In Search of the Missing Uptick

The optimism about IT spending for 2004 has hit a snag: namely, the seasonal lull that typically affects sales of SAN gear in the first quarter of any year. And so far, seasonality is winning.

As the segment's earnings reports roll in, EMC Corp. (NYSE: EMC) and Adaptec Inc. (Nasdaq: ADPT) showed its possible to increase revenues sequentially -- although their revenues grew far more year-over-year.

Dot Hill Systems Corp. (Nasdaq: HILL), LSI Logic Corp. (NYSE: LSI), QLogic Corp. (Nasdaq: QLGC), Storage Technology Corp. (StorageTek) (NYSE: STK), and Veritas Software Corp. (Nasdaq: VRTS) all reported sequential revenue drops despite strong year-over-year gains. Emulex Corp. (NYSE: ELX) barely beat its revenues from last quarter. (See EMC Earnings Up, Dot Hill Puts Revenues at $48.8M, QLogic Reports Earnings, StorageTek: No IT Spending Uptick, and Veritas Holds Steady.)

The trend should come as no surprise. When storage execs spoke at the end of 2003 about increased spending this year, they usually said the surge would come during the second half of 2004 (see Storage Bigs Brash on Budgets and HP Leery of Uptick Talk). Spending certainly hasn’t come ahead of schedule.

"While the IT environment shows some signs of progress, there's no real growth in budgets," said StorageTek CEO Patrick Martin when announcing earnings. And while EMC and IBM Corp. (NYSE: IBM) execs saw IT spending pick up in the quarter, even the optimists say the real surge is yet to come (see IBM Storage Holds Steady).“We continue to expect the overall global economy and IT spending in particular to be more robust in 2004 than it was in 2003," EMC CFO Bill Teuber said. “However, as we've mentioned many times before, we believe there won't be a steep acceleration in the economy, but slow and steady gradual improvement.”

So don’t expect things to pick up much next quarter. The storage vendors have given conservative guidance, perhaps because many were overly optimistic about this year. Indeed, the spending surge at the end of 2003 seemed to come mostly from budget flush -- followed by a guidance flush.

Dot Hill, Emulex, QLogic, and StorageTek all gave guidance after the fourth quarter that exceeded fourth-quarter revenues. None of them hit their mark. QLogic and Dot Hill slashed their estimates before they announced earnings (see QLogic Dives on Shortfall and Sun Dogs Dot Hill).

McData Corp. (Nasdaq: MCDTA) also revised its forecast for the first quarter of the year downward last month as the switch vendor’s CEO John Kelley admitted that previous guidance anticipated maintaining revenues from the fourth quarter of 2003 (see McData Slashes Guidance – Again).

Selected First-Quarter HighlightsSwitchmakers Cautious
QLogic reported a sequential drop in its sale of low-end switches and McData issued a warning -- which could be bad omens for Brocade Communications Systems Inc. (Nasdaq: BRCD) and Cisco Systems Inc. (Nasdaq: CSCO) as well. The three major switch vendors will announce earnings in May.

HBA Hopefuls
In another vein, QLogic President H.K. Desai told analysts last night that he's cautious that the HBA market might be in a short-term decline, but he has high expectations for long-term growth. He also said he expects to see the small-to-medium-sized business market begin to install Fibre Channel and iSCSI SANs in the second half of the year.

After two quarters of double-digit sequential growth, QLogic’s HBA revenues dropped 10 percent sequentially last quarter due to lower-than-expected sales with two OEMs -- Sun Microsystems Inc. (Nasdaq: SUNW) and Hewlett-Packard Co. (NYSE: HPQ) are the main suspects. Overall, QLogic reported revenue of $128.1 million for the first calendar quarter of 2004, down from $137.1 million sequentially. Net income dropped sequentially from $35 million to $32.9 million. Yet analysts see QLogic’s gross margin of 69.6 percent as a sign that there is no pricing pressure in the HBA market, and they expect its earnings to bounce back.

“With no sign of pricing pressures, we believe [the HBA] segment of the business will resume modest growth in the [current] quarter,” Lazard Frères & Co. LLC analyst Cliff Su wrote in a research note today.

Big SATA Expectations
Dot Hill CEO Jim Lambert said the systems vendor expects a boost from systems with SATA drives in the second half of the year. Dot Hill, which supplies Sun with its low-end SAN systems, also has a deal to provide Sun with SATA SAN systems. Sun is expected to announce the deal in June, but already lists on its Website a system with SATA drives that scales to 18 TBytes and carries a list price of $16,000. Lambert confirmed during the earnings call with analysts that it is a Dot Hill system, and he hopes to land more SATA OEM deals.“SATA has been expected to greatly impact the market,” he said. “In spite of last quarter’s results, we still remain optimistic about the future.”

Dot Hill's revenue of $48.8 million for the first quarter was down sequentially from $57.5 million, and it posted a slight loss coming off a profitable quarter.

Bucking the Trend
Adaptec joined EMC in increasing revenues sequentially, going up 5 percent to $121.3 million (see Adaptec Posts Q4 Profit). Adaptec’s net income of $6.6 million, or $0.06 per share, was up from $5 million in the previous quarter.

CEO Bob Stephens attributed the increase to strong OEM sales of Adaptec’s storage systems. Even he admitted surprise at the sequential uptick. “Frankly, none of us were all that certain that IT spending would continue at the rate we saw at the end of last quarter,” Stephens said.

— Dave Raffo, Senior Editor, Byte and Switch0