On Wednesday, HP CFO and interim CEO Cathie Lesjak was interviewed by Citigroup technology analyst Richard Gardner at the bank’s Global Technology Conference in New York.
The full transcript is available at our investor relations website; highlights are below.
[Editor’s note: emphasis in bold has been added to make the text easier to skim]
On HP’s investment in R&D
Richard Gardner: I think part of what makes it difficult for investors to benchmark you against other companies in terms of R&D investment is that you have such a diverse portfolio. And, at this point, services, which is not an R&D-intensive business, is 40% of your operating profit. Could you talk about maybe how you take a look at each of the individual businesses and how you feel like you stack up against industry-leading competitors in terms of R&D as a percent of sales?
Cathie Lesjak: It is important to look at HP on a disaggregated basis…we basically do look at it segment by segment and then think about where we want to put our R&D dollars.
And one of the things that has really allowed us to bring down R&D dollars…is the fact that there are IT allocations, there are real estate allocations, there are other shared service allocations that go into the R&D line, which fundamentally allows us to be more efficient because those allocations are lower.
They don't change the amount of dollars going to innovation. And if you actually look at the total HP and you look at the number of innovation R&D…engineers across the Company, we're actually up over the last five years. We have not decreased the number of people working on innovation for HP.
On 3COM and networking
Cathie Lesjak: From an acquisition perspective, the 3Com acquisition is basically above plan from both a revenue perspective and an operating profit perspective. In fact, the gross margins in that space are better than we modeled by quite a bit…They're up over 60%. And, like I said, it's pulling ProCurve margins up as well - the whole halo effect. Being able to go and talk to customers about the whole stack is incredibly positive and giving us great benefits.
On growing IPG
Cathie Lesjak: In Q3, we grew on top line revenues 9%. We grew our laser jet unit 44%....And we expect to be able to deliver greater than 30% unit growth in lasers yet again in Q4. So, in total for the year, we will increase both ink jet units and laser jet units double digits…
In terms of the trends that we see, there's the analog to digital conversion, which is generating roughly 200 billion additional pages digitally, which is where we play.
Cathie Lesjak: We at HP are very excited about winning the 3PAR deal. It is a very strategic position for us because it gives us both a cloud and a service provider offering in the storage space. So, if you think about cloud, storage cloud is expected to grow greater than 40% on a CAGR basis through 2013. So 2013, it will be about a $6-billion business.
And the offering that 3PAR has is a unique offering in the cloud space…It also gives us now our own IP in a big chunk of the high end of the storage market…
We've now converted from having OEM low margin to higher margin. So there are good margin synergies at the high end of the stack. And so we just-- We think this is going to situate us very well within our converged infrastructure space, where you really need strong storage offering - especially, a cloud-based storage offering - a networking offering, and a compute offering…
Obviously, it's not a cost synergy play at all, although there would be good operating leverage. The margins on 3PAR are in excess of 65% from a gross margin perspective. So, again, this is another example of us investing in the higher gross margin products - networking and now this storage play - that will help move up our gross margin on average and improve our operating margin at the end of the day as well.
On HP’s M&A process
Cathie Lesjak: So, from an M&A perspective, and 3PAR was no different than any other thought process around M&A-- The first thing is - Is it strategic? Does it make economic sense?
…And you basically lay out your cash flows or your P&L and cash flows out a number of years. And then you basically do a discounted cash flow analysis. The discount rate that we use is a risk-adjusted discount rate for a storage play. And the way we come up with that is we basically go out and look at betas for pure-play storage companies and, basically, put that through a model…And that basically tells us what the value of that asset is to Hewlett-Packard, both the standalone, plus the synergies.
And then, based on that, we come up with what our plan is…And, obviously, we try desperately to get it as low as we possibly can, to keep as much of the economics of the deal for the HP shareholders. Obviously, in competitive situations, sometimes you give away more-- a bigger chunk of those synergies to the target company's shareholders.
But we always make sure that we get the majority of the synergies for our shareholders. In the case of 3PAR, obviously, it was a competitive bidding situation. We had a walk-away price. We got it below our walk-away price. And we believe that this will generate more than its cost of capital.
On the health of the PC business:
Cathie Lesjak: We grew revenue last quarter 18% or 19% and have a very broad portfolio. We have real opportunities in-- frankly, in desktop virtualization area, where we're number one in that market and are starting to see some really positive signs as some of the financial services companies are leading the market in that space and rolling out more virtual desktop solutions, which is just very accretive to HP.
Lots of people ask me - Isn't [virtual desktops] going to hurt your PC business? That is a solution. It's a solution of hardware, software, and services that is margin accretive for the business.
And so we continue to feel good about the PC business and don't really see what's happening there from a unit share perspective as really-- a real change in market dynamics at all.
On the CEO search:
Cathie Lesjak: As you all know, we have a search committee. And it's their job to really focus on getting us the best CEO, in my mind, maybe a bit selfishly, as quickly as they can. And I think they're very focused on doing that and very committed to going--moving the process through quickly.
We've got Spencer Stuart we've hired, who is not only helping us with external candidates but also helping us, basically, at the internal ones. So they're really kind of the glue that holds those two together. And, like I said, the search committee is actively interviewing.
We've been very pleased with the selection of candidates. I think there was some worry that maybe there weren't going to be that many. But that certainly doesn't seem to be the issue. And so now it's just a matter of kind of getting everyone scheduled and through the interview process as quickly as possible so that they can make their decision.
On internal v. external CEO candidates
Cathie Lesjak: You know, I think that they are pretty open to either. From what I've heard from them in my discussions, they're basically looking at both internal and external, pretty much as we always do.
When I got hired four years ago, the-- I was part of an internal and an external search for the CFO. And what we look for is whether or not what you're going to get externally is kind of above and beyond what you might be able to get internally that would justify going external.
And there are going to be times when that will be the case, and there will be times when it's-- the value tradeoff that you're going to make is better to go internal. And I think that's exactly how they're thinking about it.
On the suit against Mark Hurd and HP’s relationship with Oracle
Cathie Lesjak: I think the clarification I need to make is that we actually have not filed suit against Oracle. We have actually filed suit against Mark. And Mark signed a number of agreements to basically keep trade secrets and confidential information confidential…
In terms of how it's going to affect our relationship with Oracle, obviously, with the press that Ellison had yesterday, you can imagine it strained it a bit. But I think, at the end of the day, business will prevail. And, ultimately, we will go back to being good partners-- and competitors where we've been competitors and partners where we've been partners, because I believe that HP is important to Oracle, and Oracle is an important partner of ours.