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Yes, Virginia, storage is sexy

That's a message Quantum CEO Rick Belluzzo plans to promote--but first there's that nasty red ink to stanch.

It's been a tough half-year for Quantum CEO Rick Belluzzo.

His company, which makes a variety of data storage products, including tape drives and disk-based systems, had been making financial progress until it was hit by a sharp drop in revenue from tape media. It suffered net losses of $9 million in the June quarter and of $38 million in the September quarter. (The $38 million loss included about $27 million in accounting charges.) What's more, its revenue fell even as other storage industry companies registered improvement.

About a quarter of Quantum's revenue comes from tape media, which includes sales of its branded products and royalties from other companies that license its tape technology. But prices for tape media have dropped--a shift Quantum has attributed to factors such as excess production in Japan.

Belluzzo, a veteran executive who spent years at Hewlett-Packard and served as chief operating officer of Microsoft, nonetheless remains confident he can turn Quantum around. Despite its less-than-sexy status in the tech world, tape and other products to back up and restore data are becoming more and more central to organizations, he said.

"Focusing on data protection, it really is a good place to be right now," said Belluzzo, who took over the 2,000-person company in September 2002.

Nothing has emerged to cause people to do what they traditionally did when IT was very successful--which is to invest in new, fundamental applications.

Quantum, based in San Jose, Calif., has been busy introducing new products. In the last several months it has launched DLTSage, a combination of hardware and software that aims to help customers manage tape drives and prevent problems with them; a disk-based storage device designed to speed up backup and restore functions; a new tape drive; and a new tape library product. (Tape libraries are large, automated units that can hold multiple tape drives and numerous tape cartridges.)

CNET recently sat down with Belluzzo to talk about Quantum and the future of storage technology.

Q: Last quarter Quantum lost $38 million on $195 million in revenue. How are you going to turn things around?
The biggest part of that was this deferred tax-asset adjustment (of about $21 million). That really isn't a current-quarter operating result. It's a one-time hit.

Last year, I was feeling very good about our progress. We had good growth. And in this environment, media wasn't really growing. It was mostly flat, maybe down a little bit. But the rest of the business was growing nicely. We had continuous quarter-to-quarter growth, improved gross margins, brought expenses down and began to make money. And then the big media impact hit in Q1 and Q2 (fiscal first and second quarters).

Media is a pretty huge chunk of your business. Are you trying to get away from that somehow?
It's still a good business model. We have been too dependent on that, as we've been building these other businesses?We have to make improvements to our media business. But probably more important is the need to make sure that we move through the progress we need to make in the other businesses more quickly. That's what we're doing.

What's behind the pricing issue? Are tape makers producing like crazy?
Yeah. First of all, it hasn't just been our format. Every format has been under pressure. It is purely the result of simple supply and demand. And the Japanese manufacturers just love to keep their factories going. They don't respond very quickly, because they're very motivated to grow volume, and lower cost, and improve quality. That's their model. And that's what happened. It'll adjust. It'll stabilize. In fact, we think it's stabilizing now. But it was a pretty significant adjustment.

One thing in the earnings report--it did say you're evaluating what sorts of structural changes to make. Can you help us understand your thinking?
If you look at our history as a company, one of the biggest challenges is that we were a large homogeneous business of hard drives. We divested that. We acquired pieces, etc....All of that legacy and history has led us to a fairly cumbersome structure. We have the tape drive business. We have what I would call the systems business. And we have a lot of duplicate capability within those businesses.

I recognized that very early on. But (earlier on), we were executing well, we were continuously growing. I wanted to stay the course, and we were still bringing expenses down nicely.

Now we have completed our product executions--at least, this season of them--and we've found ourselves under this additional pressure. It's incumbent upon me to say, "What's a more efficient way to run the business?" I do believe that we're at a point in the industry where just hard-core execution is where it's at. There's really very little margin for someone who isn't doing that, because it's an unforgiving environment that we're in today.

You talk about the evolution of data protection. Can you tell us about where it's at today and where it's headed?
I believe a lot of work and investment is under way in the industry to think of this as an inflection point, where everything gets better. Tape gets better in terms of its system-availability features. There's a lot of work we're doing to improve performance, improve management, put more error reporting and reliability features in tape drives with things like DLTSage. becoming more affordable, which helps customers.

A few years out, what really is going to be ideal is that these things are, in some ways, going to merge together. People are going to use tape for certain things and disk for certain things. Software is going to explode in terms of "information lifecycle management"--(that is), being able to have a piece of data flow through its life in a system, be stored on disk for ready access for a certain period of time, (and) be archived for a certain period of time. If it's information that should never change and never be altered, it can be put on certain media that going to insure that it stays there forever.

A variety of intelligence will be added, using disk, using tape, using a variety of technologies.

Where is that intelligence going to come from? Is that coming from the software providers, where you have a console, where you can set policy for data or a particular volume--you know, "By this date, move it here"?
It's going to remain to be seen where it comes from, but it's being addressed by a number of people. Certainly EMC is definitely, by their acquisitions, working to drive that. I know Veritas Software (and) the storage software companies are certainly addressing it. I think IBM and StorageTek (have) worked in this area as well...The people that are in the best position to do it are the storage software companies like Veritas and others, who have a platform.

