Lou Gerstner CEO IBM Speech 1998 Shareholders Speech Chicago, Illinois April 28, 1998 I'd like to start with some news of interest to all of you here. This morning your board of directors approved a 10 percent increase in the quarterly dividend -- from 20 to 22 cents per common share. Of course, that's on a post-split basis. This means that over the last three years, your dividend payments have increased by 76 percent. The dividend is payable on June 10 to shareholders of record on May 8. The board also authorized another $3.5 billion for the repurchase of IBM shares. In a couple of minutes I'm going to say more about our actions to increase shareholder value, but I thought you'd want that news up front. As I said a moment ago, we're delighted to be holding this meeting in Chicago. Nearly 5,100 IBMers across Chicagoland represent our all-time peak employment in the area -- more than twice as many people as were employed by IBM here as recently as 1995. You may also know that in 1995 Chicago's Public Schools received a $2 million grant as part of IBM's $35 million Reinventing Education program. IBM researchers are working with 7th and 8th grade math teachers in Chicago, using information technologies to transform one of the most archaic aspects of our nation's system of K-12 education -- namely, the way we train teachers and prepare them to help our kids achieve at world-class levels. At last year's meeting of shareholders in Dallas, I reported that IBM's transformation was on track and that we had our sights set on leadership -- in particular, leadership in the rapidly emerging networked world. A lot has happened since that meeting. You know our financial story. We reported record revenue for the third straight year, and record earnings per share. We continued to build shareholder value and to invest our cash productively. To fuel the exploration and development of future technologies, we invested $5.5 billion in research and development. Nearly $7 billion was invested in capital expenditures to strengthen our existing businesses. For example, we'll spend $700 million to build one of the world's most advanced semiconductor development facilities. We invested $700 million to acquire companies like Unison, a leader in systems management software. And we invested more than $660 million in the ongoing internal reengineering of IBM, which is paying off in reduced cycle times and improved customer service. We still had substantial cash to return to our shareholders -- directly through dividends, and indirectly by investing $7 billion to repurchase IBM shares. All of these investments, totaling about $20 billion, were completed and we still ended the year with more than $7 billion in cash on hand. Last year, our total market value increased by $23 billion. And it's up about another $10 billion so far this year. A moment ago, the stock was up to $118, so we're still working. We split the stock for the first time since 1979. And within a few days, the stock hit a new all-time high. And we posted a new record high a week ago today. So in terms of business performance, 1997 was a solid, a very solid, year. In terms of technology performance, I think we can call it a great year. For the fifth year in a row, we led the world in new U.S. patent awards. I'm even more pleased to report that one third of our 1997 patents are already at work in IBM products. RS/6000 technology went to Mars aboard the Pathfinder and it guided the rover on its tour of the Martian landscape. From our lab outside Beijing -- a major breakthrough in ease of use with speech recognition for Mandarin. It opens up the world of computing to a quarter of the world's people -- without forcing them to master typing in their native language. I remember the president of China once saying to me that I should learn Mandarin, but when I heard that its "alphabet" contains 6,700 characters, I decided to pass. The resurgence in our storage business continued in 1997 due in large measure to our technology leadership in disk drives. Our teams established new world records for storage densities and delivered the world's highest-capacity PC drives. They're about the size of an audiocassette, but they hold the equivalent of a stack of printed paper higher than the John Hancock Building. That's pretty good. But I've told our storage teams that this year I want that stack to be higher than the Sears Tower. This kind of technology leadership is a big reason sales of computer components -- mainly chips and disk drives -- has grown from practically nothing to $6 billion in business for IBM in five years. In chip development, our scientists solved a puzzle that had stumped the semiconductor industry for 30 years: How to use copper -- which conducts electricity 40 percent better than aluminum -- in the tiny wires inside a computer chip. I'm pleased to report that we'll have these smaller, more powerful copper chips in the marketplace within months. Not a year from now. This summer. And finally, Deep Blue: A friendly game of chess between a supercomputer and grand master Garry Kasparov -- an event that forced the world to fundamentally re-examine the nature of thought, and the relationship of man and machine. So a lot done in 1997. We're healthy and on track. As I prepared to talk with you today, I went back and reread my remarks from last year's annual meeting. Not surprisingly, most of that speech dealt with IBM's view of the connected world. Who would use the Net, and how? What would they do? How would they benefit? For the last couple of years, it's been important for us to explain IBM's view, because it was markedly different from the prevailing wisdom. While most people were obsessed with "content" , and consumer