Five months into his tenure as CEO of Hewlett-Packard (HPQ), Leo Apotheker already faces a host of challenges. His board has mostly turned over. The company’s financial results have flagged, along with its share price. Meanwhile, Apotheker has begun to articulate a new strategy for HP around cloud computing, even as it pursues a controversial strategy of designing its own operating system for mobile devices, a move certain to anger its longtime partner, Microsoft. Apotheker sat down for an extended interview with Fortune’s Adam Lashinsky on April 12, 2011 at HP’s Palo Alto, Calif., headquarters. An unedited transcript follows.
FORTUNE: So Leo, I want to start on a very high level if we could. IBM (IBM) is the smarter planet connecting everybody, Oracle (ORCL) is marrying hardware with software for the enterprise. What is HP?
Leo Apotheker: Everybody on. HP is about making sure that we live in a seamless, connected world where information can be shared in a secure way.
FORTUNE: And so what about HP’s product offering is differentiated from its major competitors, which for the sake of argument, are IBM and Oracle, in the sense that they are only enterprise companies? HP is an enterprise and a consumer company.
APOTHEKER So that’s a huge difference for starters. We are also from all of these companies the only one that has actually products and services that range from the consumer all the way to the enterprise. We’re living in a world where the consumer is going to drive enterprise computing, not the other way around, so that gives us a strategic advantage over all the other guys. And then the breadth and the width of our portfolio and the depth of the portfolio, gives us a pretty much unique position.
FORTUNE: So you’re positioning that as a strength, but what’s to say that it doesn’t become, I don’t know, a distraction and turned into a weakness? That way you can’t do the enterprise very well or consumer very well, you end up trying to be too many things.
APOTHEKER Well that’s what good execution and good strategy is all about, isn’t it? You really want to focus on these assets that will drive the total value: What are we all about? We want to make sure that the world can connect easily in a secure way. We want to provide cloud, and we will provide people the intelligence to drive the information from a really small point of view. So it’s analytics, it’s software, it’s the cloud services, it’s connectivity. That’s equally relevant for a consumer as it is relevant for an enterprise. Good execution management, good operational management knows how to drive these things with better focus, extract the synergies, and still drive the capabilities towards the end point, and we’re very good at doing that.
FORTUNE: Now what you’ve said so far is that HP needs to be bigger in software, it’s only about three percent of revenues right now. First of all, can you explain why?
APOTHEKER Well software is the part of the IP that becomes relevant in the usage of all of these technologies. You don’t want a cloud for the sake of the cloud; you don’t connect for the sake of connecting. You do all of this in order to do certain things and usually the way you do these things materialize or translate into software. And therefore for us to be bigger in software is important. Now we are big in software already, we just don’t use it as IP, we use it in order to enable other things. You’ll see HP start to reverse that trend a bit, make IP relevant as IP, and use other things to push more IP.
FORTUNE: Now do you have the assets in-house to flip that switch, or do you need to buy those assets?
APOTHEKER We have some in-house, we will develop some others, we will partner. And every so often, yes we’ll buy something.
FORTUNE: And you say every so often: is it a high priority, medium priority, low priority? What’s the climate for M&A like?
APOTHEKER I think the climate for M&A is pretty good right now, you know, there’s lots of optimism coming back. We are a cash-rich company, we generate good cash flow, so we are capable of doing M&A. But we want to be fiscally responsible, we’ll only do M&A where it makes sense, and we don’t want to overpay for assets either.
FORTUNE: HP did a very large acquisition a decade ago when it bought Compaq, it was a traumatic experience to say the least for the company; it was transformational also. Could you do another acquisition of that scope? I don’t want to say that size, exactly, because the numbers aren’t as meaningful 10 years later, but of that scope?
APOTHEKER Well you have to be careful when you use terms such as transformational or whatever. Usually there is a correlation between transformational and the size of the acquisition, so I don’t want to make any comments on that. But I already said in public that we won’t necessarily make these huge, massive acquisitions. We do want to make acquisitions that will transform part of our portfolio. From that perspective, yes, there will be transformation, but only from that perspective.
FORTUNE: There was a wire report today that HP explored buying Tibco (TIBX), and then didn’t. Can you comment on that?
APOTHEKER No, I don’t comment on rumors.
FORTUNE: OK. The cloud: this is probably your most public initiative, is for HP to be a bigger player than it is in cloud computing. First of all, can you explain that?
APOTHEKER Well I’m a big believer in cloud, HP is a big believer in cloud, and by the way we are already today enabled the vast majority of the cloud services that are available out there today.
