Original URL: http://www.theregister.co.uk/2013/08/13/falconstor_playing_the_violin/

FalconStor struggles on as antsy backers whine 'C'mon, let's sell'

New investor on board, new Violin deal – don't write them off yet

By Chris Mellor

Posted in Storage, 13th August 2013 07:03 GMT

After losing its CEO a few weeks ago, standalone storage software shipper FalconStor has duly reported poor results. Since then it has got into bed with a new VC to shore up its balance sheet, ended an investment banking deal with Wells Fargo, and teamed up with Violin Memory to develop new products.

The interim president and CEO is Gary Quinn, promoted from COO. Prior to that he was veep for sales in North America and marketing. Former CEO Jim McNiel tried to turn the company round after its charismatic founder ReiJane Huai died in 2011.

But FalconStor's software – continuous data protection, IP SAN software (NSS) and a virtual tape library - is proving hard to update for the cloudy and flash-focussed storage era we are entering. The company appointed Wells Fargo to advise on strategic alternatives in late 2012.

Eventually the board, led by Eli Oxenhorn, decided Jim McNiel wasn't the man to take the company forward and off he went in July with a payoff of $420,000. It was then down to Quinn to report the second quarter results which everyone expected to be dire. They weren't disappointed.

The numbers

In the three months ended 30 June revenues at were $13.9m, 15 per cent less than a year ago and 8 per cent down on the first quarter. The first quarter loss of $4.3m deepened to $5.2m. Every quarter since the start of 2010 has been loss-making. At least the latest loss is less than the $6.6m recorded a year ago.

CFO Lou Petrucelly said in the earnings call: "Total revenues fell well below our internal expectations, while total revenues from each of our regions have declined on a year-over-year basis. The declines in product revenues, specifically from how our North America and EMEA regions, as well as decreases in maintenance revenues were the primary drivers of the soft revenue performance in Q2."

He said competitors were not helping: "Our competitors have encouraged customers to question the company's declining cash balances and to raise concerns about the company's direction over the past 12 months."

Now, as well as parting company with McNiel, the board is making friends with a restructuring-type VC, Hale Capital Partners, which is investing between $7.5m and $15m in the company. Hale describes itself as investing in:

under-appreciated, under-followed, or under-capitalised businesses … restructurings, or simply good companies in out-of-favor industries. In every investment we work closely and patiently with management to help transform businesses into larger and more successful operations.

The earnings call revealed that Hale's final investment amount will be "based upon, among other conditions, a rebalancing plan for the company." The rebalancing plan will include revenue, cash flow, and operating income.

The company is selling its interest in a joint venture in China, Tianjin Zhongke Blue Whale Technologies Co. Ltd., for $3m, having originally invested $1m in 2008. It's also agreed, in principle, to settle a class-action lawsuit for $5m. Together with giving Wells Fargo the investment banking boot, these three moves look like elements of a deck-clearing exercise. But for what? A company sale or company development?

Violin Memory

Then there was the flashy surprise of:

A joint development agreement with Violin Memory, a leader in solid-state disk market, also known as flash memory, to deliver a next-generation product for the flash memory platform based upon our current NSS technology. The license and development services will produce up to $12m for FalconStor over the next 12 to 18 months.
Don Basile CEO of Violin Memory

Violin Memory CEO Don Basile

Petrucelly expanded on this, saying: "We are partnering with Violin Memory on a joint development for our next-generation products. Violin will provide the expertise in solid state drives or flash memory, which we believe will provide us with the next-generation of products optimising flash memory. We anticipate that this joint development will position the company as the leader in the market for flash memory and traditional hard disk drives, cloud storage and data protection services."

There is a cash installment of $3m due from Violin by the end of the month.

Sounds like its products will embrace flash memory in the form of all-flash arrays and, possibly, hybrid flash/disk drive arrays. The cloud storage angle suggests multi-tenancy features will be added and, perhaps, quality of service functionality.

With Violin paying FalconStor cash for this development, it strongly implies that Violin will see the resulting software, presumably with its arrays. But FalconStor could also sell it, not having given up any rights to the resulting product technology.

Recovering money from former CEO's estate – what?

There was an amazing issue raised in the earnings call's Q & A session about FalconStor recovering money from a former CEO's estate, presumably that of ReiJane Huai. John Aniblo Zaro of Bourgeon Capital Management said:

You guys were discussing and telling all of us that we were going to recover money from the former CEO's estate and that it would bring cash or reduce the size of the shares outstanding. … don't we still have that out there hanging of whether we need money or not, or is this -- you just think you need the money so quickly that you'd rather have it on the balance sheet?

Garry Quinn responded: "I can tell you that we are making available – any remedies that we have or options we have to recover what we can. But that is something that was – is not concluded and is still outstanding."

Seth R Horowitz, the company's legal exec veep, said: "In terms of the estate, as I said, we don't comment about any particular actions that we might or might not take, but we are aware of all the money that we can recover, and we're going to take all the means to recover those monies."

In other words, yes we are trying to claw money (shares?) back but don't count on it any time soon. There is no declared litigation against the dead former CEO's estate.

Quinn said that IBM was going to ship a FalconStor product later this month. There is also a deal with HP: “The Hewlett-Packard agreement is the opportunity for FalconStor to provide a virtualisation layer with its NSS technology for those customers that Hewlett-Packard is entertaining into their cloud matrix offering that are not utilising Hewlett-Packard storage and servers."

Is FalconStor for sale?

Is the company for sale? It doesn't sound like it.

Quinn, who at the time of writing is not listed as a board member, said: "As a public company, we remain prepared for any options that may be presented to the company and its Board of Directors. But at this time, we'd prefer to digest these above alternatives and focus our company around moving ahead."

He refused to say whether FalconStor had received any purchase offers for the company in the recent past.

Investor Ross DeMont of Midwood Capital Management, LLC, pursued the for-sale point:

The stocks are at 20-year lows. The go-it-alone strategy has not served us particularly well, and our competitors are orders and orders of magnitude larger than we are. So to me, what you come up with is not enough to change this company in the eyes of all of its customers and shareholders. I hope we – I hope the stock recovers a little bit here, but I think most people would have hoped you just sell the whole company and recognise that being this size, competing in this space is probably not a good strategy.

Quinn replied: "We are public, and if someone would come forward, we are more than willing to entertain any options that are presented to us."

Nobody El Reg can think of would want to buy FalconStor. It has to go it alone, for now, and that means the Violin Memory deal is crucial in product development terms.

The refinancing assures the immediate future. That gives Quinn and his team time to refocus the product portfolio and examine the profitability of its sales presence in various geographies. Duff territories will probably see some kind of FalconStor withdrawal and retreat to a distributor-led presence.

Quinn said: "We're looking to put a distribution model in place that makes the most sense for the company, whether that's FalconStor representatives on the ground distributing product on their own, working directly with a partner or a 2-tier distribution model."

Some territorial retreat to distribution should help costs.

The CEO wants FalconStor to be cash-flow positive by the end of the year and "to achieve a break-even operating income by the end of this calendar year on a run rate basis."

That probably means FalconStor will be a smaller company but it will, hopefully, be making profits in 2014. Quinn might even become a proper CEO, insofar as he gets invited to join the board. ®