What's your take on where spending on information technology is headed, through the remainder of this year to 2004?
Budgets, I think, are improving, but I they're still very tight. Much of that money is still being spent to improve the infrastructure. People still--in the IT area--are not pursuing new applications. They aren't spending wildly. They don't have big budgets in that respect. But as their budgets improve, they're going back and doing projects that are largely infrastructure-oriented.

Sometimes I look at the stock, and I get frustrated. In other ways, I don't look at the stock, because I know what we have to do.

Like Sarbanes-Oxley?
Sarbanes-Oxley. I think data protection is one. Security has been one. Disaster recovery is one. Just updating the old infrastructure. I saw a survey recently that says the infrastructure today is the oldest--in terms of years since it's been (upgraded)--since 1986...I think that's where money is being spent.

Contrast that with the consumer business. Consumer IT spending--to the extent it's IT business--has actually continued to do quite well. And people are pursuing new applications. They're buying music players, they're buying digital cameras. They're putting Wi-Fi in their home. They're doing that stuff.

In the IT space?nothing has emerged to cause people to do what they traditionally did when IT was very successful--which is to invest in new, fundamental applications. They don't believe yet.

Do you see a closer relationship between the IT part of the business and the business function itself? You see a lot of these buzzwords like utility computing and adaptive enterprise?
Every IT person worth their salt, for the last 10 years, has always worked very hard to make IT a business imperative. Definitely, spending was loose and free, relative to today, but I don't think that changed that particular goal.

I was talking to somebody recently, and they pushed back on me about this "no new applications." They said, "Well, what about adaptive enterprise?" and all these things. I said, "That's all infrastructure stuff." Whatever it is, it's just about getting an infrastructure that's lower cost--that's all that it is. There's nothing about delivering any new value or any new applications. It's just doing it cheaper.

Do you think that there's a point at which we will see more innovation on the application side?
Yeah, there is a relationship--kind of both ways--between the application and the infrastructure. Applications drive the need for infrastructure; and good, reliable, low-cost infrastructure facilitates good applications. It's definitely a necessary progression. Everybody is sitting back, waiting for what the big new application is. I frequently think it's the ones we tried to do before, that didn't work well--I don't think it's necessarily a bunch of fundamentally new things. I think it's things like Web services and tying the supply chain.

Are you going to upgrade to Office 2003?
No, I don't think so. It's not in the budget. I don't know if we've even updated, by and large, to Office XP. There is that debate as well. It's going to be increasingly difficult for those?versions to get companies to step up to the work--not just the investment--of making those changes.

In terms of getting back into Wall Street's good graces, do you feel you're in a state of purgatory right now?
We have work at do. Sometimes I look at the stock, and I get frustrated. In other ways, I don't look at the stock, because I know what we have to do, and I know that the stock is a lagging indicator, really. I'm not trying to go out and tell a story that makes Wall Street feel like the stock should be higher.

If anything, I like to set a path that's more predictable that we can deliver on. I'm pretty focused on working the changes in the company, improving our products, getting connected with customers, generating revenue, lowering our costs, and letting Wall Street catch up with that.

It sounds like it's a market share game. Who do you need to take market share from? If IT spending is still on a slow ramp, then you need to take share from other people.
Part of our strategy is to be the consolidator and leader in the midrange tape market. To do that, we have to take share, for sure, from the LTO (Linear Tape Open Ultrium) consortium--from Hewlett-Packard, IBM--and from the AIT technology from Sony. We have to do that.

We have today developed the broadest range of DLT products, we have the best compatibility story, we have the lowest entry-point price, and we have the highest performance, highest capacity. We need to execute on that and take share.

What's your research and development spending, as a percentage of total sales?
It's high. It's in the 12 percent range.

Really, that much? Will you keep that steady over the next few quarters?
We'd like to hold it. We think we're spending enough. And maybe even let it come down a little bit and have our revenue grow--12 percent is very high. That's almost software company economics, and we don't have software gross margins. We have decent gross margins--in the thirties--but it's not a software gross margin to be able to make those investments.

It's funny that you guys started out in hard drives, you got out of hard drives and into tape. And now the hard drive companies that have survived are all doing great, and you guys are having trouble. Do you think it was the right decision to go into tape in the long run?
The rationale--if you go back in time--was that there were too many players in the hard drive industry. You could argue that we did a good thing for our shareholders. We basically took our hard drive business, combined it with Maxtor, (and) they got shares of Maxtor. Maxtor's done well. And if our shareholders stuck that out, they got a good return.

Would the market be as good if there were more competitors in the market--if IBM didn't consolidate, if we didn't consolidate? I don't know. It might not be such a good place to be. We either helped make that happen, or we missed an opportunity. I think we helped make that happen.

Some of the same phenomena exist in these markets as well. There are too many companies in tape drives. For the fact that the market's not growing, having HP and IBM vertically integrated in this business?really doesn't make a lot of sense. Sony (also is vertically integrated). These are big players. These are nits of the business for them. Their success is going to come in bigger battles. This market will hopefully consolidate over time as well.

Do you imagine it will end up being independent vendors like you and StorageTek?
I try to tell people that in every component technology, they've tended to go to a horizontal player. Microprocessors have gone to people like Intel, operating systems have gone to people like Microsoft or open source, graphics chips have gone to people like Nvidia, and disk drives have gone to people like Seagate and Maxtor. Why are tape drives vertically integrated in systems companies? I have no idea--other than (that) this funny consortium was built.

If it would take the course that the industry has taken, you would think it would go to people like us, StorageTek, etc. That remains to be seen.