Another Reason to Hate Compliance

Instead of becoming a boon for storage companies, compliance might actually be hurting software sales.

Backup and recovery vendors Veritas Software Corp. (Nasdaq: VRTS) and BakBone Software Inc. (Toronto: BKB) admitted their sales were disappointing for the quarter that ended in June, and thats also been the case with large software companies outside the storage sector. (See BakBone Announces 1Q Earnings and Veritas Takes a Dive). BMC Software Inc. (NYSE: BMC), PeopleSoft Inc. (Nasdaq: PSFT), Siebel Systems Inc. (Nasdaq: SEBL), and Sybase Inc.

are among the major software companies who preannounced earnings below expectations. The common theme for their underperformance has been poor U.S. sales in June.

One analyst, David Rudow of U.S. Bancorp Piper Jaffray, suggests that CFOs are too preoccupied with getting their companies into compliance with Sarbanes-Oxley to take on any major software installations. “We believe the CFO’s workload to complete this [compliance] is overwhelming, and they might not have the time or budget to sign large software contracts at the last minute of the quarter,” Rudow wrote in a research note today.

He also wrote that consultants are advising companies to hold off on applications that touch financial systems until they reach compliance.

This is a critical time for large companies in regards to Sarbanes-Oxley. Annual reports for companies with more than $75 million in market capital whose fiscal years end on or after Nov. 15 must be compliant this year. Rudow writes that software sales are probably just delayed until compliance work is finished, but that it might take until the last quarter of the year before they pick up.Analysts say Veritas has another compliance-related problem – its email archiving product released in May was late and lacks features of smaller competitors, including EMC Corp. (NYSE: EMC) Legato and privately owned KVS Inc. (see Veritas Manages Data Lifecycles). Archiving products are among those expected to receive a boost from compliance. (See A Rosy Look at Compliance, Insider: Compliance, the Bright Side, and The Real Cost of Compliance).

One analyst who asks to remain unidentified suggests that Veritas should buy KVS, which has a strong partnership with EMC. “If Veritas has half a brain, they’ll buy KVS right now,” says the analyst, pointing out that such a deal would give Veritas the best archiving product on the market and cut away a piece of EMC’s compliance puzzle. (See KVS Puts New Combo on Vault and EMC Helps AT&T Archive Email).

We won’t know the full impact of the slow quarter on storage software until EMC and IBM Corp. (NYSE: IBM) are heard from. If EMC Legato and IBM Tivoli do poorly, that would lend credence to the theory that compliance is delaying sales. If they do well, then it could just be a case of shifting market share.

Maybe these are just tough times for storage sales. Last week, HBA vendor Emulex Corp. (NYSE: ELX), tape library company Overland Storage Inc. (Nasdaq: OVRL), and hard drive company Maxtor Corp. (NYSE: MXO) all had bad financial news. (See Emulex Hits the Deck, Overland Guides Under, and Maxtor Cuts Heads, Guidance).

We do know that BakBone isn’t cutting into Veritas’s share after it announced today it would narrowly miss its forecast for the quarter. BakBone keeps following its larger rival down the wrong paths – accounting errors and now, disappointing earnings.In May, BakBone said it had to restate earnings as it moves to U.S. GAAP standards from Canadian GAAP. (See Bakbone Reports Restated, BakBone Slip Called Temporary, and BakBone Calls a Reverse). The transition is part of BakBone’s plan to get listed on Nasdaq. It is currently traded on the Toronto Exchange. Bakbone’s revenue from its first three quarters of fiscal 2004 were adjusted down after several large contracts were recategorized as deferred revenue. Also, the company did not properly take into account deferred stock-based compensation charges when it reconciled from Canadian GAAP to U.S. GAAP for its fiscal 2002 and 2003.

Veritas announced accounting irregularities on March and refiled a bunch of financial statements in June. (See Veritas Files 2003 Forms and Veritas Searches for Truth). The irregularities include incorrect deferral of services revenue, unsubstantiated accrual of expenses, and the overstatement of accounts receivable and deferred revenue.

Today, BakBone CEO Keith Rickard said he expects revenue from the last quarter to be approximately $7.8 million compared to its previous guidance of $8.0 million to $8.5 million released. Rickard says his guidance for the fiscal year remains unchanged – $40.0 million to $42.0 million in revenues with projected earnings of $0.04 to $0.06 per share.

BakBone will try to jumpstart sales by offering discounts to its larger channel partners. That will decrease BakBone’s margins of course, but BakBone hopes it will attract more channel partners. At least it’s doing something to try and boost sales during what has become a challenging time.

“It appears a number of vendors out there are experiencing softness,” BakBone’s North American sales VP Scott Petersen says.— Dave Raffo, Senior Editor, Byte and Switch