Michael Brown, Chairman and CEO, Quantum

"The reaction from Wall Street, any time you preannounce, is terrible. But we think it's exaggerated."

July 17, 2002

19 Min Read
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Quantum Corp. (NYSE: DSS) has made a few graceless stumbles in the first half of the year. Some of those missteps have to do with the current slowdown in IT spending, but Quantum's main problem has been botched forecasting: For the past two quarters, the company has warned that it will miss its projected quarterly revenues (see Quantum Sees Huge Miss, Cuts Staff and Quantum Sees Another Bad Quarter).

Michael Brown, Quantum's chairman and CEO, says these shortfalls are hiccups in an otherwise solid business. For the first three months of the year, Quantum posted revenues of $242.6 million and a net loss of $21.2 million -- sales that were lower than expected because it was coming off an unusual spike in media sales in the last quarter of 2001, according to Brown. The quarter that ended June 30, meanwhile, was off because of a forecasting error by a key OEM partner, he says.

"The reaction from Wall Street, any time you preannounce, is terrible," he says. "But we think it's exaggerated. Nothing changed fundamentally in the business. Nothing changed in terms of product lines."

But investors don't like surprises, and Wall Street's faith in the company has been rattled. Quantum's stock price has dropped from $8 at the beginning of April 2002 to close at $3.85 today. A quantum leap downward, so to speak: The company has lost half its value in about three months. Yowch.

Now Quantum is trying to dig itself out of the hole, and a big part of its rebound strategy is to increase sales of its networked storage products and services. In other words, it's looking to expand its lines of business not related to tape drives or media.Of course, Quantum today is predominantly a tape drive and media supplier. For the year ended March 31, 2002, tape drives and media accounted for about $800 million out of Quantum's $1.1 billion in revenues. By 2005, Brown says he wants half of the company's revenues to come from disk-based backup systems, NAS servers, tape automation libraries, and storage support and integration services. Currently, those business lines account for about 27 percent of sales.

It won't get there easily. In the NAS market, it's the leader in terms of volume of units shipped, with more than 100,000 Snap servers sold to date. But it plays at the low end of the market, where the margins are razor-thin, and what's more, Quantum is competing there with none other than (ulp) Microsoft Corp. (Nasdaq: MSFT), whose Windows Server Appliance Kit has been slurping up market share like an underfed hog (see Microsoft's SAK Attack). IBM Corp. (NYSE: IBM) and Dell Computer Corp. (Nasdaq: DELL) are two of the largest vendors shipping NAS systems based on Microsoft's SAK. To play in a NAS segment with better margins, Quantum has introduced the Guardian 14000, a Linux-based NAS system aimed at the midrange market (see Quantum Casts Its Lot With Linux).

The company's also betting that its still-in-beta DX30 -- one of the first disk-based devices purpose-built for online backup -- will become a healthy new business (see Quantum Slips Disks Into Backup). But as executives admit, while there is some strong initial interest, this is a very early-stage category and the DX30 won't be a major source of revenue anytime soon. Finally, Quantum sees potential in ramping its services offerings, a relatively small part of its overall business today at $70 million for the fiscal year ended in March. It remains an open question as to how rapidly the company can expand this side of the house.

Brown, along with Barbara Hoey Nelson, Quantum's EVP of corporate marketing and strategy, recently sat down with Byte and Switch Senior Editor Todd Spangler. Read as they talk about:

Byte and Switch: Your earnings will be lower than you expected for the first quarter of your 2003 fiscal year. Why?Michael Brown: I'm glad you asked. We've said this quarter we're going to have revenue between $200 and $215 million. Earlier we thought it was going to be $230 to $235 million. What happened was, one of our major OEMs was going to take more than one of these tape automation lines. It was new to them. They started to ramp early in the quarter, and they were too optimistic, frankly, in the environment we're seeing there today about the uptake in their channels. Our channel business was actually up, quarter to quarter. Overall, the business is what we expected it to be -- except for that one customer.

Byte and Switch: Which OEM was it?

Brown: We haven't disclosed that, but it involves two different product lines in tape libraries. The reaction from Wall Street, any time you preannounce, is terrible. But we think it's exaggerated. Nothing changed fundamentally in the business. Nothing changed in terms of product lines. It really represents one OEM and a forecast error that's being passed through the system. [Ed. note: Quantum expects to report its earnings for the quarter on July 24.]

Byte and Switch: You also warned you would miss expectations the previous quarter. That was a different issue, right? You said that the sales of media were most of the problem.

