Chairman and CEO letter

Dear Shareholders, Customers, Partners and Employees:

Peter Voser, Chairman of the Board and Ulrich Spiesshofer, Chief Executive Officer (photo)

Peter Voser
Chairman of the board

Ulrich Spiesshofer
Chief Executive Officer

As we compose this letter, we realize that 2016 has been a historic year – both for ABB as well as the world at large. ABB delivered solid performance in 2016, and we made steady progress in transforming the company into a leaner, more customer-focused, digital technology leader. There were many rewarding moments, and ABB earned its share of success.

On the macroeconomic front, extraordinary geopolitical forces emerged, challenging established orders and throwing the world’s post-World War II economic architecture into turmoil. In the aftermath of this turbulence we recognize that the journey forward for a large, multinational organization such as ABB demands deliberate, thoughtful navigation. At the same time, we can clearly see the value of a bold vision as we invest in new ways to do more for our customers, partners and employees – and continue to support the growth of economies and ABB’s communities around the world.

To maintain leadership, technology companies must pay constant attention to the changes in the technological landscape and adapt to take advantage of the latest trends – it is often said they must see the future first. As a company with a heritage of more than 125 years, ABB has successfully learned to stay abreast of the latest technologies. Today ABB sees two simultaneous developments that will guide our strategy going forward – the Energy Revolution and the Fourth Industrial Revolution.

The Energy Revolution

The economics of electricity generation, transmission, distribution and consumption have changed dramatically in the past two decades, primarily due to the rise of economically viable renewable energy sources, such as solar and wind power. What used to be a simple, linear process of electricity generation-transmission-consumption has become an exponentially more complicated system. In the old framework, electricity in the form of alternating current was generated by a turbine using fossil fuels or hydropower. That electricity was typically transmitted over a distance of a few dozen kilometers through power lines, usually after having been stepped up to a higher voltage to avoid losses. Finally, near the point of consumption, the electricity was stepped down through transformers for use in homes and industry.

Today the situation is much more complex. Electricity is generated not only by large conventional power plants but also by distributed solar panels and windmills. Many houses have solar panels with battery storage and have become, in effect, mini-power plants. On sunny days, they generate more than enough electricity for their own use, and feed energy back into the local grid. In countries like Germany, we see on some days negative pricing when the sun is shining – a development few could have predicted five years ago.

The other issue with electricity from renewables is that it is often generated in large fields far from where it is consumed. For instance, wind farms in the North Sea and solar panels in the Atacama Desert send power to European and South American cities, respectively. High-voltage direct current (HVDC), pioneered by ABB, can transmit this distributed energy at scale with low rates of loss. With its software and digital technology, the company is now a leader in HVDC, enabling and optimizing national grids in the Americas, Europe and Asia.

A few ABB Energy Revolution highlights from 2016:

  • We are working with our customers to bring the benefits of electricity to everyone on the planet, as more than 1.2 billion people remain in the dark today, according to the World Bank. During the last month of 2016 alone, ABB received orders worth more than $840 million to bring HVDC power to hundreds of millions of people in India and Brazil. Our microgrid technology – which can provide standalone power in remote areas or integrate such renewables as solar, wind, and hydropower into existing power grids – is accelerating human progress in sub-Saharan Africa and Asia, among other regions.
  • The high-efficiency ventilation and electrification systems that ABB supplied for the new Gotthard Base Tunnel under the Alps, the world’s longest railway tunnel, defined the current state of the art for major infrastructure projects.
  • ABB’s partnership with Solar Impulse 2, which completed the first round-the-world, solar-powered aircraft flight last July, symbolizes our commitment to stretching the limits when it comes to providing enough reliable, efficient energy to run the world without consuming the earth.
  • In another small example, our flash-charging technology is allowing zero-pollution electric buses connecting Geneva’s airport to the city’s suburbs to recharge their batteries in just 15–20 seconds.

With our strong heritage in power technologies and global market penetration, it is accurate to say that anywhere there is electricity, ABB has likely been at work. Today, ABB is making smarter, greener grids possible for the world as a whole, and is a key player in major energy infrastructure buildouts globally. We will continue to invest in this market and related technologies.

The Fourth Industrial Revolution

Digital technology and connectivity has changed the world. Manufacturing is being transformed as digitalization and connectivity transform machines and factories worldwide. This meshing of the digital world with machines as the Internet meets production is what we call the Fourth Industrial Revolution.

The mindset and business model that manufacturers will need to succeed in the future will be different. For one thing, there will be a greater need for the type of industrial digital services ABB is building today.

The mindset and business model that manufacturers will need to succeed in the future will be different. For one thing, there will be a greater need for the type of industrial digital services ABB is building today. By the end of this decade, more than 20 billion devices will be connected to the Internet – and this number does not include computers or smartphones. The stream of data these connected devices will generate will be a rich source of business intelligence. There is enormous opportunity in analyzing that data and then feeding the resulting digital insights back into machines and systems to make them more efficient, powerful and reliable.

Automation, robotics, artificial intelligence and machine learning have resurrected fears of job losses. We see a significant need for responsible leadership today from the private sector, politicians and academics – and at ABB, we are working to do our part. Our viewpoint is that the world of jobs will fundamentally change due to digital technologies – but we will never be short of work. In the future, in particular, there will be an increased need for software-differentiated services.

