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Cyan, Inc. (NYSE:CYNI)

Q2 2014 Earnings Conference Call

August 11, 2014 5:00 PM ET

Executives

Maria Riley - IR

Mark Floyd - Chairman and CEO

Jeff Ross - CFO

Michael Hatfield - President and Co-Founder

Analysts

George Notter - Jefferies & Company

Simona Jankowski - Goldman Sachs

Ashwin Kesireddy - JPMorgan

Operator

Good day everyone and welcome to the Cyan Incorporated Second Quarter 2014 Financial Results Conference Call. Today’s conference is being recorded.

I would now like to turn the conference over to Maria Riley with Investor Relations. Please go ahead.

Maria Riley

Thank you and thank you everybody for joining us today for Cyan's second quarter 2014 financial results conference call. I am joined by Mark Floyd, Cyan's Chief Executive Officer; Jeff Ross, 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 second quarter ended June 30, 2014. If you would like the copy of today's press release, you may access it online at the Company's Web site, 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’s demand for our products, futures cash requirements and resources and other matters.

Forward-looking statements include those in which we use the terms believe, anticipate, expect, target, among other words. 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-Q that was filed for the quarter ended March 31, 2014. 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 GAAP results and reconciliation of non-GAAP to the most comparable GAAP measures can be found in our financial results press release on our Web site. The information we are providing represents our views of the matters discussed as of today August 11, 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 Floyd, I would like to note that management will attend the Jefferies Conference in Chicago on August 27, 2014. We hope to see many of you there.

I will now turn the call over to Mark Floyd. Mark?

Mark Floyd

Thank you, Maria, and thank you all for joining us. Today we reported that we delivered $24.4 million of revenue above our guidance of $21 million to $23 million. Revenue from Windstream came in above our expectations and increased to $6.7 million or 28% of revenue as we continue to help fulfill their next generation network requirements. While we expect their buying patterns to fluctuate from quarter-to-quarter, our partnership with Windstream remains strong and we continue to be very involved in the design and implementation of their metro network and metro Ethernet services.

Our top-line results were also driven by international revenue which was up 15% over the first quarter largely as a result of increased momentum in Asia particularly in Japan and Korea. We believe this bodes well for continued international revenue growth. In the North American carrier market, excluding Windstream, we did continue to see some softness, especially among Tier 3s, to obtain partner CapEx spend through federal funding. This funding is likely to pick up again in early 2015 through the second installment of U.S. Government’s Connect America program.

During the quarter, we remained focused on our key objectives. We launched a significant new application to the Blue Planet platform and we announced several new customer and partner collaborations. I am pleased with the team’s execution and momentum we see in the market. More specifically, we added two new partners to the Blue Orbit ecosystem, Certes, a leader in multi-layer encryption solutions for high performance networks, and Fortinet, a global leader in the high performance network security. In collaboration with these two new partners and existing Blue Orbit partner RAD we demonstrate the ability to deploy virtualized software functions in the distributed NFV architecture. In this HC Park sponsored by CenturyLink we showcase Blue Planet’s ability to provision the network and turn on value-added revenue generating functions like firewall and encryption.

We also announced our SDN services automation work with NTT which includes the development of an open API designed to drive rapid provisioning of optical wave services. This API allows NTT’s existing OSS provisioning tools to interact with Cyan’s Blue Planet software to facilitate rapid and automated provisioning across NTT Com’s global IP network.

On the product front, after a year of trials customer products and development, Cyan launched the latest Blue Planet application Planet Orchestrate. Planet Orchestrate is the industry’s first multi-vendor and multi-domain application that integrates cloud services and NFV orchestration with the WAN. By combining the power of the WAN service creation and automation with orchestration of virtual resources, Planet Orchestrate enables network operators to deliver new revenue generating services on both physical and virtual infrastructure quickly and at a lower cost. Planet Orchestrate is an important addition to the suite of Blue Planet applications. Deployed in production networks around the world, Blue Planet can help customers design inventory, manage, visualize, automate and orchestrate networks all from one interface. This clearly differentiated from the simple utilities and tools offered by most players in this market. We are happy to note that we have already tuned up Planet Orchestrate in labs of the global Tier 1 operator for testing and the initial results are positive. Being the first to market with a carrier focused SDN platform has given us a tremendous opportunity to actively engage with network operators to help them define the first used cases and assure that Blue Planet platform is tailored to meeting real world requirements.