Brown: Actually, if you look back over many quarters... We had $98 million in media in the March quarter. That was an all-time high -- except for the previous quarter. So in December we had a huge spike up; it was $119 million, and the previous quarter before that was probably in the low 90s. Then it came back to what would have been a record. This was really related to the introduction of SuperDLT. This was unexpected -- what we were doing at the time was ramping up on SuperDLT media. I can't explain why we might have fluctuations in the number of cartridges that are sold one quarter versus another. Quarter to quarter you could have a revenue swing as much as a $20 million. All the pieces are hard to forecast.Byte and Switch: It's bad news to warn two quarters in a row.

Brown: It sure is.

Byte and Switch: In general, what's business like these days for you?

Brown: IT spending is not where it used to be. We kind of got used to that arrow, where double-digit spending increases were the norm. So now that that's not the case anymore, people are really learning to live with less... We're launching the most aggressive series of products in the company's history. We have five different lines being introduced simultaneously. Our approach has been, let's make sure we're protecting their investment because now they're less interested in experimenting.

Byte and Switch: They might have been willing to do that before?Brown: That was never something that people were excited about. But the idea that they would be able to try completely new models -- storage service providers is an example of that.

Byte and Switch: So much for that [see SSPs: RIP].

Brown: How much difference two years make. When you have a lot of money it's not as big an issue. People say, "Let's buy something new and see how that works."

Barbara Hoey Nelson, Quantum's EVP of corporate marketing and strategy: When the money's tight, you tend to go with what you know. Your older technologies live longer. We see that with DLT -- we thought that would be end-of-lifed six months ago. And it's because people have gone and bought what they've bought for the last seven years.

Byte and Switch: That makes it difficult to introduce new products, doesn't it?Nelson: Unless they're really compelling -- yeah. Or if they're in a market space that's new to us, like the DX30, we're not expecting them to take off quickly. There are other places we're going after that is proven territory in the market, we just haven't been there.

Byte and Switch: What's the status of the DX30 disk backup system?

Brown: The DX30 is probably the most innovative thing we're doing in terms of a brand-new category. We have 40 different customers in beta. One customer is so excited they asked us to ship revenue units this quarter, which we did for them but it's not really generally released yet. It just speaks to how desperate the need is for something to help with the backup problem. A third of the storage dollar is spent on storage backup, and here's a great way to make sure that I can do the backup in the backup window. I can make sure I have a backup, whereas a third of businesses run without a fresh backup copy. They're working with something that's two days old.

Byte and Switch: When will that be shipping?

Nelson: This fall. It will be generally available in October.Byte and Switch: What are the trends that make this possible? Is it basically the dropping cost of IDE drives?

Brown: That's one of them. Another thing is pretty clever packaging. The unit has drives stacked three deep, and it's unbelievable density. It's 3 terabytes in 2U-high box. Nobody else can do this kind of density, because they're doing disk arrays for primary storage. We're the only ones that started with the concept of, let's do a disk array for backup. Ironically, it took a tape company to think about disks packaged for backup. Other disk companies are saying, "Oh yeah, we can do disk-based backup, but please use our standard array and change your procedures."

Byte and Switch: You're talking about Network Appliance Inc.'s [Nasdaq: NTAP] NearStore? [See NetApp's Backup Plan.]

Brown: NetApp is one. They're really saying, "You have to think of a different way to back up. Don't necessarily think you're going to use Veritas Software Corp. [Nasdaq: VRTS] or Legato Systems Inc. [Nasdaq: LGTO]." We're saying you can use those backup packages. The key to this is that we've used our own software to make it look like a tape library. So Veritas doesn't know it's not talking to a tape library.

Byte and Switch: How is the DX30 better than the NetApp product?Brown: NetApp works in a NAS environment. But what if you're not in a NAS environment? This works in a Fibre Channel SAN as well.

Byte and Switch: With that dense design, have you accounted for the fact that someone will restore it all at the same time? It doesn't overheat?

Brown: That's right. The trick is, we don't have all the disks going at the same time. The key for backup and archive, though, is that until you get the data to tape it's not completely secure. With every disk-based system, including ours, EMC Corp.'s [NYSE: EMC], and NetApp's, you're still susceptible when the data's online to a virus or some kind of corruption. So you're not truly not backed up until you get the data offline. That's the hidden fact that people selling disk-based systems don't like to admit. That's the reason why, in the disk-versus-tape debate, they're both going to be used. Tape has a pretty long life in front of it. It's still a lot cheaper than disk.

Byte and Switch: Why is this new SuperDLT 320 drive significant for you? [See Quantum Ships Midrange Tape.]