FORTUNE: Now this means that HP’s servers for example will be powering somebody’s cloud service…
FORTUNE: …that they’re serving other customers with?
APOTHEKER That means that HP’s infrastructure capabilities, our servers, our storage, our networking capabilities to software that ties it all together, is already powering a big chunk of what you see today in cloud services. Four out of five of the largest cloud service providers use HP, the same is true for the search engines, for the most visited websites. So we are already big time in this game. And we want to actually continue playing in this, we want to help enterprises move from the classical environment to a hybrid environment. I believe people will be on both sides of the fence. They’ll be running their traditional client server or mainframe environments, they want to have some public cloud, they will want to have some private cloud–HP can bring it all together. And yes, we’ll be moving into offering our own cloud services, HP-branded services: infrastructure, platform, open marketplaces, and then the connectivity that actually allows people to use it wherever they want it to be. All secured, and all service by HP.
FORTUNE: And how will that not present a problem with the customers that you already alluded to who you’re serving now–you’re essentially saying you’re going to go into competition against them, right?
APOTHEKER Well we can offer to our customers our own open marketplace capabilities, we can actually re-market some of their capabilities, they can re-market some of our capabilities. You know, the cloud industry, the cloud business is going to go in such a big fashion that there’s enough space for everybody.
FORTUNE: In terms of the new product offering, you said that it’s coming in late 2011. Is that right? What’s the advantage to announcing something early in the year and then offering it later in the year, as opposed to waiting until it’s ready and then announcing it?
APOTHEKER I’m not too sure that we’re kind of talking about the same thing. So we announced a very exciting ensemble of cool connected devices: smartphones and tablets–we call it the TouchPad. That’s coming out in the summer, so that’s very soon. There will be a whole ensemble of new devices that will follow on, and there will be a wider and wider product set from these connected devices that will be on the market as we move along. In the end of 2011, early 2012, etc., etc. So no, we only announce what it is we’re going to make available in the summer, that’s coming up.
FORTUNE: I meant the enterprise cloud services.
APOTHEKER Ah, but enterprise cloud services, that’s actually a journey that will take a few years. So we are making available infrastructure as a service as we speak to enterprises, then there will be platform services, and then additions will come out. It’s a two-year road map; it’s important that customers understand what a road map is, today, so they can actually get organized in order to take benefit from these announcements that we are making.
FORTUNE: Now, you mentioned the TouchPad, this is the tablet product that’s growing out of HP’s acquisition of Palm.
FORTUNE: What about the TouchPad will be better, and all of Palm products for that matter, will be better than say Google Android products or Apple iOS products that are already on the market?
APOTHEKER Well, it has a certain set of very unique capabilities that only we can provide. It’s all by design in a sense, because WebOS is the only operating system that was developed from scratch to be always connected. It assumes that you’re always connected, except when you’re not connected, that gives it a whole kind of web-capabilities that actually no one else has. So we can synchronize all kinds of data points and bring them all together on a device. We can have connectivity between devices: we just touch one device to another and data flows from one device to the other. We can do certain things like parallel processing: you don’t need to work in a synchronous way, you can actually work in parallel, which is very, very interesting, and opens up a whole new vista when it comes to these smart devices that we call smartphones or touch pads. And they’re going to get a lot of attention, and they will pull a lot of attractiveness when it comes to the market it. We feel very good about it.
FORTUNE: Now the way you’re describing, although you’ll be selling them in the enterprise to businesses and to consumers, you sound like they’re positioned to be particularly attractive to enterprises, which is a historic computing strength for Hewlett-Packard.
APOTHEKER Well maybe I should make sure that we all understand each other: we positioned them to be equally attractive for the consumer, as for the enterprise. The sweet spot being what we like to call the pro-sumer, the professional consumer. We believe that we have a very special offer for that particular market segment.
FORTUNE: When you come out this summer you’ll be more than a year behind Apple, and some length of time behind Google, and it’s a very different strategy of licensing for free its operating software to cellphone makers around the world. Why is that not a big disadvantage?
APOTHEKER Because we happen to be the world’s largest PC maker and we happen to be the world’s largest printer maker. And I believe in connectivity not in smartphones; the smartphone is just one use case of connectivity. So as we are making the world connected, a printer is a connected device, a PC is a connected device. For that matter your TV will be a connected device, your home appliance will be a connected device. We can create a platform for developers of 100 million devices a year on an ongoing basis. That is the biggest platform in the world. On that platform we feel confident and we have evidence to prove it, that developers flock to us in order to create applications on that platform. We have also the selling machine behind it to actually distribute it to the consumer and to the enterprise. So yes, we start a little bit late. But we start with the best technology, with the best distribution capability, and probably with the largest platform capability of all vendors. So, history will probably be a better judge of this. But this is not a sprint, this is just a beginning of a marathon.
