HP Services Can't Rescue Grim Second Quarter

"The services business more than doubled its profits and is now our largest segment," said CEO Mark Hurd, reporting HP's earnings for its fiscal second quarter Tuesday. The Palo Alto, Calif.-based company is in the process of laying off 24,600 employees as part of the EDS acquisition, and on Tuesday said it will cut another 6,400 workers, about 2 percent of its total workforce, from its products businesses over the next year.

HP reported a 3 percent decline in overall revenue for the second quarter as compared to the same period in 2008. As was the case in its fiscal first quarter, three of HP's four biggest business groups suffered double-digit revenue declines year-over-year, even as HP Services, buoyed by last year's EDS acquisition, saw sales increase 99 percent against the year-ago period.

The computing giant reported revenue of $27.4 billion for the just-concluded quarter as compared to $28.3 billion in the second quarter of 2008. Second-quarter earnings of $1.7 billion were down by 17 percent compared to the same period in 2008. That was similar to the first quarter, when HP also saw its earnings decline by double digits, with a 13 percent drop year-over-year.

HP Services pulled in $8.5 billion in revenue for the second quarter and operating profit was $1.2 billion, up from $507 million in the previous year's quarter.

"The integration of EDS is going well. The pipeline has grown in double digits since the deal closed [in August 2008]," Hurd said. HP Services also enjoyed 116 percent year-over-year revenue growth in the first quarter and Hurd pledged that "the best days of our performance in our services business are ahead of us."

But the HP chief wasn't as rosy in his outlook for the overall technology market. Hurd said HP would need "to look at more data" before proclaiming that an economic recovery was in sight.

"Our view is that it's roughly going to be the same the rest of the year," he said, but later called it "good news" that the second quarter was "not as volatile" as the first quarter. He also said that enterprise spending on technology was unlikely to loosen up until new yearly IT budgets were made in the fall.

In the first quarter of 2009, the extra income generated by HP Services was enough to actually propel HP to 1 percent overall revenue growth compared to the same period in 2008, even as other HP businesses saw sales decline. But that wasn't the case in the second quarter, when some of HP's major business segments took even bigger hits.

HP's Enterprise Storage and Servers (ESS) business reported total revenue of $3.5 billion, down 28 percent from the second quarter of 2008. Sales for ESS also declined in the first quarter, but by just 18 percent against the previous year's numbers. The Personal Systems Group's (PSG) revenue declined 19 percent year-over-year to $8.2 billion -- about the same as in the first quarter -- even as HP cemented its position as the PC market share leader in every region.

HP Software, which had a single-digit revenue drop in the first quarter compared to the first quarter of 2008, joined HP's other major business groups with a double-digit decline in the second, to the tune of a 15 percent plunge to $880 million in sales. HP Financial Services, with revenue of $641 million, had a 6 percent decline compared to the second quarter of 2008.

The Imaging and Printing Group (IPG) also took a bigger sales hit in the second quarter than it had in the first. Revenue declined 23 percent year-over-year to $5.9 billion, as compared to the first quarter's 19 percent drop.

HP's printing business came under particular scrutiny ahead of Tuesday's earnings report, with particular attention being paid to IPG supplies revenue. Sales of printer consumables dropped 14 percent in the second quarter, due to "lower user demand and reductions in channel inventory," according to HP's chief financial officer Cathie Lesjak.

Ahead of its earnings release, Raymond James analyst Brian Alexander said sales of printing supplies "will probably stay negative for the rest of the year" as large corporate customers and consumers cut back on purchasing products like ink.

But HP channel partners servicing smaller and midsize business customers may not be feeling the same pinch as retailers and enterprise-focused HP resellers.

"I'd say HP sales have dropped in the last two years, but they're still quite respectable," said Mark Szalkiewicz, a senior account manager at Horizon Computer Resources in Sacramento, Calif.

Szalkiewicz, who is also a Xerox reseller, said that his company has not seen a drop in consumables, despite spending pullbacks.

"We're still seeing a lot of color adoption and moving quite a bit of color on the consumable side," he said, but added that Horizon's sales cycles are getting longer.

"We're seeing people take a closer look and scrutinize what they're spending. Instead of taking a 36-month lease, customers may stretch that. Obviously, they're taking longer than we'd like," Szalkiewicz said.

Michele Masterson contributed to this article.