Brown: In this market, where LTO [Linear Tape Open, a tape technology backed by IBM Corp. (NYSE: IBM), Hewlett-Packard Co. (NYSE: HPQ), and Seagate Technology Inc.] has the jump, we now have something that is 50 percent better. We have a really significant time to market lead. The earliest we hear that LTO will have something competitive will be next calendar year. Before, we were late [behind LTO] and if you look at our resulting market share, we still had 70 percent of the midrange market, according to IDC. That's in a market where we were late. Now, we've got a pretty significant time to market advantage. One of the keys here is that these customers have already started to qualify the product, they started shipping in the June quarter. So we're already on a path to generate momentum that we think is going to pick up in the September quarter.Byte and Switch: How long will tape will live on? Ten years? Fifty years?

Brown: Ha! Well, it would silly to project out 50 years. Any technology that's on the drawing board today would be impossible to commercialize in the next five years.

Byte and Switch: What kinds of technologies?

Byte and Switch: Holographic storage, optical memory, bacteria memory. [Ed. note: "Hey, Frank, did you put the plankton in the backup unit yet?"] It's things that have the cost, the removability, and reliability characteristics of tape. The truth is those ideas have been around for a long time. But commercializing them -- showing that they'd have hundreds of thousands of hours between failures, getting them ready for an HP or an IBM to take and put in their systems -- they're nowhere near that.

Byte and Switch: You don't think magnetic disk is there?Brown: No.

Nelson: Not in terms of cost. It's come down over the years because people have gone from SCSI to ATA. But if you look at ATA and tape over time, it's still going to be 5X to 10X difference [in price] depending on application. ATA is $15 to $25 per gigabyte. Tape is $3 to $5.

Byte and Switch: How's the Guardian 14000 [Quantum's new midrange NAS box] selling?

Brown: It's a bright spot for the quarter for us because we sold out of it.

Byte and Switch: How many units did you sell?Brown: We haven't disclosed that. The quarter isn't even over yet.

Byte and Switch: Is the market comparing this against the high-end SAK boxes or the low-end NetApp box? What's the apples-to-apples comparison?

Nelson: There isn't an apples-and-apples comparison, which is kind of a nice thing. It's kind of between the high end SAK and the low end NetApp. Low-end NetApp is really $70,000 to $100,000. What we've done is taken 80 percent of the NetApp features, we don't have everything -- we don't have all the interfaces -- but we've got kind of the 80 percent for a much cheaper price per megabyte. So you're looking at $25,000 with enterprise-class features and Snap ease of use.

Byte and Switch: Did you at any point consider using Windows SAK on this?

Brown: No.Byte and Switch: Why not?

Nelson: This product is all software. The value proposition in NAS is in the software. Anybody can do the hardware. The R&D group for the Guardian 14000 is all software. There's one hardware guy.

Brown: We've really invested in R&D this year. We're not very popular on Wall Street right now because our earnings reflect the fact we've made all these product investments. [Ed. note: Quantum reported $126.6 million in research and development expenses, 11.6 percent, for its 2002 fiscal year. That was actually a decrease from the prior year, when it spent $130.1 million in R&D.] On the other hand, our financials don't reflect the fact that these will be contributing to revenue and will have some growth potential going forward.

Byte and Switch: Will R&D spending go down?

Brown: I don't know that it's going down. We have enough on the R&D line that I don't think we'll have to scale up.Byte and Switch: Are you looking to expand into other product categories?

Brown: We are looking at other categories. But primarily we're looking at, when you think about solutions, that means you get to add the service component to what's already a reasonable-sized business for us. How do you combine the service and the hardware with additional software capability that makes these products more functional? We've already made software acquisitions -- you wouldn't think of them that way, but when we made the acquisition of Connex [from Western Digital Corp. (NYSE: WDC) in August 2001] what we bought was a Linux development team. It was software to help make this product [the Guardian 14000]. We think about software not as let's get into the packaged software market and compete with Veritas, but let's think about functionality or utility that we can bring to these products.

Byte and Switch: Wouldn't it be easier to have a single NAS operating system?

Nelson: Over time, sure.

Byte and Switch: Is that in the plans?Nelson: We'll keep [the Snap OS] going. But this very low-end space will be commoditized by [Microsoft] SAK.

Brown: The other thing is the Snap OS is already developed. So we may not be taking that further in terms of developing the OS. It's very stable. It does everything you need it to do for that entry-level market.

Byte and Switch: What about your services business?