FORTUNE: So on your market share, smartphones would be something like a fifth- or a sixth-place player now. And your point is look at our position in PCs and in our ability to distribute PCs, don’t look at our share in this younger device market?
APOTHEKER Look, will all due respect for my friends at Apple, who do a great job, they invented the PC and for a number of years they had a huge market share in PCs. And then, the market shifted, and we all know what their market share in PCs is today. It’s a marathon, this is just the beginning.
FORTUNE: Is Hewlett-Packard running the marathon in PCs as well, by which I mean are you absolutely committed to staying in the PC business?
APOTHEKER Look, I am pretty much convinced that there will be convergence over time between the various form factors that we call tablets or Touchpads, and netbooks and notebooks and PCs, these things will come closer and closer together. So from that perspective, of course we are committed to the PC business. It’s a great business for us to be in, we enjoy a strong position there. We are the number one in that business, we have great innovation coming out. The fact that you can now use ARM chips in PCs in conjunction with Windows, creates a whole new dynamic for innovation in that space as well. So yes, we are connected.
FORTUNE: I would say it’s a good business, not a great business, in that it has notoriously thin margins: you sell a PC for far less profit for example than Apple does, even though you sell more PCs. Is that good enough, is my point?
APOTHEKER Well, you know, people always look at the margin, people forget to ask the question which is really important: What’s the return on capital? And the return on capital in the PC business, at least for us, is very high. It’s a great cash flow business. So it has some very nice attributes that makes it very relevant for HP.
FORTUNE: You almost seem to be making the argument on PCs by the way, that X-years down the road we won’t be calling it a PC, and therefore maybe we won’t be in the PC business even though we didn’t exit it in the dramatic fashion that IBM did, for example?
APOTHEKER No, no. I’m making the argument that PCs, like any other piece of intelligent connectivity, will evolve, and we want to be in the driving seat of that evolution. That’s why we are in the PC business today. It might just be called something different in five years, but I will sure hope that HP will be the leader in five years as well.
FORTUNE: Talk a little bit about your competition with Cisco. Cisco is re-trenching as we speak, they’re getting out of the flip-video business, they seem to be acknowledging that maybe they made a mistake getting into the consumer business in the first place. You compete with Cisco on their making servers, you bought 3Com so you’re making networking devices. What’s the state of that competition?
APOTHEKER Well we were actually in the networking business before that, and we bought 3Com to strengthen our offer, and the networking business in HP is a very, very strong business. It’s growing double-digit every quarter, we’re doing very, very well, we’re gaining market share every quarter, significantly, and we are probably one of the reasons why Cisco is re-trenching. So that competition is going strong. I think we are in a much better position than, unfortunately for Cisco, they are in. We don’t see them that much in the server business, they see us much more in the networking side of the house. And given the innovation that we are putting into this, I think they’ll see us even more.
FORTUNE: And how about your high-end video conferencing business?
APOTHEKER That is just a minor line of business. By the way it’s not that different for Cisco, there’s as well. And we have some ideas on what to do in the video conferencing business in general…
FORTUNE: That you have not discussed yet, you mean?
APOTHEKER …But it’s a bit early to talk about that.
FORTUNE: You’ve been on the job now for what, four months, is that right? Five months?
APOTHEKER Five months.
FORTUNE: And correct me if I’m wrong, you haven’t made any major personnel moves in terms of HP management, is that right?
APOTHEKER That’s right.
FORTUNE: And do you intend to?
APOTHEKER You will be the second one to know.
FORTUNE: [laughs] After the person that finds out that they have new responsibilities?
APOTHEKER And there is the board as well.
FORTUNE: I’m not asking necessarily what, the moves you’re going to make, but I’m asking you, do you intend to make moves or are you satisfied with the management as it’s constituted today?
APOTHEKER I have a great management team. HP is fortunate enough to have a strong team, the leadership of this company, we have a good bench. I love working with these guys. Now, there will always be some changes and we’ll make these changes as required, as necessary; we’ll try to bring some talent in, we’ll try to move some people up. But the core team is in place and I’m delighted about that.
FORTUNE: And what’s your sense of the morale of the company, it’s been an up and down story for a very long time now?
