Chairman and CEO letter

ABB chairman, Hubertus von Grünberg, and CEO Ulrich Spiesshofer (photo)

Dear shareholders,

2014 was a demanding and difficult year, in which we had to navigate in an uncertain, volatile market environment and to overcome internal challenges in our Power Systems division. Geopolitical tensions in the Ukraine and the Middle East, a slow world economy, turbulence in energy markets and the health crisis in West Africa made 2014 a particularly challenging year for global businesses.

Our global team in ABB demonstrated in 2014 that our business of power and automation is well positioned in attractive markets with long-term prospects, and that our strategic alignment works. In the face of major external and internal challenges, we delivered on our promises to drive organic order growth through our “PIE” formula of Penetration, Innovation and Expansion, and to restore Power Systems to profitability. A major highlight of the year was the development and launch of our new strategy, “Next Level”, for the 2015–2020 period. We laid the foundations for its implementation and therefore for accelerated sustainable value creation.

Strong orders and business execution

In 2014, we delivered robust growth in orders of 10 percent on a like-for-like basis to $41.5 billion. Orders were steady to higher in all regions and divisions, driven by our organic growth initiatives and continued focused investments in innovation, customer service and sales. Base orders, the backbone of our business, grew every quarter on a like-for-like basis and we finished the year with an increased order backlog (in local currencies) that will support revenues in the years ahead.

In Power Systems, we made solid progress in turning the division around by reducing its risk profile, changing the business model and setting it back on a path to long-term growth and profitability. This involved exiting engineering, procurement and construction (EPC) projects in the solar power generation sector and changing our business model in the offshore wind sector. We dealt with operational legacy issues and adjusted the focus of the division towards projects suited to our core competencies of power transmission and conversion. We delivered on our ambition of breaking even for the full year. The Power Systems division increased base orders and won significant milestone orders, e.g., two major orders worth $800 million and $400 million in Scotland and Canada respectively, for power transmission links to integrate renewable energy into the grid.

The other four divisions continued to execute their businesses successfully, generating steady comparable margins. We improved cash generation and, for the sixth consecutive year, took out more than $1 billion in costs. We again increased customer satisfaction, reflecting our continuing efforts to improve customer service. We also raised more than $1 billion in 2014 from pruning non-core businesses that had no substantial synergies with the rest of the portfolio.

To you, our shareholders, we returned more than $2.8 billion through share repurchases and the annual dividend. For the sixth consecutive year, we are proposing a dividend increase at our 2015 annual general meeting (AGM), honoring our dividend policy and in line with our commitment to long-term sustainable value creation.

Investing in growth

This year again we took important steps towards future growth. We unveiled groundbreaking new technologies, expanded our global presence with new manufacturing facilities and sales and service capabilities in high-growth markets, and forged partnerships with other leading global companies to increase value for our customers and enhance growth momentum as part of our new strategy.

On the innovation side, we launched the world’s most powerful submersible power transmission cable system. Our new 525-kilovolt extruded high-voltage direct current (HVDC) cable doubles power flow and extends range, enabling greater integration of distant renewable energy sources into the grid and improving inter-grid connections. Another groundbreaking innovation is our “YuMi” robot (pictured on the cover), a new dual-armed industrial robot that uses innovative force-sensing technology to work safely alongside humans for small-parts assembly. In April, we will have the official launch of YuMi at the Hanover fair, one of the world’s most important industrial trade shows.

We announced a $300-million research and development and production hub in China for power and low-voltage products. We also extended our network of sales and service operations in China, targeting faster-growing cities in the country’s interior. In Brazil, we opened a production site as part of a $200-million expansion plan to further extend our offering of locally produced products.

Finally, we made good progress in establishing partnerships with other leading global companies. Our most recent significant agreement is aimed at supplying – together with Hitachi in Japan – our leading HVDC systems to develop the country’s high-voltage power transmission network. Other important partnerships are with the Chinese technology group BYD on energy storage and electric mobility; and with Philips on building automation.

Next Level: laying the foundations for the future

In 2014, ABB laid the foundations to take the company to the next level, with a new strategy aimed at accelerating sustainable value creation. Our Next Level strategy is designed to make ABB more agile, to succeed in an uncertain world by strengthening our customer focus and building on our strong position in attractive markets. We are driving a fundamental shift in our performance culture. We have already taken decisive action on performance management, appointed the company’s top 1,000 leaders and strengthened the link between performance and compensation.

“We unveiled groundbreaking new technologies, expanded our global presence and forged partnerships with other leading global companies.”

With the building blocks of our three focus areas – profitable growth, relentless execution and business-led collaboration (see Next Level strategy) – firmly in place, we are well positioned to capture opportunities in our markets, which we estimate will grow from about $600 billion in 2014 to $750 billion in 2020. Our Next Level strategy provides clear and actionable steps for moving forward.