Brown: It was our fastest-growing business last year even in the face of some revenue decline. It grew 28 percent year over year. It starts with product support, we sell extended warranty and on-site support, and it goes up from there. Customers have increasingly asked us to integrate a storage network they're putting in. One of the little-known facts about Quantum is that we've installed 1,000 SANs as a company at this point, over 200 this year. Why is that? Customers look at us and say, you're going to supply the tape library -- one of the biggest, most expensive pieces going in the SAN -- can you help us with this stuff? We can resell Brocade Communications Systems Inc. (Nasdaq: BRCD) switches and resell Veritas software... It's not our business to resell that but we can offer that if that's what the customer wants.

In terms of people, it's about 120 people. Our whole company right now is about 3,000 people. But it's a fast-growing area and it's much more profitable than our company average, so we want to see this grow.Byte and Switch: What are the margins on your services business?

Brown: We haven't disclosed the exact margins, but our company average margins are 33 percent and the margins in this business are significantly higher. If you think about it, service is something that is unique expertise, so you're not necessarily pricing at the same point you are hardware products.

Byte and Switch: Was the Imation Corp. lawsuit settled to your satisfaction? (See Quantum, Imation Settle Lawsuits).

Brown: Absolutely. If you think about what happened there, here we were battling this out -- it was something they brought against us. They didn't want to pay any royalties on shipping DLT tape cartridges. Of course, we were going to fight that, and we actually won in California court a preliminary injunction, which is very difficult to do in the legal system. So Imation said, "OK, let's see what we can do to settle this." We entered into those discussions, because who wants to keep a legal battle going? We were spending $3 million a quarter on legal expenses. Even though the judge found for us preliminarily, we didn't want to take it all the way to court. So the settlement was, we made a cash payment to them of $5 million. I didn't want to pay $5 million. But that's a lot less than taking to trial 12 months from now. And, they're qualifying their media again with us.

Byte and Switch: You paid them $5 million -- for what?Brown: To settle the lawsuit. To say, "Please come into the model that we've established. Work with us, instead of against us, like the rest of our partners."

Byte and Switch: But if you didn't do anything wrong, why did you pay them?

Brown: Good question. But you asked me, was this to my satisfaction? Yeah, because the alternative is to say, "To hell with you, let's take this to trial, see you in court." And how many more millions would we have spent?

Nelson: It's also an incredible management distraction. Everybody gets deposed. It's not central to your business.

Byte and Switch: Kind of like the Clinton White House, then.Brown: What's like the Clinton White House? Let's be careful! [Laughs] He was distracted by a lot of things.

Byte and Switch: But Imation made some very serious allegations. They were basically calling you a monopoly.

Brown: Does our business look like a monopoly to you?

Nelson: We've got competitors like LTO in the marketplace. And we've got an open standard in media where anyone can qualify -- it's an ANSI [American National Standards Institute (ANSI)] standard.

Brown: Let's look at the companies that have been called monopolies: AT&T, Intel, Microsoft, IBM. Now look at Quantum and our market power. You tell me: Do we look like a monopoly? Really, I think we've boiled this to its essence: The issue was [Imation] wanted to be in the biggest market for computer tape media -- 50 percent of computer media is DLT, and they were not in that market by their own choice. They saw they missed the boat on this market. Then they said, "Gee, how do I make that up in a short period of time. Maybe I can bring a lawsuit." That's what this is about.Byte and Switch: But as you said earlier, you have 70-plus percent market share in the midrange tape drive market. So you do have a lot of clout in this particular sector.

Nelson: IBM is one of our competitors, and so is HP. If we were just competing against Exabyte, it might be different... but this market is very competitive.

Byte and Switch: A question on headcount. You've had some layoffs in the last year. Is 3,000 the right number going forward?

Brown: Yeah, we've had layoffs this year to try and get the cost structure in line. Some of that was associated with moving the manufacturing to Penang, Malaysia, from Colorado Springs. I think we've got a good base moving forward.

Byte and Switch: What were the total layoffs you had in the past year?Brown: If you included all the folks associated with the Penang transition and shutting down the Colorado Springs plant, it was about 600.

Byte and Switch: Why is Colorado the tape mecca?

Nelson: It's because of the engineering talent that's been there, and the people there don't want to move. A couple years ago, our R&D was mostly in Shrewsbury, Mass., with just a small group in Boulder. We looked at all the talent in Boulder, and we said, we're in better shape having our design site in Boulder to take advantage of the fact that it is the tape mecca.

— Interview by Todd Spangler, Senior Editor, Byte and Switch
http://www.byteandswitch.com

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