Exclusive Interview With FalconStor CEO Jim McNiel

  James P. McNiel, 47, is interim president and CEO of FalconStor Software since last September, succeding ReiJane Huai, after serving as chief strategy office of the company. Prior to that, he was co-founder and CEO of Fifth Generation Systems, a social networking start-up. He was formerly general partner at Pequot Ventures (now FirstMark Capital) for nine years, where he managed investments in Netegrity, NetGear, OutlookSoft and other technology companies. In addition, McNiel was a board’s member of Cheyenne Software, sold to Computer Associates in 1996 for $1.2 billion. McNiel started his career as a software developer for LucasFilms Ltd. He studied Business and Advanced Management at The Wharton School and Finance at MIT’s Sloan School of Management.

StorageNewsletter: Since it was revealed on September 29 that your predecessor ReiJane Huai made improper payments to a customer and was consequently fired, what have been the initial results of your company’s investigation?
McNiel: The results of the special investigation that we performed, managed by the board of directors and special attorneys outside of the company, was concluded recently. The report was given to the board and to the auditors. The board having received that information, reviewed all the financials, and made the decision that there was nothing extraordinary or out of the ordinary after a complete 3-year forensic audit, and authorized the release of the quarterly financials, resulting in the SEC receiving those financials and authorizing us to make to do our earnings call.

So, there were no improper payments?
No that’s not what I’m saying. I’m saying that the improper payment is still under investigation by U.S. authorities. What the auditors and the SEC were concerned about is was there anything that could have affected our accounting or reporting, historically. And that’s not the case.

Which customer was it?
It’s not been disclosed.

A U.S. firm?
It’s not been disclosed.

A large one?
How do you measure big? How long is a piece of string? It’s bigger than a small business.

How do you explain that a savvy industry veteran pulling off this kind of action, given how well-known he was in storage, as chief architect at Cheyenne, then executive VP at CA?
I don’t know. How does Sarkozy divorce his wife and marry Carla Bruni, as the president of the nation. It’s a good question, but unfortunately the only person who could answer it is ReiJane Huai.

Has anyone calculated how much this issue will cost your company?
We’ve not calculated it. There are two sides to it – what it cost us to perform the special investigation, and those numbers will largely be communicated in Q4, our next earnings announcement. The second level of cost is going to be associated with any class action suits that get filed and prosecuted in the United States, of which there will probably be 6 or 7, which will then be consolidated into a single suit that we have to fight. Those suits will be handled by our insurance, which is already paid for.

It will be probably be millions of dollars.
It may be millions, which will be paid by insurance, or it may be nothing, because the suits are in my opinion baseless.

A similar thing happened at Isilon. The class action lawsuit cost them $15 million.
Believe me, if you’re asking me if I’d rather be managing the company under different circumstances, the answer is decidedly yes.

For how long will you be interim CEO?
Until either I’m full-time CEO, which is up to the board, and which they’ll decide on this year.

The company is not seeking a new CEO.
No, there’s no search.

So there’s a good chance it will be you?
There’s a greater chance I will be than I won’t.

Similar to DataCore, why is it that your company, now ten years old, never quite caught fire, given it was one of the first in virtualization?
It’s a good question. I think the reason the company did not achieve the trajectory of some of its peers, there’s a number of opinions. One is that since the company is delivering software support in multiple platforms and multiple environments, we invested a lot of time and money in compatibility and interoperability, while our competitors were taking their software and putting it on a single hardware platform and doing a much smaller amount of work and delivering exactly what the customers needed at the time. So you had NetApp which was very focused and delivered its software in a hundred pound box. That’s one view. The second view of it is that our company was focused on supporting the OEMs, and today, EMC has to make 10 VTLs to make up for us selling one VTL with Hitachi Data Systems. So the discounts to the OEMs were significant. So the company didn’t get to recognize as much value as it was bringing to market. The last thing I think is that ReiJane Huai is as you said, an industry veteran, a storage architect, an innovator…

More than a manager?
Perhaps. But he’s really keen on understanding and delivering the next greatest piece of technology. And when I talk to our customers, they’re not asking me to give them the next greatest piece of technology, they’re asking me to make sure that what they have is reliable, predictable and of the highest quality, and that I think is what’s really missing, the fact that they want bullet-proof reliable data protection solutions. And lastly, this company, we talk about data protection, that’s our job. But historically the company was in the storage industry, so primary storage, secondary storage, virtualization, continuous data protection, replication, WAN optimization, VTL, de-dupe, so there’s a lot of different disciplines for a company of our size. So our job is to really narrow the focus, deliver exactly what our company is looking for in the narrow space that we want to operate in. And the narrow space that I want to operate in is that $10 billion software business called data protection.

