Exodus' Krause on the road ahead

Exodus Communications CEO and Chairman William Krause, who took over less than a month ago after founding CEO Ellen Hancock resigned abruptly, quickly determined Chapter 11 was the only way out for the struggling Web hosting pioneer. Network World Senior Writer Jennifer Mears talked to Krause about the decision and the process.

How did Exodus's balance sheet get so out of whack?

I don't really spend much time dwelling on the past because there's not much we can do to change it. But to try to answer the question, the fundamental difference in Exodus now, at least the fundamental difference in the past 18 days, which is how long I've been here, is that the focus for Exodus is managing for profitability vs. revenue growth at any cost. During the dot-com boom it was market share and revenue growth at any cost. And I think it's easy to get caught up in those lines going from the lower left to the upper right at a 60-degree angle and think it's going to go on forever.

I was with Hewlett-Packard for 14 years and was involved as early founder, chairman and CEO in 3Com, where I put in practice what I learned at HP. And what I learned at HP was that, No. 1, you have to start with a business value of managing for profitability, because no profits - no business; and No. 2, as a corollary to that, you cannot sacrifice profits for market share because you don't know what's going to happen in the future. One of the tenants that Dave Packard taught me is managing for profits today is better than managing for profit tomorrow. And market share is managing for profit tomorrow. So in a long-winded way, that would be one fundamental thing we might have done differently.

It's pretty well agreed that hosting and managed hosting is here to stay, that it wasn't that model that was flawed, it was the financial model. Is that accurate?

Right. In other words, the way we think about the business is we're in the Web tone business, to plagiarize a term created by my good friend (Sun chairman and CEO) Scott McNealy. The Web tone business is going to be every bit as big, if not bigger and not more important, than the dial tone business. We're the people who provide enterprises with Web tones. And our data centers are just like central offices. The only difference is instead of us being one Baby Bell, we're the equivalent of seven Baby Bells, spread around the country. So no question that Exodus is in the thick of what already is a very large business that is going to get a heck of a lot bigger.

Did Exodus' move into managed hosting and managed services cause the current problems, since Exodus was initially rooted in collocation?

Your definition of collocation (basically providing a living space and connectivity for servers) is pretty close to what I would call managed Web hosting. What is managed Web hosting? Managed Web hosting is fundamentally providing customers with Web tone, providing them with all the necessary PBX or central switching equipment necessary for them to have Web tone and connecting them up to the network. So, at the core of the business is managed Web hosting and network services. That is the fundamental product for Web tone. Turns out Exodus does that better than anyone on the planet, at least that's what my customers tell me. And that is a core competency of Exodus, and we're going to build around that core competency. Where we've made a mistake is we have burdened our business with excessive overhead in terms of debt, unneeded facilities and headcount.

As for the data centers, you're closing 10 that were under construction, but some analysts say more consolidation will be necessary. Will operational data centers be closed?

We have nothing to report there. Obviously, we evaluate our business just like everyone else does. We are managing for profitability. In doing so we're going to look at data centers in terms of, are they providing unique value to our customers, and if so, then we ought to be able to charge for that value a price that's high enough to cover our costs and allow us to make money.

Where we have four data centers, such as in the Washington, D.C., area, and we've got customers in all four but all are operating under capacity, if customers didn't care about being moved to one of the other data centers that would be a smart move for our customers and for us. So those are the kinds of things we'd evaluate, but we've not made any of those decisions yet.

What capacity are you running at?

That is a question I cannot answer because I should not disclose it.

I'm curious about the Global Center data centers. Is Global Crossing still on those leases?

I have no idea.

If they are, would Exodus be able to walk away from those data centers?

Two answers to that question, one is I don't know the answer and secondly I would not disclose it because it has an impact on an important constituent of ours, Global Crossing, who is a shareholder. So I wouldn't answer that question because it's their question to answer.

As far as layoffs, how many more are you expecting?

