Storage specialist solution provider Datalink on Wednesday reported record revenue and strong earnings growth for all of 2008, but tighter customer spending, especially on new products, caused its sales and earnings to drop during the fourth quarter compared to last year.

Charlie Westling, president and CEO of Datalink, said that market conditions in the last few weeks have clearly deteriorated, and that the company is seeing uncertainty and caution in customer purchases. Customers are delaying projects unless there is a clear, immediate ROI or there is an urgent need, Westling said.

The solution provider reported revenue of $48.2 million for the fourth quarter of 2008, which ended Dec. 31. That represented a drop of 5 percent compared to the same quarter last year.

Services revenue for the quarter rose 10 percent, but that was more than offset by a drop in product revenue.

The company said it earned $843,000 or 7 cents per share during the quarter, down 41 percent compared to the $1.4 million or 12 cents per share it reported last year.

For the entire year, revenue was $196 million, which was up about 10 percent compared to all of 2007. Services revenue for the year rose 23 percent compared to a mere 2 percent for product revenue. The company reported earnings of $3.4 million or 27 cents per share, up 183 percent from its earnings of $1.2 million the previous year.

Product revenue fell during the quarter due to a drop in the budget flush normally expected during the fourth quarter, said Greg Barnum, Datalink's vice president of finance and CFO.

Services, on the other hand, were up as customers looked to do more with existing storage infrastructures and engaged more with Datalink on professional services, Barnum said. Margins on services revenue also increased because customers looked for ways to better utilize their existing infrastructures, he said.

For the quarter, about 39 percent of revenue came from disk-based products, 8 percent from tape, 7 percent from software, 4 percent from networking, and 42 percent from services, which Barnum said reflects a big drop in the tape business and a big increase in services.

Barnum said Datalink saw strong bookings early in the fourth quarter, but that bookings slowed in November and December until the last two weeks of the year when they picked up again.

Scott Robinson, Datalink CTO, said fourth-quarter results reflected tight budgets and flat IT head count among customers. However, he said, analyst firm IDC estimates that a typical company's data accumulation grows at 50 percent per year.

"Customers are hunkering down," Robinson said. "But they are looking at efficiencies. They are looking at new vendors or new products that lead to that [increased efficiency]."

Any customer spending on new storage capacity has to be as efficient and as cost-effective as possible, which is leading customers to quickly adopt specific technologies, Robinson said.

One of those is data deduplication, which actually cuts capacity requirements by 10 times or greater in a typical customer environment. That, in turn, leads to decreased spending on power and on data center floor space, Robinson said.

The other key technology is server virtualization, where adoption of products from companies like VMware leads to increased use of shared storage infrastructure, increased capacity utilization and increased productivity, Robinson said.

He cited the case of one unnamed customer that invested $300,000 in virtualization technology and saw its storage capacity utilization increase to 80 percent, compared to 50 percent in the past. That, he said, led to a delay in purchasing of $1.2 million worth of new storage products. By adding deduplication technology, that customer saved an additional $60,000 in storage purchases, and expects to save $30,000 per year. As a result, he said, that customer has grown its data storage capacity to 250 Tbytes compared to 20 Tbytes in the past without having to hire new people to manage the growth.

Going forward, Datalink will continue to focus on virtualization and consolidation, backup and recovery, compliance and database utilization to develop new business practices, Robinson said. "By focusing on these four practices with related services offerings, we can help customers increase the efficiencies of their infrastructures," he said.

Revenue in the fourth quarter also took a hit from reduced vendor rebates stemming from a drop in purchases from vendor partners, both Westling and Robinson said.

"Our vendor partners are still trying to drive growth and set their rebates against growth targets. We are seeing increased flexibility around margin enhancements," Robinson said.

Datalink started the first quarter of 2009 with a backlog of $33 million, Westling said. However, it recently saw five large projects totaling about $6 million get pushed out beyond this quarter due to customer issues with data center power and wiring issues and other issues beyond Datalink's control, he said.

And while those projects were already paid for, Datalink does not recognize revenue until a project is implemented, causing first quarter revenue to be lower than that of the same period last year, he said.

As a result, Datalink expects revenue for this quarter to be between $37 million and $42 million, which compares to last year's revenue of $47.7 million. He also expected the company to post a loss of between 4 cents and 9 cents per share this quarter, compared to a profit of 4 cents per share last year.

In 2009, Datalink expects services revenue to continue to grow faster than product revenue.

While the customer-support part of Datalink's business grew 27 percent in 2008 compared to 2007, Westling said he does not expect it to grow so fast in 2009. "But we could see it grow faster than product revenue this year," he said.

Software sales are expected to continue to grow faster than hardware sales, Robinson said. And whether hardware sales even grow this year is an open question, he said. "I expect software to grow, and software to grow faster than hardware," he said. "But it is a little misleading, because in many cases software is tied to the hardware."