Sour Report on Storage Spending

Remember the increased IT spending that storage companies were counting on for 2004? Well, it hasnt happened yet, and now a Wall Street investment firm says it not likely -- this year or next.

Goldman Sachs & Co. today issued a research note saying its CIO survey indicates tech spending isn’t what its analysts expected. They revised 2005 revenue forecasts downward for a bunch of companies, including Brocade Communications Systems Inc. (Nasdaq: BRCD), EMC Corp. (NYSE: EMC), Hewlett-Packard Co. (NYSE: HPQ), McData Corp. (Nasdaq: MCDTA), Network Appliance Inc. (Nasdaq: NTAP), Storage Technology Corp. (StorageTek) (NYSE: STK), Sun Microsystems Inc. (Nasdaq: SUNW), and Veritas Software Corp. (Nasdaq: VRTS).

According to the note written by analyst Laura Conigliaro, anticipated revenue growth for the storage sector is now 6 percent compared to previous guidance of 8.4 percent.

The gloomy outlook is primarily for next year. Goldman Sachs’s vendor forecasts for 2004 mostly remain the same, and a research note issued by RBC Capital Markets last week says storage revenues are in line or slightly above expectations for the current quarter that ends in two weeks.

Further, as the third quarter winds down, it appears likely that fewer companies will issue earnings warnings compared with last quarter.“The current quarter appears to be tracking in line to slightly up in the U.S. market, according to our recent checks with contacts,” RBC’s Tom Curlin writes in a research note.

That apparently doesn’t apply to one area of technology that also impacts the storage market -- components companies. LSI Logic Corp. (NYSE: LSI) and Broadcom Corp. (Nasdaq: BRCM) this week issued earnings warnings for the current quarter, although Broadcom’s storage products don’t appear to be its trouble spot. The other storage company that issued a warning was Adaptec Inc. (Nasdaq: ADPT), which last week said it would hit the low end of guidance (see Adaptec Unveils OEM, Revs Guidance).

LSI’s new forecast calls for revenues of $370 million to $400 million, down from guidance of $435 million to $465 million. Analysts expect a lot of the shortfall will come on LSI’s consumer products, such as chips for game consoles and DVD controllers. With other chipmakers including Texas Instruments Inc. (NYSE: TXN) and National Semiconductor Corp. (NYSE: NSM) also issuing warnings, the problem isn’t limited to storage chips.

But storage components account for 40 percent of LSI’s revenue, so there’s likely a sizeable drop in revenue there, after a 6 percent plunge last quarter. LSI said all of its semiconductor business units were affected by the news. But it’s been mum on Engenio Information Technologies Inc., its storage subsystems business, which runs a profit and accounted for about 25 percent of LSI’s revenue last quarter.

Engenio has other problems right now as a proposed spinoff from LSI is still spinning its wheels (see Engenio Gets Cold Feet). Engenio postponed its scheduled IPO in July because its share price would have been far below its target range. Now sources say performance of the FastT midrange storage systems it sells to IBM -- its biggest customer -- are disappointing.“This quarter numerous contacts have reported displeasure with the FastT line of storage arrays sourced from LSI Logic,” Curlin writes.

Another source says the systems Engenio sells to StorageTek aren’t generating much revenue either. It is widely believed that Engenio will soon announce an OEM deal with Sun for a midrange system, but IBM turned to Adaptec instead of Engenio as its OEM for a new entry-level SAN (see Engenio Certifies Kashya).

Overall, the current quarter looks better for storage sales than last quarter, when HP, Veritas, Emulex Corp. (NYSE: ELX), Adaptec, StorageTek, and Overland Storage Inc. (Nasdaq: OVRL) all disappointed. (See HP Storage Slammed, Veritas Rides Earnings See-Saw, Emulex Cuts Guidance, Jobs, Unknown Document 59442, StorageTek Decries IT Spending, and Overland Guides Under). Those that performed well -- especially EMC, NetApp, and Dell -- were clearly outnumbered (see EMC Bucks June Swoon, NetApp Nets Plenty, and EMC Bucks June Swoon). RBC’s Curlin sees EMC, Network Appliance, QLogic Corp. (Nasdaq: QLGC), and Sun on track to at least meet expectations this quarter, and it doesn’t appear that any major storage company is heading for a huge fall.

Even the dour Goldman Sachs report notes that things could get better before they get a lot worse for storage companies. “Tech follows strong seasonal patterns and we again expect a seasonal uplift for the fourth quarter, in part driven by the year-ending clearing of budgets,” Conigliaro writes. But she also writes of “muted” tech spending growth in 2005.

— Dave Raffo, Senior Editor, Byte and Switch0