APOTHEKER Well, I’m very much committed to make sure that this company is going to be a great place to work at. I believe that in order to be a company that shareholders get the light from, you have to be excellent with your customers and for that you need very motivated employees. So there’s a big effort going on to address some of the issues that you are hinting towards to, I think we are making good progress, I think morale in the company is improving. But it’s never done, it’s one of those things that you always want to be better at. I want to make sure that HP is the best company in the world, also from that perspective.
FORTUNE: Conventional wisdom certainly among investors would be that your predecessor, Mark Hurd, was able to do very well with earnings at Hewlett-Packard by cutting costs, which had the knock-on effect of hurting morale at the company. Again, that’s the conventional wisdom, can you have it both ways? Does it take money to improve morale and does that hurt the expense side of the company?
APOTHEKER Success is the best recipe for morale, and therefore we are focusing on being successful first. For that you need to make some investments in order to be relevant. That doesn’t mean that you don’t want to be very cost-conscious, that means that you want to be very efficient, it means you want to be very effective. But you just can’t cut a business to starvation, that doesn’t work. There comes a moment where you have to create some value. We are about value, we are about creating value in the most efficient way possible. And by the way, there are still a lot of inefficiencies that we can deal with inside HP.
FORTUNE: What’s an example of that?
APOTHEKER When it comes to quality for example, we have to be better in quality. When it comes to innovation, we need to bring innovation much faster to market. That’s all efficiency that we can drive, and we are driving it and there are programs in place to address these in a very, very straightforward manner. So I’m very much committed to that, people respond very well to these ideas; they raise to a challenge. We have great people in HP globally, and I believe that you will see HP coming out of its corner swinging.
FORTUNE: One comment on a major…A significant partner of Hewlett-Packard has for many years now been Microsoft (MSFT). To what extent is embracing WebOS, which you bought from Palm, and building the companies mobile products around your own operating system, a threat to that long-term relationship with Microsoft?
APOTHEKER It’s not a threat at all. People have been writing a lot of stuff on that, that’s good for us. You’re using ink, so please continue. [laughs] But Microsoft doesn’t view it as a threat, and we don’t intend it to be a threat. Future PCs will be running Windows, whatever version, and they will also be running WebOS–it’s not a threat, it’s complimentary. Microsoft knows about WebOS, we know what they want to do. It’s a great partnership and I look forward to continuing that partnership in the future.
FORTUNE: But the argument is the future of the computing industry isn’t in PCs, it’s in mobile devices, and you’re making a major investment in mobile devices. And if the future of mobile devices for Hewlett-Packard does not include Microsoft’s mobile software, that’s a threat to Microsoft?
APOTHEKER Yeah, sure. But I believe the future is in connectivity, not just in mobile devices, and I believe that there will always be some form of heterogeneity in the world. I don’t think people should have a binary, homogeneous view of things. Nobody in the world would be entirely one or the other. Customers want choice, which is one of the challenges some of our competition has. People want choice, people are living in the heterogeneous world, and we want to support that, and WebOS will support heterogeneity.
FORTUNE: Meaning that a WebOS device may well have Microsoft’s software in it as well as HP’s software.
APOTHEKER Yes, for example. Or the cloud might have some Microsoft software in it, that you can access through a WebOS device, or vice versa for that matter. So you have to open up, you have to encourage openness, otherwise we’re going to be in a very dry and sad world.
FORTUNE: So, I mean, if I understand you correctly, you’re suggesting that Apple’s view of the world is, we do it one way, and that’s the only way you’re going to do it, and that’s sad and boring, I think, to use your words?
APOTHEKER Well, it’s a pretty limited point of view of the world, isn’t it? It’s a world-garden approach, and if you can’t get into the garden you can’t play. Unfortunately, 95 percent of the world seems to be out of the garden. So what are we going to do, declare the rest of the world as a desert?
FORTUNE: I’m getting lost in the metaphor, but you’d be a hero with your investors by building the kind of profitability and growth that they’ve built with that limited, boring, walled garden.
APOTHEKER That is absolutely true, and I want to deliver shareholder value by creating a long-term sustainable business, and therefore you have to bring the walls down and not have higher walls. And if you really want to be in connectivity, then you have to address four billion potential connectivity points. That’s just human beings, and I haven’t even spoken about machine to machine, which by the way is hard to do in a walled garden. And therefore that is where the future is going towards to, that’s where I think HP can be positioned really well, and that’s how we will create long-term attractive shareholder value.
FORTUNE: And to reiterate, Microsoft isn’t the least bit concerned that HP is not embracing its vision of mobile operating software?
