Software And Storage Spending Hits the Skids

My initial reaction was--what's going on at Veritas? But what ensued was an avalanche of earnings warnings from the likes of BMC, PeopleSoft and Siebel, and most recently CA and StorageTek, among others throughout this shortened week. Actually things started to look ominous last week when several analysts raised concerns that tech bellwether Intel may miss forecasts due to weak demand and that it had to recall some of its new Grantsdale desktop processors. Moreover, in a keynote address at the annual StorageWorld conference in Long Beach, Calif. last week, StorageTek chairman and CEO Patrick Martin appeared quite pessimistic about the so-called rebound in IT spending.

"This is not an environment where we are seeing robust growth," Martin said.

Although his remarks preceded StorageTek's announcement Thursday that orders for the last two weeks had slowed, prompting the company to say revenues would only be $510 million 520 million, compared with $527 million year-over-year, he had hinted things were not as rosy, despite the launch of two major new tape-library systems.

Indeed, there is growing evidence that spending growth is not meeting even the modest expectations with which the year kicked off. Veritas chairman and CEO Gary Bloom in a statement blamed the revenue and profit shortfall on a slowdown in enterprise spending in June. "Our anticipated results were impacted primarily by weakness in our U.S. enterprise sales," Bloom said in a statement. Others have cited similar reasons for their late quarter shortfalls.

Whether we're seeing a short-term lull or not remains to be seen. But at the moment, the bulk of the bad news appears to be coming primarily on enterprise-software suppliers and vendors offering storage systems. Investment banking and asset-management firm Needham and Company released a report last week predicting major storage vendors were scrambling to meet revenue expectations despite what appeared to be a robust pipeline in early June. Yet in a report released Thursday, Merrill Lynch predicted the major systems vendors including EMC, IBM and Sun would likely meet expectations, though probably not exceed them (with some exceptions such as Apple, Lexmark and NCR). The Veritas announcement and a warning last week by storage vendor Emulex that revenues and earnings would be off by at least 25 percent could be a mixed bag for EMC, which carries Emulex Fibre Channel host bus adapters, wrote Merrill Lynch analyst Steven Milunovich. But Veritas loss potentially could be coming at the gain of EMC's Legatto division, he added.

So when Bloom blamed the shortfall on enterprise CIOs in the United States holding back at the end of June, it seemed like he was in good company. Some analysts say the market overreacted to Veritas' warning and at $17 a share, the company is a steal. Maybe it is over the long haul. But that Veritas' stock was hammered much more so than most other IT companies begs a few questions. Hence, back to my original question--what's going on at Veritas? Suffice to say, the Street didn't see this coming and didn't appreciate being blindsided.

In what JP Morgan analyst Adam Hold described as "puzzling" in a report downgrading Veritas' stock, the company will report $475 million to $485 million in revenue and 18 cents to 20 cents a share, compared with expectations of $501 million in revenue and 24 cents per share. The puzzling part was that license revenue would fall between $263 million and $273 million vs. JP Morgan's forecast of $315 million.

Banc of America Securities analyst Rob Stimson raised the same question in a report released Wednesday. Among the questions raised: Was the weakness company-specific or due to industry-related issues? Is the competitive landscape shifting as such that its business is being impacted? And is management credibility in jeopardy?

JP Morgan analyst Holt concurred, raising the specter that Veritas still has internal control issues that surfaced prior to its earnings restatement. Holt also warned that the possibility of an SEC inquiry could make matters worse if in fact one is looming. It seems Veritas' has more fundamental issues it needs to address--for one, the company's longstanding licensing practices. This has been an issue with customers for some time but has been overshadowed by strong demand for its products. In an interview last week following his speech, StorageTek's Martin related a horror story with a joint customer (StorageTek and Veritas have a partnership). The customer, looking to consolidate its data centers, had a bid for a hardware solution with a Veritas competitor that Martin declined to name that came in at half the price for the Veritas software alone. Although the customer, already a Veritas shop, wanted to stick with Veritas, the software came in way over its budget for the whole project.

"Veritas hasn't budged on the price," Martin said. Though StorageTek intervened, Veritas responded that if it made an exception for one customer, it would open the floodgates for others, according to Martin. "I don't live in Bloom's shoes so I don't know what the challenge is but clearly [he must address ] the pricing and license fees," Martin said.

Veritas insists it has more flexibility in its licensing. "If that was done with a customer, it was done with a salesperson that didn't address the problem with the customer," said Robert Maness, Veritas senior director of product and solutions marketing. "We have a mechanism in our licensing model to accommodate discounting if we think it's necessary and we think it's competitive."

Maybe so, but complaints about Veritas' per-server licensing fees have existed for years, and until now have not come back to haunt the company, noted John Webster, senior analyst with Data Mobility Group, a Nashua, N.H.-based consultancy that specializes in storage. In fact, customer enthusiasm for Veritas never seemed higher, said Webster, who attended the vendor's annual Vision conference in Las Vegas back in May. Boasting record attendance of 3,400 people, 80 percent were customers.

"I'm hard-pressed to try to figure out what's going on here with the numbers," Webster said. "It doesn't fit with the support they seemed to be getting at Vision from users."

Perhaps reality has set in with the company's announcement that it is moving to a utility-computing model, which is the other key challenge facing Veritas. Not only does Veritas have a steep hill to climb in that it is not a known player in such areas as network management, but its license fees could become more problematic as it seeks to move into new areas.

"It's possible some uncertainties about their future are starting to come to bare," Webster said.

The upside to Veritas, notes Banc of America Securities' Stimson, is a deeply discounted valuation and the likelihood of a stock buyback at some point. Hopefully, he noted, the deals that fell through in June were deferred not lost, though JP Morgan's Holt argues that Veritas "is unlikely to make up the entire miss." He also notes that maintenance and service revenues, which will be $212 million"a 36 percent year-over-year growth"masks the degree of the miss on a license basis.

It bears noting that Veritas' revised revenue forecast spells a year-over-year growth rate of 13 percent (assuming the lower end of the revenue forecast) instead of 16 percent under guidance, certainly not shabby. Nevertheless the partner community has much to contend with. That includes a slew of new products, a new and uncertain turn toward utility computing and a recently launched new partner program. In the wake of this week's developments, the bigger question that remains, though, is whether IT spending is just taking a breather or whether it's hitting the skids again. If it's the latter--for Veritas and its partners--it could be a double-edged whammy. If either scenario holds true, the fireworks won't fade away anytime soon.