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It is almost exactly three years since the systems giant Hewlett--Packard (HP) first announced to surprised and somewhat sceptical customers and shareholders that it planned to buy Compaq, one of its biggest rivals, for a record $25 billion. Just getting the deal done took a year, but even now, there are still clear signs that HP has yet to solve all the integration problems posed by the mammoth merger.

By the middle of 2004, with revenues heading towards $80 billion for the year and seven quarters of profit under its belt, analysts were at last beginning to say the merger of the two loss-making companies had worked.

But HP's most recent third quarter results, ending in July 2004, were notable for the poor performance of its server and storage lines, casting a shadow over other areas of its business that continued to grow.

Sales in its Enterprise Server and Storage division fell 5% year-on-year, from $3.5 billion in the third quarter of 2003 to $3.2 billion in this most recent period. The division reported an operating loss of $208 million. To make matters worse, arch rivals IBM, Dell and EMC all reported strong growth.

HP blamed falling sales on problems it has had migrating to a new supply chain system, meaning orders were not fulfilled, and European channel management problems that led to "overly aggressive discounting".

But the problems appear to be most acute at the top end of the lines it acquired from Compaq. Sales of its aging Alpha servers (originally developed by Digital Equipment) were down 32% compared to a year before, while sales of (formerly Tandem) NonStop fault-tolerant computers fell 25%. This contributed to a fall in high-end server sales of 8% to $828 million.

So concerned was HP over this performance - branded "unacceptable" by HP CEO Carly Fiorina - that it announced immediate management changes, including the removal of Peter Blackmore, executive vice president of its Customer Service group. Blackmore, formerly a Compaq executive, had been mooted as a possible successor to Fiorina as CEO by some commentators.

Sales of these systems were expected to fall, as they are due to be replaced, but not so steeply. Analyst company Gartner says that the market for Alpha and NonStop servers is declining. "Companies increasingly favour more open solutions," it says.

HP is also under increased pressure from IBM and even Sun Microsystems, which is fighting back after a difficult period. IBM has been aggressively courting its rivals' Unix server customers with its new Power5 range, based on the company's new microprocessors. In August, Sun unveiled plans to extend its campaign to woo HP server customers, with its 'HP away' programme. Sun is offering 40% discounts to HP's Unix customers that migrate to its servers.

HP has also suffered in its storage sales, which were down 15% year-on-year to $709 million. Sales of its enterprise server storage systems fell, while tape sales also declined.

Analyst firm IDC says that price erosion accounts for some of the fall. But in its most recent results in July 2004, storage rivals EMC reported 40% growth for its high-end Clarion range. Dell, now working in partnership with EMC, is also winning business from HP.

Overall, HP reported sales of $18.9 billion for the third quarter, a 9% increase year-on-year. Its imaging and printing unit posted sales of $5.6 billion.

Analysts believe that HP could recover some of the ground it has lost with improved management and new models. But many are concerned that HP is too weak in software (which accounts for just 1% of revenues) and services (18% of revenues).

In August, HP took one step to tackle this, announcing it had reached an agreement to buy UK-based Synstar for £163 million. Synstar provides services ranging from basic systems and software support to full disaster recovery.

The acquisition will have a negligible impact on HP's services revenues. In its August results, HP's services revenues stood at $3.5 billion. But Synstar will give HP long sought-after skills in disaster recovery, says Douglas Hayward, senior analyst at market watchers Ovum. "With support services, it might seem like a dull but dependable buy. It will certainly give HP services some solidity, with fairly reliable revenues," says Hayward.

Back in 2001, HP thought it had secured Comdisco's service group, one of the world's largest specialist disaster recovery services, for $840 million. However, a US judge ruled in favour of a rival bidder, SunGard. It also failed in its attempts to boost its service arm by acquiring PwC's consultancy division (that ended up at IBM).

Fiorina and her depleted management team must now show that the Compaq acquisition, and indeed that of Synstar, does not form part of HP's patchy M&A record.