Colt is likely to be the most likely first half large contributor. Windstream is building out in the second half in these new cities. So should we expect a ramp in second half from Wind? The other thing I wanted to ask was Infinera made an announcement that Windstream had chosen them for 100 gig backbone. Is that going to impact the timing of any of your revenues or are you mostly focused metro at Windstream?

Mark Floyd

That's a great question, Scott. Yes, I believe, Windstream is building out their backbone based on Infinera, which is the long-haul piece, which we don't participate in, but what happens is that now you got to feed that backbone. And so you've got to build out your metro and you got to move upgrade your metro from 1 gig to 10, to 10 to a 100, and that's what we said. So from a sequence view point, you build out your backbone rings first, and then you start building your metros, as you rollout services too, as you get success base with your customers rolling out services. But I think you have a right on about the timing.

Operator

Our next question comes from the line of Rod Hall with JPMorgan.

Ashwin Kesireddy - JPMorgan

This is Ashwin on behalf of Rod. My first question, I think is on deferred revenue. It was down in the quarter. Can you walk us through some of the drivers there? Also on the service provider trials, I think you mentioned two of this trials passed important milestones. Can you give us more color around exactly what's going on with these trials and when could we probably expect some wins?

Michael Hatfield

I'll take the latter part of the question first. Yes, when you think about the trials, we've been in four and we're making progress. And each carrier does a trial differently. So it's not ubiquitous across all the different carriers. I do know that in the two that we talked about, both of these have made decisions to go over some hurdles and they start eliminating other vendors as time goes on.

And so we've made progress in two of them that we've crossed these milestones. Now, with that said, there is no guarantee we're going to win the business, but what's good about it is that we're making progress in the Tier 1. So that's what the indicative there is. And I'll turn it over to Jeff for the second part of the question?

Jeffrey Ross

So on deferred revenue, not anything terribly unusual. The amount that deferred revenue went down by was similar to the pattern seen between, say Q2 and Q3 of last year. So the primary component of deferred revenue that is coming down is amounts for which we were awaiting customer acceptance. And we received certain customer acceptances this quarter and so deferred revenue went down accordingly. We would expect that over the next few quarters, similar acceptances will be received and deferred revenue will come down accordingly.

Ashwin Kesireddy - JPMorgan

If I could follow-up, Mark, on the two trials again. So just to make sure I have understand that clearly, were there like four vendors in these trials and two off them are eliminated and now operators is left to chose between two suppliers. Is that the sort of milestone we are talking about here? And also what was book-to-bill during the quarter?

Mark Floyd

So the first part of your question is that, I can't comment on exactly how many vendors they've looked at. I mean I don't know. It's just a process that they all go through. I think what they do is they quantify a group of companies that have technologies, that they think they want to use going forward. And then they start doing lab trials and tests, and then they start moving them into more significant tests, putting more resources behind it, but I couldn't tell you how many, of which and such, and they are all different, like I mentioned.

Ashwin Kesireddy - JPMorgan

Anything on the book-to-bill?

Mark Floyd

It stayed pretty well the same. It's a measure we don't comment on. We've never put it out there, but it's relatively stable, has been for the last couple of quarters.

Jeffrey Ross

Yes, there was nothing unusual in the quarter in that regard.

Operator

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

Simona Jankowski - Goldman Sachs

I just wanted to clarify first, if you expect Windstream to be a 10% customer at some point again this year? And then on the Web 2.0 customer you mentioned, who is now 10% of revenues, I think that for the first time that they have broken through that 10% market. So if you can just confirm that? But also just comment a little bit on the opportunity there. Is that a kind of one quarter deal or is that something that you think maybe more sustainable or even build over time? And then any other potential, other with 2.0 opportunities behind that?

Mark Floyd

As far as Windstream, it's our anticipation that they would be greater than 10% customer. But we're going to wait and see as they turn back on, and when that happens, it will happen, and we'll be where we need to be with them. But the expectation is yes. Now, as far as Web 2.0 customer, you're correct. This is the first time they broke 10% of revenue. And we expect them to continue to be a very strong customer throughout 2014 for us.

Jeffrey Ross

And the further on that, they have been a customer in past quarters. This is the first time that they crossed that threshold, but this is a number of follow-on purchases from that customer.

Simona Jankowski - Goldman Sachs

So it sounds like you think they might be in that 10% or better mark for most of this -- for most, if not all of this year?

Mark Floyd

Its quarter-by-quarter, but I do -- we have visibility into their build-outs and what they want to do. And I just think that they'll be a good customer this year for us.

Simona Jankowski - Goldman Sachs

And can you just update us on that pipeline. Are there others you're still pursuing in that category of Web 2.0 customers?

Mark Floyd

Yes, there is.

Jeffrey Ross

And Simona, the interesting thing in that realm is that we're starting to see some interesting network architectures come about in this. A lot of these web guys are now getting into the network business and getting into bring their fiber in or certainly leasing fiber and then writing it up. And in that context, they're beginning to looking at places where they are much more tightly coupling the data centers.

So what would have been a situation, where they would have gone up through the routing network and back between data centers and now interlocking the data centers all the ways down to the top of racks side, which means there's more capacity required between these data centers. And so it's an interesting development that we spent quite a bit of time within that realm that we certainly benefit from that metro configuration.

Simona Jankowski - Goldman Sachs

And then just my last question. Can you give us some insight into who you've been competing with as far as you know at those four Tier 1 carrier trials. Then I think obviously one of them we know about which is AT&T going with Tail. As I assume you've seen them in some of the others, but who else are you seeing as you go out with Blue Planet for these trials?

Mark Floyd

It's the usual companies. The thing is that from a broader platform, there is no one else out there that has a broader platform orchestration platform than Blue Planet. But what we're seeing is we're competing against companies that have a vertically integrated SDN controller with their own hardware. And so I am not sure how viable that is in the long-term, but from our perspective, there is a lot of companies that claim they have different SDN capabilities. And we'll just kind of see what they think. Mike, you got any?

Michael Hatfield

No, I think that covers it.

Operator

Our next question is a follow-up question from the line of Scott Thompson with FBR Capital Markets.

Scott Thompson - FBR Capital Markets

A follow-up on the software revenues. We had talked potentially about those revenues becoming significant by the end of the year. Is it likely that that will be pushed out as a result of the Tier 1 push? And is it possible to separate the software from the hardware product yet. Can you expand on that a little bit and when we might expect those to be sold independently and maybe have a positive impact on margins as a result?

Mark Floyd

We do sell the Blue Planet independent of our Z-Series. And we've been doing that for a while. I think you're going to see, as Wind, their software crosses a 10% threshold on an annual basis and continues to grow, I think that that's dependent on how well we execute within our customer base quite candidly. And so we are not putting any kind of forecast out there separating hardware and software at this point. But when we do get to an annual run rate when it's greater than 10%, we'll break it out. But at this point in time, we are not putting a projection out there.

Operator

And there are no further questions in the queue. At this time, ladies and gentlemen, that does conclude the Cyan Inc.'s first quarter 2014 earnings conference call. We thank you for your participation today. And you may now disconnect.

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