As an example, in May we announced a new collaboration with Telefónica and Red Hat to develop a deterministic NFV architecture. Utilizing Red Hat’s OpenStack platform and Cyan’s Blue Planet, Telefónica is looking to orchestrate the placement of virtual functions within a predefined server infrastructure, a requirement that is critical on developing projectable performance of NFV functions within a telco datacenter. Our efforts are also resulting in numerous industry awards. While industry accolades are important, we are most proud when our technology produces recognizable results for our customers.

In this light we are pleased that in May Colt's carrier modular multiservice platform powered by Cyan’s Blue Planet and Z-Series platforms won global telecom’s business fixed network infrastructure innovation award. In June, Colt’s MMSP won Light Reading’s most innovative Ethernet optical service award. Finally, as reported last quarter, our engineering team swiftly upgraded a Z-Series optical capabilities, especially around 100 gigs and the metro. Because we follow an open systems model, our team was able to productize capabilities that exceeded many of our competitors in a short period of time, resulting in a number of recent optical wins.

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

Jeff Ross

Thanks, Mark and good afternoon to everybody on the line. With the exception of revenue, 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 second quarter we achieved revenue of 24.4 million, up 28% over the prior quarter and above the guidance we provided in May of 21 million to 23 million. The upside in our revenue was largely attributable to greater than expected revenue from Windstream. Revenue from Windstream in the quarter totaled $6.7 million.

International revenue in the second quarter grew to 4.8 million or 20% of total revenue. This was up 15% when compared with the first quarter of 2014 and over three times the amount of international revenue reported in Q2 of the prior year. For the second quarter, we reported gross margins of 42% compared with 43.5% for the same period last year and 39.3% for the first quarter of 2014. Consistent with our expanding footprint within our customer base, the sequential increase in gross margin was primarily attributable to a higher mix of packet line card sales. Our gross margin will continue to fluctuate based on the mix of chassis and line cards sold in any given quarter.

Second quarter operating expenses were relatively in line with our expectations with R&D expenses at 8.6 million, G&A expenses at 3 million and sales and marketing expenses at 10.4 million. We believe that this operating expense level is fairly representative of our near-term run rate. The net loss for the second quarter was 11.9 million or $0.25 per share based on 46.9 million weighted average shares outstanding. This compared with a net loss of 15.3 million or $0.33 per share in the first quarter of 2014.

Moving on to the balance sheet and cash flow, at June 30, 2014 our cash, cash equivalents and marketable securities totaled 38.1 million. A decrease of 8.1 million from our March 31st balance. As expected, deferred revenue which primarily consists of shift and build hardware of winning customer acceptance decreased in the quarter. Deferred revenue was 12.1 million at June 30 compared with 16.3 million at March 31st. In the quarter, cash used in operations was 7.2 million, less than half the cash utilized in operations last quarter. We were pleased with our ability to deploy existing inventory to fulfill customer orders in the quarter which was the most significant contributor to our second quarter’s improved cash flow.

We ended the quarter with 13.1 million in inventory a decrease of 6.1 million from March 31st. Inventory turns increased to 3.5 to 2.3 in the first quarter. We believe our inventory levels are now more normalized and as a result we expect a more modest contribution to cash flows from inventory reductions. Overall, we anticipate cash used in operations to increase in the third quarter compared to the second quarter but be well below the level of Q1.