Does your shift from an OEM to distribution business model explain your bad financial results? For the last quarter, revenues were only $19.0 million, down 12% from one year ago, not to mention you posted enormous losses, $26.4 million.
But you have to understand. Most of that is a tax conversation. It’s not a cash loss. It’s not a loss from operations. We have had tax losses that we’ve been carrying forward to apply to our future tax obligations. Because the company has not been very profitable for the past 6 quarters, we’ve had to realign the way that tax loss was being applied, and we had to accept it as one big discount, just for one quarter.

For just one quarter?
Next quarter it’s gone. From an accounting standpoint it’s very positive for the company. Revenues have been going down for the past five quarters. So now that it’s my job to run the company, they have to go in the other direction.

But do you think it was a wise decision to change your business model away from OEMs?
I think it was a bad decision to wait as long as we did.

But you continue to work with OEMs?
Of course.

Such as Hitachi?
It’s a different business.

So who are your OEMs now?
Well we have Hitachi. We have Hewlett-Packard. Those are very different OEMs, because those OEMs are selling FalconStor-branded product, those OEMs are public partnership, those OEMs are paying a different discount than what our historic OEMs such as EMC, IBM and Sun were paying. So it’s a much more attractive business for us. So if you think about HP, HP’s disaster recovery business operates out of 60 data centers around the world, and is managed by a $40 million business unit. They’re the number one disaster recovery business continuity provider. Their core technology is NSS from FalconStor.

That for HP’s own use? No?
They’re reselling it. As a service. The HP disaster recovery cloud. The reason they chose FalconStor is because we have the most flexibility in terms of operating in different storage environments. Nobody is as inter-operable as we are, it’s one of our key strengths. So that’s a very valuable OEM relationship for us, especially in the future when every single FalconStor customer who’s running BlueStone will be able to see that HP cloud and choose it as a target, or maybe choose an Amazon as a target, or choose Nirvanix as a target, so that’s a very valuable OEM relationship for us. Hitachi is equally valuable to us, because Hitachi is in my opinion a tier-one storage manufacturer. They have some of the best hardware in the business, they can compete head to head with EMC or any other storage company, and when you couple our VTL and de-dupe technology with Hitachi storage, you have the industry’s most highly scalable de-dupe and VTL solution, bar none. We’re managing the largest VTLs in the world.

It’s strange that Hitachi doesn’t have de-dupe.
They do now, with us.

But they’re the last big company without their own. Tell me a little more about BlueStone?
Of course. The major disconnect between the data protection vendors today and the customers who are trying to use the technology happens to be the approach to the problem. The customers are operating and delivering a service, whether it is an email service, or an ERP solution or web portal or customer service, it’s all based on a service. And that service is comprised of multiple components – databases, applications, servers and the like. They want us to protect the service – not the individual files and blocs underneath that service. So BlueStone is the first product of its kind to deliver service-oriented data protection. And what that means is that we have the knowledge and the understanding to collect all of the various components that comprise the service, put them into a single protection set, apply the levels of protection that the customer is looking for, and then move all of those components in formation, in harmony, to back them up, to replicate them and to restore them. That’s what BlueStone does. It’s a single pane of glass management system, running as a web-based application that talks to job engines throughout the enterprise, and it manages all aspect of storage and data protection.

Available in?
Q2 of 2011.

Do you really intend to enter into hardware, given that customers always want software and hardware protection. You’re already in hardware, in a way, since you began to resell SSD appliances from Violin Memory?
We deliver our product in three basic configurations. At the highest level, we deliver the product in what’s called a software application kit. That is – our software running natively on a Linux server…

But you don’t sell the server…
We don’t sell the server, we just deliver it on whatever hardware the customer wants, that’s number one. Number two is we can deliver all of our solutions as a virtual appliance. So you can run it in a virtual machine on just about anything you like. Number three we deliver our product as a physical appliance. So NSS and CDP and VTL and de-dup all can be shipped on our FalconStor-branded hardware.

What kind of hardware platform?
We’re consolidating our hardware platforms into an OEM relationship with Dell today, and they are in a position to deliver our solutions globally. We pass the order to Dell, and Dell manufactures it and delivers it to customers. It’s FalconStor-branded.

Do you sell it?
Yes. We sell it with our software, all embedded.

How many have you sold?
Let me put it this way – Dell OEM is the fastest growing business unit at Dell. They have a customer advisory board, and we are on that board with very big names. Such as Cisco, and others. We’re one of their major customers. And we’ve been shipping Dell appliances now for over a year.

Will you push this hardware trend?
I think the question gets answered differently depending on what market you’re talking about. If you’re talking about the mid-range, small-to-medium size enterprise, in our view under 5,000 employees, that business is actually very fond of having a turn-key hardware solution. So when we’re selling through our partners, through our channel, they want something that they can turn on, plug in and be done with. So the hardware solution runs itself very well to that. When we get into the much larger enterprise where we’re doing multiple data centers, they want a custom-built solution using our software and whatever hardware they choose. And so those business are very very different, and we recognize that. That’s why we’re in the appliance business to begin with, because our fastest growing segment of business is in that medium-range marketplace.