Yes, there will be additional layoffs. However, they will not impact areas related to the operations or service. We believe we are close to the right size, but we'll continue to make reductions on the basis of what's in the best interest of the company. I'm looking forward, which I think is in the not too distant future, to the point when I'll be able to answer that question with a "No."

Obviously keeping customers is a big concern. What are you expecting in terms of customer losses, and what is the percentage of Exodus customers who have some sort of penalty-free exit clause?

I have no idea, No. 1, and No. 2, I wouldn't disclose it. But, more importantly, I've talked to 26 or 27 customers. I've heard three consistent themes: to a person they tell me that they value our products and services, and for the most part the products and services are better than our competitors, and they are staying put.

The other two themes, the bad news, is to a person they tell me they are nervous. But they're less nervous today than they were the other day because they know with Chapter 11 bankruptcy filing we are a much more secure company than we were before. And they tell me that as prudent businessmen they are evaluating contingency plans to mitigate the risk. And I tell them I'd do exactly the same thing and all I ask is before they pull the trigger, give me a call and let me be sure I've given them all the information they need to make an informed decision. And they've committed to do that.

But let me also answer your question with, there are some customers that we've acquired that aren't customers. And what I mean by that is, in my definition of a customer you have to meet three requirements. One is that you have to have a need, two is that it's something Exodus can fulfill, so that No. 3, you'll pay us for it.

Unfortunately, in this emphasis on revenue growth at any cost, we've taken on some obligations for people who aren't customers. And I'd just as soon have those people burdening somebody else's balance sheet. And so we are taking actions, aggressive and swift, to ask these organizations to get their services from somewhere else.

Let me also be clear, we're not being arrogant about it. We're not being nasty about it. We're giving them time to make a transition, but we're also being very firm that if you can't pay your bills, we can't afford to have you burdening the balance sheet. If there's any decline in our customer base, that's where 90% of it will come from.

You've compared Exodus' situation to that of Covad Communications, which filed a prepackaged Chapter 11. You filed before having a creditor agreement in place. Is an agreement in the works?

Exodus has a board member in common with Covad. I won't tell you the person's name. And also the interim CEO at Covad, Frank Marshall, has been a longtime colleague and I happened to spend a day with him about a week ago. So I'm well versed in the process they've gone through. And, yet, there is a difference in the process we are going through. However, we are confident given the nature of our business being vibrant and valuable that we will be able to work with our creditors to get a plan of reorganization and get through this process rather quickly.

What sort of timeline are you looking at? Are you near some sort of an agreement?

I wouldn't disclose that if we were, but let me say this, I'm not an expert in these procedural matters of reorganization and emergence, but we do have advisors who are and they're telling me it's normally about a four- to eight-month process. I would expect we would be on the shorter side, rather than the longer side.

Is there a bottom line for the process?

There is going to be negotiation between a series of parties. One is the management, and the management is supposed to facilitate a negotiation between current equity holders, creditors and any other potential new investors should we ask them to be involved. And then the negotiation is about who gets how much of the pie. We'll facilitate that process, but we want to make sure that if there is any opportunity for existing equity holders, that they participate. So the answer is no, we don't have a firm number. And we may be driven, by the way, by the bankruptcy code itself, which puts some restrictions on that.

You say that you would entertain acquisition overtures. Are you talking with any prospects?

I can't answer that.

As far as the market itself, we've seen several acquisitions recently: WorldCom acquiring Digex, Cable & Wireless acquiring Digital Island. Do you believe Exodus can continue to operate independently, or do you think the market has changed enough that you need some other revenue to offset hosting?

I'm absolutely and totally confident that Exodus can operate independently as a profitable and growing business. I've already talked about the market demand. No. 2, we're the gorilla. And the reason we're the gorilla is we've got the most assets, 44 data centers, and we have a core competency in the core, underlying service of the business: the Web tone. We're better at doing Web tone than anybody else.

So I'm completely confident we can operate as a profitable and growing business. I have no worry about that. But my role and my goal and the goal of the entire company is to maximize value, and if that means being bought or acquired by another company that maximizes value for Exodus, everyone of us is signed up to do that.

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