APOTHEKER Let me just say it this way: I don’t manage Microsoft, that’s a question you should ask Steve and Microsoft. But I can assure you that the relationship between Microsoft and HP is intact and strong.
FORTUNE: Intact and strong?
FORTUNE: How will you measure your success one year into the job, and say three and five years into the job?
APOTHEKER Well, you know, one of the things I want to measure my success, is do we become a better company? Do we have a better return for our shareholders, do we have a better return for our customers? Because these two things are very much correlated. And are we delivering better, newer, more innovative things to the market than ever before? If we achieve all of these things, we’re on a good way, and they’re all interconnected.
FORTUNE: You mentioned your board earlier. Are you satisfied with the way that you reconstituted the board? You’ve taken some criticism for the manner in which you and the new chairman Ray Lane switched out and switched in certain people. Are you satisfied with how that process went?
APOTHEKER So just to be clear, I didn’t drive this process, the board drove this process. And the board drove the process with normal governance procedures, just to be absolutely clean on that. And by the way the vote of the shareholders at the last shareholder meeting, was clear: the new directors have been elected, the entire board has been re-elected. As far as I am concerned, this question is done, over, and we move on in life.
FORTUNE: And how would you describe–I asked you about the morale of the company, how is the morale of HP’s board? You are on the board, even though you’re not the chairman of the board.
APOTHEKER It’s a very strong board, it’s a world-class board. We are privileged and proud to have such a board.
FORTUNE: So as a PC user, I’m very familiar with how the software on my PC works today. I use a BlackBerry, I know I’m using proprietary BlackBerry software, for example. What will an HP PC look like to me as a user in the future, if it has WebOS on it in addition to having Microsoft software on it–and a similar question for a smartphone?
APOTHEKER Let me answer the smartphone question first. HP smartphones and tablets will be running WebOS, only WebOS, at least that’s for the near future, that’s the plan. And the PCs will be running Windows, and you can also then have a WebOS experience on that Windows environment.
FORTUNE: And what’s an example of a WebOS experience–an app store, a mobile app?
APOTHEKER You could access the app store; you could use the WebOS user interface, which makes it very distinctive, on top of a Windows platform.
FORTUNE: But what’s an example of an activity I might use that for? Why would I want to use the WebOS on my PC?
APOTHEKER You would want to synchronize all of your calendars that you have out there on the web: your professional calendar, your personal calendar. If you use third-party service providers for your calendar you can bring it all together in one calendar, synchronize it on the go, automatically on your WebOS environment, as an example.
FORTUNE: With the device you mean?
APOTHEKER On the PC as well, in the future.
FORTUNE: But I mean as an Exchange Outlook user, I can do that today, with Outlook. But you’re saying I can do it with Outlook, with Gmail, and whatever else I want?
APOTHEKER Whatever else, as many as you have. You can update a contact on all of your social media and on your Outlook, by updating one, and automatically all the others will get updated.
FORTUNE: Isn’t this going to drive up the price of the PC, to have two operating systems on it?
APOTHEKER No. No.
FORTUNE: But why not, are you going to get a discount from Microsoft because you’re not using as much of it?
APOTHEKER No, that’s a pricing decision that we have, and we want to make sure that as many people as possible get to enjoy a great experience.
FORTUNE: OK, and that as many people as possible have exposure to your new OS, as well, right?
APOTHEKER As well. And we want to make sure that that gets the kind of proliferation that we wanted to achieve, and for that we have other ways to make sure that we can provide a high-class, highly competitive, hugely differentiated PC at a very competitive price.
FORTUNE: So I’ll ask the question a slightly different way: will it hurt HP’s margins to do that?
FORTUNE: So where will you make up the margin? You’re giving me more–you’re not charging me more.
APOTHEKER Well, there is the app store, for which we will get something, there are some additional services for which we probably will be able to charge something for. And if we add additional features on top of WebOS, it’s a little bit early to talk about them right now, we might be able to charge something for that as well.
FORTUNE: If you’re going to enable your PCs to do more, yet you said your tablets and your smartphones will be purely WebOS, why not make that a heterogeneous experience as well?
APOTHEKER Because that’s a question of capability of the chip that you have inside a smartphone or inside a tablet. At the end of the day, a tablet is still not a PC, so there’s only so much you can cram into a tablet. You have way more space in a PC, where you have more flexibility when it comes to hardware and operating systems, and for that matter, most importantly, for microprocessors.
FORTUNE: Good. Terrific, thank you.
APOTHEKER Thank you.