Data Storage Feels the Pain of Tech Slowdown Covey: ‘Companies have pulled back on budgets… shelved products and haven’t deployed new applications.’ By SHELLY GARCIA Senior Reporter A year ago, data storage was the darling of information technology management some estimates projected the category would account for 70 percent of IT spending by 2005. Fast forward to today’s economy and, instead of taking priority over other types of spending, data storage is feeling the same pain as nearly every other IT category. “What I think has happened is that companies have pulled back on budgets, they’ve shelved projects and they haven’t deployed new applications,” said Bob Covey, vice president of marketing for QualStar Corp., a Simi-Valley based provider of automated tape storage solutions. With the corporate march to e-commerce all but ended and the overall recessionary climate still in place, it is no surprise that IT spending has been greatly reduced. But what is so unexpected about the cutback in a sector like data storage is that, unlike the speculative nature of the Internet frenzy, the promised growth in data storage was based on a real and legitimate need for storing, managing and protecting the information that is corporate America’s stock and trade. Add to that the fears raised by the Sept. 11 attacks where protecting data is concerned, and some might expect spending on data storage to escalate enormously. Instead, even industry leaders have seen their stars dim over the past six months. “There is unquestionably a need for increased data storage in the future,” said Robert V. Green, a technology analyst for Briefing.com. “But we’re talking about millions and millions of dollars, and no one has put the budget in place yet. So, while the need is becoming clear, no one has rushed right out to spend the money to do so yet.” With the emergence and advances in Internet technology, the need to manage the sheer volume of data reports, streaming video and audio grew all the more demanding. At the most basic level, companies need to back up data, but ultimately, most businesses and large organizations are moving toward ways to manage data in increasingly complex ways so that it can be saved, accessed and distributed on different systems, and to protect it from loss. The dramatic downturn in IT spending that began last year impacted all sectors of data storage, but some, like disk and tape storage, were hardest hit. “Many companies had already revamped storage and server strategies in and around Y2K and companies had also added capacity in anticipation of the continuing growth we’d seen in 1999 and 2000,” said Covey, at QualStar. “So when business slowed down in 2001, they already had some excess capacity.” QualStar last month reported that for its second quarter ended Dec. 31, revenues declined to $10 million from $15.5 million in the comparable period last year and net income dropped more than 47 percent to $1.2 million or $0.10 per diluted share from $2.3 million or $0.18 per diluted share in the second quarter of fiscal 2001. QualStar had moved to Simi Valley, doubling the size of its facility in anticipation of the growth in the category, about a year ago. But the market changed dramatically since then. Even now, QualStar executives say, the outlook is so uncertain, they are unable to give guidance beyond the third quarter, when they expect sales and income to be flat or slightly higher than second-quarter results. “We’ve seen perhaps the economy hit bottom, but we haven’t seen a robust turnaround, and things aren’t like they were a year ago,” said Bill Gervais, president and CEO of QualStar. “We’re just playing it safe to make sure we’re not promising things we can’t deliver.” Analysts are more sanguine about QualStar’s prospects, but they note the outlook for IT spending continues to be uncertain. “While we believe this guidance is setting the bar low, we are concerned regarding the lack of guidance beyond next quarter,” said Scott P. Sutherland, an analyst with Wedbush Morgan Securities. “IT spending has definitely created a difficult environment to forecast.” Corporate users have scaled back IT budgets dramatically in response both to the downturn in the economy and, in some cases, to the exorbitant expenditures invested in Internet technology that did not yield the expected results. At the same time, much of the hardware-related storage business has become a commodity business subject to intense price pressure. Market researcher International Data Corp. revised its predictions for growth in the hardware segment to just under 4 percent over the next four years, compared to earlier prognostications of a 12-percent annual growth rate. The more sophisticated storage networking segment has not been subject to the same price pressures, but that sector too has softened. “All expectations have come down across all categories of technology, so it’s not growing at the 50-percent to 100-percent growth rates we expected to see coming into calendar ’01,” said Steve Denegri, a managing director at RBC Capital Markets. “While some thought that data storage would circumvent the economic challenges, all segments of technology were affected.” But if the horizon for a recovery in some sectors remains uncertain, prospects are considerably brighter for storage networking, Denegri said. “One of the interesting outcomes of our research since Sept. 11 is the appetite for network storage has increased, primarily because it enables an architecture for disaster recovery.” Indeed, one local company, Troika Networks Inc., has already seen a sharp upturn in business in recent months. “The fourth quarter of last year October, November and December was the best revenue quarter in the history of the company,” said Alan Skidmore, CEO of Westlake Village-based Troika, a provider of fiber-optic storage networking solutions. “Even though managers have had to double check on their purchasing decisions, at the end of the day they’re realizing their data storage requirements are critical and they’ve moved forward on purchasing decisions.” The events of Sept. 11, along with the juggernaut that is the information technology revolution, will lead a rebound across all segments of the data storage business eventually, industry experts say. “Ultimately, once the technology segment starts to come back into favor, the storage group is likely to see the first fruits of the comeback,” said Denegri.