Moving to our Q3 outlook, we expect international revenue to grow as we continue to leverage the investments we made in 2013 to expand our international sales activities. In the U.S., while the Tier 3 market continues to be soft, we are beginning to see traction in the Tier 2 space on the back of recent enhancements we’ve made to the Z-Series platform specifically around the 100 gig. Balancing these factors we are currently estimating our third quarter revenue to be between 25 million and 27 million. We expect non-GAAP net loss of 11.0 million to 13.0 million, and the net loss per share to range from $0.23 to $0.27. On a GAAP basis, we expect net loss of 13.5 million to 15.5 million and the net loss per share of a range from $0.29 to $0.33.

And with that I will turn it back over to Mark. Mark?

Mark Floyd

Thanks Jeff. Before we open up the call for questions, I’d like to share with you a few recent events that will help provide some visibility into our midterm prospects; first, with a major global network equipment vendor, we have demonstrated our Blue Planet platform automating, managing and orchestrating several of their market leading hardware systems. This capability allows us to turn up Ethernet services in minutes versus weeks or months, creating a significant opportunity for Cyan since its vendor has deployed in the majority of networks around the world; second, we’re entering a lab of another large Web 2.0 Internet company. The application takes advantage of our Z-Series open system approach along with Blue Planet Orchestration to scale and manage the expediential growth of their network. We believe this application is something every major Web 2.0 company should evaluate; third, we have received a 10 plus million dollar order from a major customer that we expect to convert in revenue in the first quarter of 2015. This order represents new opportunity within existing account and it’s one of the largest orders we have received. We believe this serves as a good indication of this customer’s belief in our industry leading 100 gig packet optical technology; finally, as mentioned earlier, we have entered a Tier 1 lab with our newly released Planet Orchestrate, which is an initial validation of our newest application. Altogether, our solutions are now in fixed Tier 1 labs for trials.

These examples of recent traction reinforce our confidence ion Cyan’s future and demonstrate our continued execution.

With that we’ll open up for questions, operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And first we will go to George Notter with Jefferies.

George Notter - Jefferies & Company

Thanks very much guys. I wanted to ask about your perspective on the marketplace for orchestration systems. You guys obviously were very early movers with Blue Planet but you’ve got other alternatives out there in the marketplace OpenStack, CloudStack are certainly potentially applicable to service provider environments. And you mentioned the collaboration with Red Hat on OpenStack. And I guess I am trying to really understand where you guys fit in relative to some of those developments going on in the marketplace and how you see kind of Blue Planet progressing in that environment? Thanks.

Mike Hatfield

George, this is Mike. So, what you see in some of the dynamics going on as you got the OpenStack, which is really all the way down at the virtual machine level. What we’re doing is orchestration on top of that. So, OpenStack is actually complementary to us that is why this partnership that we announced with Red Hat, is so significant. What that, and to give you some insight on to what that is. When you go in and just deploy a virtual machine anywhere in a compute infrastructure you don’t really control the performance and as a lot of these things begin to virtualize they were fairly complex, they need specific types of horsepower in the compute infrastructure and so this deterministic placement that we’re doing is a complement of Red Hat and what they are doing on OpenStack and the ability to say for a particular virtual function it needs this kind of capability we can direct it by knowing what’s happening all the way down to compute level. So that’s where that piece comes together.

In terms of just a general orchestration that’s happening what we’re seeing is that there really aren’t very many players doing what we’re doing. We continue to get that reconfirmation as we reach out and work with our customers that we really have a leadership position in this and that that should see us turning up that in the Tier 1 lab this just recently.

George Notter - Jefferies & Company

Got it. And then can you give us the metrics on Blue Planet right now in terms of number of customers you’ve deployed it with. And I’d also love to get a sense for how many customers have adopted Blue Planet without underlying Z-Series hardware from you guys?

Mark Floyd

George, this is Mark. We have, I think 141 customers turn up on Blue Planet right now and we haven’t broken out the software revenue only in what we have stated when it gets more than 10% of revenue on an annual basis we will break it out. And so we are getting close, so I think we are good on the progress and along with what Mike said about the orchestration layers, what we are seeing is that. If you look at some of these carriers, they are looking for this orchestration features and the vertically integrated equipment guys just don’t have it that supports third-party hardware. And so we are seeing that as the market we identified long time ago and the carriers are asking for just more software controlled network and I think it’s playing into our strategy and quite frankly we feel pretty good about it.

