Editor’s note: HP (NYSE: HPQ) on Wednesday reported an increase in revenue for its most recent quarter, ending a streak of 11-straight declines. Surging PC and x86 server revenues helped – two markets where Lenovo either leads the world or hopes to when its $2.3B deal for IBM’s x86 business closes. Analyst Jack Narcotta of Technology Business Research examines HP’s earnings report.

HAMPTON, N.H. – HP’s revitalized PC business and healthy revenue growth of x86 servers show some, but not all, of the pieces are beginning to fall into place

HP CEO Meg Whitman’s multifaceted turnaround plan continues to grow HP’s stockpile of cash, shielding the company from the effects of a volatile market, as well as position it to invest in growing enterprise segments such as cloud, big data and security. However, the prolonged transition of its traditional business model – selling individual products and discrete solutions stacks – into the solutions-led focus that aims to drives market share growth will limit its ability to stem attrition of enterprises to vendors offering less expensive solutions, such as Lenovo and a growing number of white-box vendors.

Despite HP’s total revenue in calendar 2Q14 increasing only 1% to $27.6 billion, TBR believes HP is making progress aligning its wide product portfolio to trends in PC markets and strengthening its go-to-market messaging across all facets of the enterprise marketplace. A revitalized PC business, especially consumer PCs, and sustained success in its x86 server business are positive signs that highlight the segments that will fuel HP’s evolution into an end-to-end solutions provider.

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Additionally, HP’s revitalized PC business and its ability to counter Dell’s and Lenovo’s efforts to infiltrate HP’s x86 server installed base show how HP’s initiatives to leverage an empowered roster of channel partners to sustain revenue growth is bearing fruit.

However, while 2Q14’s results demonstrate HP’s proficiency as a hardware vendor, it is still struggling to develop compelling messaging that fosters deeper customer engagement segments beyond servers and PCs. Storage, software and services revenues declined year-to-year in 2Q14, illustrating the challenges HP faces in aligning its go-to-market messaging to evolving trends in these fast-moving markets.

Dell’s efforts to strengthen its channel operations, combined with the imminent entrance of Lenovo into the data center market and the increased traction utilization of cloud-based services from Amazon and Google, further complicate HP’s long-term growth strategies.

As a result, TBR expects flat revenue and operating profit growth from HP through 2015 as its advances in PC and server markets are offset by declines in its services, software and storage businesses driven by pricing pressures applied by cloud-based service providers and more nimble hardware vendors.

  • Enterprise demand for 2-in-1 PCs shows HP how it can reignite its PC business, but the devices will be unable to sustain momentum through 2015

With 2-in-1 PCs well-established as a product segment in the PC market, PC vendors are better equipped to boost their appeal in their consumer and commercial install bases. However, total PC market growth remains modest as PC market share gains by Lenovo, HP and Dell are at the expense of Acer, Asus and Toshiba. With the PC market in a “replacement” phase, leading vendors such as Lenovo and HP will shift focus to the higher-margin 2-in-1 PCs to improve profitability.

To combat Lenovo’s sustained momentum in the marketplace and protect its install base, HP expanded its notebook PC portfolio beyond traditional clamshell form factors to 2-in-1 PCs that better align with the needs of an increasingly mobile workforce. However, with the market for 2-in-1 PCs growing as Windows 8 adoption increases in tandem with workforce mobility, rival Lenovo is using similarly designed PCs and the allure of its ThinkPad and Yoga brands to position itself as the leader in this emerging segment.

With HP’s turnaround strategy hinging on protecting, then boosting profitability across all its lines of business, TBR believes PSG revenue growth was buoyed by an overdue refresh of enterprise endpoints, propelling commercial PC revenue up 14% year-to-year. However, aggressive pricing from Dell as it aims to sustain the resurgence in its PC business and the proliferation of Lenovo’s ThinkPad and Yoga devices risk muting the value proposition of HP’s 2-in-1 PCs, priming PSG for flattened growth in 1H15.

PSG revenue rose 12% year-to-year to $8.6 billion in 2Q14, the largest year-to-year increase in nearly four years. Commercial PC revenue climbed 14% year-to-year in 1Q14, illustrating the strength of HP’s portfolio in that market and the effect of PC refreshes to Windows 7 and 8 devices due to the end-of-service date for Windows XP in April 2014. In consumer markets, HP’s expanded portfolio, especially for devices between $350 and $400, helped counter the continued pressure from rivals such as Lenovo and Asus, as well as a continued proliferation of Android and Apple tablets into the consumer marketplace. PSG’s consumer PC revenue fell 8% year-to-year.

  • Sustaining x86 revenue growth is essential to HP’s long-term data center growth strategy, but HP is challenged to craft the right go-to-market messaging

HP is focusing its data center messaging on selling bundled hardware, software and service solutions aimed at helping enterprises solve business problems, rather than selling piece-part servers and storage differentiated by product specifications. TBR believes that by helping enterprises build secure and nimble data center infrastructures to capitalize on big data, analytics, cloud, security and mobility opportunities, HP will strengthen its reputation as a trusted adviser to IT and deepen customer loyalty. This will allow HP to weave in its software, support services and converged systems into the day-to-day operations of its clients.

An uptick in revenue in 2Q14 from its Industry Standard Server (ISS) segment, which climbed 8.6% year-to-year to $3.1 billion, shows that the company’s revamped go-to-market strategy is not only helping protect its position at the top of the x86 server market, but also expand market share, likely at the expense of IBM and, to a lesser extent, Dell.

However, TBR believes HP’s core competencies are firmly rooted in its IT products, and as such its business model is still evolving into that of a “business solutions” company, limiting the impact of its new go-to-market strategy on the service, software and storage components within its Enterprise Group. Technology Services, Software and Storage revenues all decreased year-to-year, with Storage falling down 4% year-to-year to $769 million as traditional tape and hard-disk-based storage fell 14% year-to-year to $432 million.

New storage and server products released in the first half of 2014 that are designed to allow enterprises to implement big data, analytics, security and mobility illustrate HP’s awareness of the trends influencing the enterprise market. HP’s converged storage revenue of $364 million was up 9% year-to-year from 2Q13, the third time in the last four quarters that converged storage revenue climbed year-to-year.

However, this added layer of complexity – laid over an already broad and complex portfolio – dilutes HP’s messaging to enterprises in its important mid-tier and large enterprise markets. Without a greater focus on business outcomes,

TBR believes HP’s Enterprise Group will face competitive and pricing headwinds, exacerbated by Lenovo in later 2014, even as revenue performance from servers improves.

TBR expects storage markets become more competitive due to increase commoditization and fierce competition in the midmarket, and HP will grapple with rebuilding the cachet of its organic Technology Services portfolio as enterprises transition data center management to cloud-based service providers.