On profitable growth, our focus is to shift the company’s center of gravity towards greater competitiveness, higher organic growth and lower risk. We intend to drive organic growth through our “PIE” formula, further increase competitiveness in technology, service and software, and reduce intrinsic business risks, for example, by aligning business models more closely with ABB’s core competencies. Organic growth will be complemented by incremental strategic acquisitions and partnerships, such as those launched in 2014 with Philips, BYD and Hitachi.

On the execution side, we are taking processes for improvement that are already successful in areas such as customer satisfaction and supply chain management, and making them more widely applicable in a leading operating model that covers the entire value chain of our business. We will maintain the momentum on customer satisfaction and cost while, for example, driving forward white-collar productivity and capital efficiency to free up more resources for growth.

A key ambition of our Next Level strategy is to become more agile and responsive by increasing the focus on our markets and customers, and simplifying how the organization works. To achieve this, we streamlined our regional organization – reducing the number of regions from eight to three and taking out one organizational layer – and placed regional management on the Executive Committee to bring us all even closer to the market. At the same time, roles and responsibilities were clarified – including giving global business lines undiluted responsibility for their businesses – and processes put in place to strengthen cross-business collaboration.

As of January 2015, the Next Level strategic direction and targets had been defined, broken down to the individual businesses and widely communicated and accepted. Our new organization is in place and we have instituted a “1,000-day” program office which is the primary vehicle for driving and coordinating large change initiatives across the company. Our Next Level strategic objectives and targets have been explicitly linked to a new performance management and compensation model.

We have set ourselves ambitious targets. The Next Level strategy is targeting operational earnings per share (EPS) at a 10–15 percent compound annual growth rate (CAGR) and aims to deliver attractive cash return on invested capital (CROI) in the mid-teens over the period 2015–2020. Revenue targets are on average 4–7 percent per year on a like-for-like basis over six years, faster than forecasted GDP and market growth. Over the same time period, we plan to steadily increase profitability, measured in operational EBITA, within a bandwidth of 11–16 percent while targeting an average free cash flow conversion rate above 90 percent. The new financial targets took effect on January 1, 2015. The margin target for Power Systems will be in effect as of January 1, 2016, after concluding the “step change” turnaround program.

Outlook

Looking ahead, 2015 marks a new era for ABB. The Board of Directors has unanimously nominated Peter Voser, former CEO of Royal Dutch Shell, as its new Chairman to succeed Hubertus von Grünberg, who will be stepping down at the next AGM in April after eight years in the role. A Swiss citizen, Peter Voser has intimate knowledge of ABB, having been CFO between 2002 and 2004 and a key leader behind the successful turnaround and repositioning of the company for long-term profitable growth. Peter Voser also brings a wealth of experience as a Board member of publicly listed companies such as Roche, IBM, UBS (until 2010) and Aegon (until 2006). His nomination as chairman of the Board will be voted on at the next AGM, together with that of David Constable, President and CEO of Sasol Limited, as a new Board member. Michael Treschow will be stepping down from the Board after 12 years of service.

“Key opportunities include the big shift in the electricity value chain, industrial productivity improvements and the ‘internet of things, services and people’.”

In 2015, the world will remain an uncertain and volatile place. We are prepared for more volatility on financial markets and for continued political and economic uncertainty. The fall in the oil price will affect our business by influencing customer and capital spending along the oil-and-gas value chain, but also offering opportunities in spending decisions by government and many other ABB customer segments. The recent changes in currency valuations found us well prepared – over the past several years we have worked hard to increase the resilience of our Swiss and global operations.

Our Next Level strategy is well suited to drive our business momentum in the challenging environment in which we are operating. It will reinforce our position as a leading global provider of power and automation technologies, and drive growth in our main customer segments. Key opportunities include the big shift in the electricity value chain; industrial productivity improvements, where our strong and growing robotics capability is a key differentiator; the “internet of things, services and people”; as well as rapid urbanization and the need for energy efficiency in transport and infrastructure (see Customer segments). ABB is well positioned to tap these opportunities for long-term profitable growth with its strong market presence, broad geographic and business scope, technology leadership and financial strength. Next Level transforms us into a more agile, market-focused, simplified organization, better able to meet and master the challenges ahead.

Looking back on a difficult year, in which we addressed legacy issues, laid the foundation for a successful future and achieved a great deal, it remains only for us to thank our employees for their commitment, hard work and dedication, and to thank you, our shareholders, for your continuing trust and support. In 2015, we will drive momentum and execution across our business to make ABB stronger, better and more successful than ever – together.

Signature of Hubertus von Grünberg, Chairman (handwriting)

Hubertus von Grünberg
Chairman

Signature of Ulrich Spiesshofer, CEO (handwriting)

Ulrich Spiesshofer
CEO

March 5, 2015