applications like movies on demand and online magazines, we saw things another way. As early as 1996, we were saying the Net was about business, not browsing. About commerce, not content. Last year, we coined a new term -- e-business -- and launched a global campaign to tell our customers all about it. E-business isn't just about buying and selling on the Net -- although that's a huge opportunity. E-business describes all the ways individuals and institutions derive value from the Net. It includes transactions among employees within a business to improve the way ideas are shared, and teams perform... Transactions across supply chains -- improving cycle times and efficiencies between a business and its suppliers, distributors and retailers. We see the total market for Internet commerce hitting $200 billion by the end of the century, most of that in business-to-business activity. And you don't have to look very hard to find forecasts that exceed that by orders of magnitude. And it's not just limited to the commercial world. E-business includes all the world's important interactions -- between governments and citizens, students and educators, healthcare providers and patients. When we launched our campaign these were new ideas. Now, just a few months later, I'm pleased to report that the marketplace has ratified our position. In the key markets we track, one in four key decision makers knows the term e-business -- which didn't even exist one year ago. Among these decision makers, IBM is seen as the company for e-business solutions -- by a 2 to 1 margin over our closest rival. Every day there are new examples of enterprises fundamentally transforming themselves through the Net. From giant financial services firms like First Chicago/Banc One and ABN AMRO delivering networked home banking services, to a small business in Allentown, Pennsylvania, that's in the prosaic business of work boots. Their market was once defined by how many factories they could reach by truck, because that's how they sold their boots -- off the backs of trucks. Now, they sell boots via the Net, and they're taking orders from China, Indonesia, and from workers on off-shore oil rigs. Suddenly, they're a global company thanks to the Net and they've increased revenue 150 percent. Now, what does this transformation mean for IBM? It means that the networked world, or what some call the networked economy, plays precisely to the things we do best. First, our way of working with customers -- starting with helping them plan strategy. And believe me, they are asking for help. Because their biggest issues and toughest decisions aren't about technology. They're about how to participate and exploit the networked world. Think about any traditional retailer making the decision to go into Net-based sales. They've already got big investments in brick-and-mortar store fronts. Selling directly over the Net puts them into competition -- with themselves. Think about a Wall Street brokerage. Does it have to become a discount broker to compete with companies offering dirt cheap trading on the Net? Tough issues. And over the last year or so, we've helped thousands of customers develop a network strategy that's right for them. This is what we mean when we say IBM is a solutions company. We start with a customer's business problem, and work back to the right combination of technologies and expertise. This drives enormous demand for services: Our services business continues to grow substantially faster than the industry -- up 28 percent last year, and 27 percent in the first quarter. We have long-term contracts worth tens of billions of dollars recently signed with leadership companies including Ameritech, Lucent and GE Capital. In the first quarter, we added eight new services contracts worth more than $100 million each, including deals with two major Japanese companies -- which may signal that the world's second largest economy is becoming a rich new market for strategic outsourcing. And we're very pleased that some of our existing services customers, like Hertz, are renewing and in some cases, expanding their contracts with us. Of course, customers taking their business to the Net need a range of technologies. And not just browsers, search engines and any of the other cool technologies that are important to Internet users. When customers take their business to the Net and make their Web site the front door of their enterprise, that door is open 7 days a week, 24 hours a day, 365 days a year -- no lunch breaks, no weekend closings. And when hundreds of thousands of people walk through that cyber door at the same time -- as they did with our site during the Nagano Winter Games -- the customer's computing infrastructure has to easily scale up to handle that load. So by definition, e-business technology is serious enterprise computing technology: Industrial-strength servers, bullet-proof databases, powerful transaction systems and comprehensive systems management tools. As more and more e-business applications come online, we're seeing growing demand for our entire portfolio of enterprise computing products. In System/390, we've shipped record computing power for five years in a row -- up 30 percent last year alone -- up about 45 percent in the first quarter of this year. In about a month, we'll mark the 10th anniversary of the AS/400, the world's most popular midrange system. This war horse underwent a radical transformation last year. It's now completely Web-ready and it grew revenue in double digits in the first quarter. The RS/6000 SP, our line of supercomputers -- symbolized by Deep Blue -- has had three straight years of double-digit growth. Our Netfinity PC servers are growing faster than the marketplace and