Jeff Ross

The other thing, I would add George is that, in terms of customers who are using Blue Planet that don’t have the Z-Series that continue to expand as Mark talked about pretty significant enhancement to our offering for non-Cyan hardware that we have just done with a major equipment supplier. So, we will continue to see that expand as a footprint of applicable devices grows inside of Blue Planet.

George Notter - Jefferies & Company

And then last thing I also wanted to ask about just timing, I know in the past you have talked about, how long it takes operators to evaluate and deploy and really commercialize these kinds of systems. Can you talk about your perceptions of what’s going on in the marketplace right now on that front?

Mark Floyd

George, we have said it all along which was interesting last couple of quarters of 2014 would be a time where you are going to see a lot of trials and like I said we are in six now Tier 1s and we have several other opportunities behind that. The things that we are seeing now is we are seeing RFPs becoming, to us right now RFI and RFPs we have actually helped participate and write some of these which I think is fascinating. And I think the decisions will be made on the second half of this year and I think you are going to see deployments in 2015 if we are successful in winning these RFPs. But from a carrier view point and it’s on a global basis, it’s not just U.S. centric, we are seeing the RFPs and that the carriers were very serious about this and we think it’s a 2015 revenue event but I think most of the decisions made this year.

Operator

Moving onto Simona Jankowski with Goldman Sachs.

Simona Jankowski - Goldman Sachs

Hi, thank you. I just wanted to start with the 10 million order you mentioned, is that mostly for your 100 gig products and also what is the mix within that of hardware and software?

Mark Floyd

That’s right it’s for our Z-Series platform with our 100 gig capability and we saw this complete system and so in that order the software is not broken out, so it’s complete system in that and we will be able to take that to revenue in the first quarter of ’15 and it’s pretty exciting. It’s one of our largest orders we have ever received and when we get little bit further in we can tell you about the application, I think it’s something that we can replicate elsewhere in a lot of carriers market but we feel pretty good about that.

Simona Jankowski - Goldman Sachs

And it includes both packet and optical?

Mark Floyd

Yes.

Simona Jankowski - Goldman Sachs

Great and it doesn’t sound like it includes Blue Planet, is that right?

Mark Floyd

It does, Blue Planet is a piece of it but most of the revenue comes with a Z-Series.

Simona Jankowski - Goldman Sachs

Sure and more broadly, can you comment on what part of the business is now 100 gig versus 10 gig and how do the margins compare?

Mike Hatfield

Simona, this is Mike. What we are seeing is a pretty significant improvement towards the 100 gig, so that’s been pretty exciting to see because we have put a lot of our development attention towards that. And as Mark said in his comments, the approach that we have taken on the 100 gig has given us some pretty good flexibility in terms of bringing the latest and greatest 100 gig into the solution set. So, we have had a number of pretty significant bake offs recently where we have beaten sort of usual suspects on that and so this movement towards the 100 gig is happening quite rapidly. 10 gig still is predominant out there right now but 100 gig has made a big jump in this last quarter.

Simona Jankowski - Goldman Sachs

And Mike, how should we think about any margin implications from that, is 100 gig neutral, accretive, dilutive to your overall margin profile?

Jeff Ross

This is Jeff, so at this point it’s pretty neutral to our margin profile as the technology matures a little bit and as the supply sources mature a little bit we may expect the ability to enjoy slightly higher margins but probably nothing hugely different.

Mark Floyd

One other thing to add to that is that when we have a couple of new customers who just want a 100 gig, so we are shipping on the chassis as well and so chassis don’t carry as much margin obviously as line cards do. So, I think Jeff has accredited it’s neutral to accretive in our installed base and it’s a little bit lower than a normal margins with new customers and new deployment chassis.

Simona Jankowski - Goldman Sachs

And we kind of imply that logic to that 10 million in Q1, would be we expect that to be a bit of a lower margin just given the size of the deal and I am assuming it’s a lot of chassis in there?