gaining share. Distributed software products like DB2 and CICS are growing faster than the industry. Three years ago, when we acquired Lotus, there were 2 million users of Notes. Today, there are 22 million Lotus Notes users. Tivoli, our other major software acquisition, is an extraordinary story. Revenue from their distributed software actually doubled last year. Those are some of the reasons we believe e-business will be a strong growth engine for IBM. At the same time, we're looking out for the next big marketplace opportunities. Let me briefly tell you about two of the most important ones. The first is what we call "Deep Computing." Yes, the name is inspired by Deep Blue. Deep Computing describes an emerging class of computer systems that, like Deep Blue, combine very sophisticated analytical software with superfast processing. How fast? Well, consider that Deep Blue was able to calculate 200 million possible chess moves per second. Last week we announced a new RS/6000 SP that's five times more powerful. If it were playing chess, it could analyze a billion moves per second. In the year since Deep Blue's historic victory, we have moved on to apply what we learned to much bigger challenges than chess. We're working with the Department of Energy to build an SP supercomputer that will be the fastest in history -- capable of a trillion calculations a second. The agency will use it to simulate nuclear reactions, eliminating the need for live weapons tests. Pharmaceutical firms can mimic chemical reactions and cut years off drug research and development through Deep Computing. And there are scores of other applications -- from weather forecasting to predicting financial markets. (I suspect that will be the hardest). A big new application area is called data mining -- sifting through mountains of information to find patterns and relationships that were previously unforeseen. The second important trend we are preparing for is called "pervasive computing" -- "pervasive" because computing is about to permeate nearly everything around us. This is possible because computer chips are getting so small and inexpensive that it's possible to embed them in everything: In clothes, in cars, household appliances, consumer goods, machine tools. So the networked world, which will soon allow perhaps a billion people to interact with a million e-businesses will extend further to interconnect perhaps a trillion "intelligent" devices. The applications and implications are really intriguing. Let's say you're a company that has millions of vending machines all over the world. How do you know exactly what's selling, how much is left in the machine, and when to dispatch your route drivers? You could track all that with a little chip in each machine, and some companies already are. Now, let's suppose it's a soda pop machine, and that machine had a thermostat that could tell it: "It's freezing here, drop the price by a quarter."Or better yet:" It's 98 degrees. Up the price by a quarter." Like e-business, pervasive computing will make work and life easier and more fun for individuals, but the real payoff will be for enterprises that deploy these devices to amass knowledge -- knowledge about product performance, knowledge about customer preferences, and buying patterns -- all things they can use to build better products and get closer to customers. Now, I've covered a lot of ground fairly quickly. Let me show you a short video that illustrates many of these ideas coming out of IBM research and development. [ROLL VIDEO] Now, I thought about doing live demonstrations of some of those technologies, but we all know how risky that can be, especially in front of big audiences, in Chicago, on this stage. So that's just a quick look at some of the things we're working on and where we see the industry headed. Every day, there's new evidence that our fundamental strategies are correct. We see it foremost in the decisions by our customers. And we also see it, interestingly, in the actions of our competitors: PC vendors like Compaq buying Digital to get a toe hold in the services business. Computer Associates trying, and failing, to take over Computer Sciences. Microsoft scrambling to line up partners to build an enterprise strategy. They're all doing the same thing. They're trying to morph themselves into companies that can offer what we already have under the IBM logo. I like our chances in this kind of race. I like our odds against any of the IBM wanna-be's. So as we look ahead to 1998 and beyond, the priorities for all of us at IBM are clear: Relentless improvement in our execution. Aggressively investing in new technologies, new markets and new skills for our people. And finally, accelerating the companywide reengineering of IBM: From our organizations and processes -- to our mindset and the behaviors that will drive the high-performance culture we need to win. All across IBM that culture is taking shape today. IBM people are energized today in ways I haven't seen in my five years here, and some of my colleagues say they've never seen. Their spark is the final reason -- maybe the most powerful reason -- I have for telling you that our course is correct. Some of these people are new to IBM -- the best talent we can find. More than 29,000 people chose to join our team in 1997; another 26,000 signed on the year before. Others have been with us 5, 10, 20 years or more. They possess a special quality. They've seen hard times, they've come through them, and they carry a personal commitment to never, ever go back. Together, we're committed to return IBM to the top. To industry leadership. And so on behalf of the 270,000 people of IBM, I thank you for your support and the confidence you've placed in us.