Mark Floyd

No not really, not really we feel pretty good about that.

Simona Jankowski - Goldman Sachs

Okay. And then just lastly kind of back to the orchestration discussion from the prior question, what does Cisco’s acquisition of Tail-f means to you guys and have your conversations with customers or partners changed since then?

Mark Floyd

So, I think there is two things about the acquisition of Tail-f, one is I think it’s a good indicator of what’s happening in the industry and how significant some of these movements are to see Cisco jump in that way. What I would say though is from a marketplace perspective the customers have been largely negative around it because they’re not sure how Cisco is going to use it and when they actually use it to be open in the way that Tail-f was positioning when they’re an independent company or whether they will be restrictive with that. So I think there is -- it's caused some significant concern within the customer base about what actually happens with that and that’s been doing that benefit for us. So we’ve had interesting discussions based on concerns around what Cisco is going to do with that asset.

Simona Jankowski - Goldman Sachs

Interesting, thank you.

Operator

Next we’ll go to Rod Hall with JPMorgan.

Ashwin Kesireddy - JPMorgan

This is Ashwin on behalf of Rod. Thanks for taking my question, with regard to your comment on Tier 2 and 3 activity picking up in early 2015, I was wondering what gives you see the confidence that is probably the case is there something specific you could point us to that helped you with the visibility? Also I wanted to ask about the $10 million deal can you elaborate on some risks that could pull the deal forward or push it like any factor that we should be thinking about in terms of recognition of the deal?

Mark Floyd

That’s a good question I’ll answer the second first. No, it’s going to be -- will be in the first quarter and we feel pretty confident with that. So it’s not kind of we don’t see it coming forward or pushing out at this point in time. As far as the Tier 2s and Tier 3s, as Jeff said, we expect the Tier 2 to start picking up in second half of this year and the Tier 3s the Connect America fund the second one it’s a $9 billion fund it’s over a five year period and we think that’s going to be a major push for the Tier 3 guys who rely on outside capital to build their network.

And it’s very positioned for rural areas and they’re trying to get the speeds up from 5 to 6 megabits now over 10 megabits and going to 24. So it’s a combination of a longer period of time and I think that once the thing has worked out and starts rolling you’re going to see the Tier 3s take advantage of that because we have pent up demand for our products with our Tier 3 customers but some of them just don’t have the access to the capital until the fund gets relative easy to draw down from.

Ashwin Kesireddy - JPMorgan

Okay. One more clarification question really, I think you mentioned that you are expecting international revenues to grow in Q3. Is that as a percentage of revenue or on an absolute basis? And again on both valid as you mid out the percentage of revenue on an absolute basis it looks like your U.S. revenues are going to sort of deteriorate on year-over-year base in Q3. Is that like a fair assumption?

Mark Floyd

I wouldn’t call that fair assumption I think one of the things that on an international front probably the better way of stating that I might have said it little bit wrong in the better way saying is we think our third quarter bookings is going to increase over 2Q and that would be one of the largest bookings quarter ever in the international market and how that converts to revenue we just got to go through the revenue recognition process with that. Jeff you’re going to?

Jeff Ross

No, I mean the other thing is moderate it was a pretty strong quarter from Windstream and we expect it to be a little lumpy going forward and we’ve got definitely in the account and continue to do significant business with them but we’re modeling them slightly down from Q2 to Q3, which accounts for some of the mathematical maturations that you’re pointing out.

Ashwin Kesireddy - JPMorgan

Okay, thanks guys.

Operator

(Operator Instructions) And we do not have any further questions I will now turn the conference back over to Mark Floyd for any additional or closing remarks.

Mark Floyd

Thank you very much and thank you all for listening. I think we had a very positive quarter and we’ll continue to work hard on this end and hopefully be back next quarter with another good one. So we’ll talk to you then. Take care.

Operator

Once again, this does conclude today’s conference. We do thank you all for your participation.

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Source: Cyan's (CYNI) CEO Mark Floyd on Q2 2014 Results - Earnings Call Transcript

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