ABB started moving its business focus from selling pure hardware to providing digital services and software a number of years ago. A good example of successful transformation is our robotics business. In the past we simply sold individual robots – robots by the kilogram, if you will. Today, our robots are designed to solve business problems. It is a solution-oriented approach, delivering what customers need. Each robot a customer buys can be networked, and send data to a central monitoring system. Pooling data from thousands of robots allows us to develop best practices for such things as the most efficient and productive arm movement, for instance. We can then share the learning with all connected robots through networked software.

ABB robotics (photo)

A few Fourth Industrial Revolution highlights from 2016:

  • In 2016, ABB launched its smart sensor, which can be attached to the hundreds of millions of electric motors now in use globally, connecting the motors to the Internet of Things through cloud-based software to enable transcontinental industrial digitalization. ABB’s new sensor cuts motor downtime by 70 percent, extends lifespans by 30 percent, and reduces energy consumption by up to 10 percent – potentially saving energy equivalent to the output of 100 large power plants.
  • We are leading the industry in “co-bots,” collaborative robots that work with – rather than replace – humans, to improve safety, boost productivity and free people from dirty, dangerous work in mines and factories while allowing them to do more valuable, rewarding jobs. Our robots use machine learning and artificial intelligence and can perform tasks, such as solving Rubik’s cube in seconds. In 2016, ABB’s YuMi collaborative robot won the Invention and Entrepreneurship in Robotics and Automation Award at Automatica, the leading tradeshow for robotics and automation.

To take advantage of the latest developments in the market and to better serve its customers, ABB has changed its divisional structure into four market-leading divisions: Electrification Products, Robotics and Motion, Industrial Automation and Power Grids. The divisions are being empowered as entrepreneurial units within ABB, and benefit from sales collaboration orchestrated by regions and countries as well as from the group-wide digital offering; ABB’s leading G&A structure; common supply chain management; and corporate research. ABB will continue to strengthen its divisions through active portfolio management. This includes pursuing strategic additions, transforming business models and pruning non-core businesses as well as business partnerships.

Financial highlights

ABB performed satisfactorily in 2016. The company finished the year in a solid financial position, having delivered consistent margin improvements and further strengthened its ability to generate cash.

Financial highlights for the full year 2016:

  • Orders were down at $33.4 billion
  • Revenues on a comparable basis were stable at $33.8 billion
  • Operational EBITA margin increased by 50 basis points
  • Basic earnings per share increased 2 percent and operational earnings per share was 4 percent higher (constant currency)
  • Free cash flow increased to $3.1 billion, 161 percent of net income

The management has focused on running the company with discipline and has maintained its commitment to generating shareholder value. Sustained geopolitical and macroeconomic uncertainty in the U.S. and E.U. through 2016 prompted customers to adopt a wait-and-see approach to investing in large-scale infrastructure projects. While working to sharpen and focus our offerings across industries, ABB used this period of global uncertainty to strengthen operational excellence. Our white-collar productivity program outperformed expectations, allowing the company to increase its cost-reduction target by 30 percent, saving $1.3 billion.

ABB’s regular efficiency programs continued to achieve savings equivalent to 3-5 percent of the cost of sales each year, and its 1,000-day working capital program is on course to free up approximately $2 billion by the end of 2017. The company’s focus on operational excellence will continue in 2017. Our ambition is to move from initiative-driven optimization, which was necessary over the past two years, to an industry-leading operating model.

During 2016, we completed an extensive strategic portfolio review for the Power Grids division. We listened carefully to all stakeholders and considered all views on how to create maximum value for ABB shareholders. In October we announced the Power Grids division would continue its transformation under ABB’s ownership and, through that, this business can unlock the most value for shareholders, customers and employees. The outlook for the utilities industry is improving. India and China are making big investments in energy infrastructure and Power Grids will benefit from that spending. In addition, the changes brought about by the Energy and Fourth Industrial Revolutions are good for Power Grids as there is more demand created for HVDC and other ABB products, such as the software-enabled system for utilities that monitors the health of their assets digitally.

We have raised ABB’s operational EBITA target margin corridor for Power Grids by 200 basis points to 10 to 14 percent, effective 2018, reflecting management’s confidence in the future of the division. For ABB as a whole, we reaffirmed our 2015-2020 financial targets.

Given ABB’s strong financial position, the company plans to return more cash to you with a new share buyback program of up to $3 billion from 2017 through 2019.

In addition, the Board of Directors is proposing to raise the dividend to CHF 0.76 a share at the 2017 annual general meeting. This is in line with the dividend policy of a steadily rising dividend that ABB’s management has outlined as part of its Next Level Strategy for the company.

Over the last three years, ABB has returned $8.7 billion to its shareholders in the form of dividends and share buybacks.

One very unfortunate development was that ABB uncovered a sophisticated criminal scheme involving significant embezzlement and misappropriation of funds in its South Korean subsidiary. The company immediately launched a thorough investigation, involving internal and external parties, which is progressing well. The company has checked and reconfirmed the balances of its global bank accounts and can confirm that this situation is limited to South Korea. ABB has a zero-tolerance approach to unethical behavior and maintains the highest standards regarding integrity and ethical business practices. We have started implementing disciplinary consequences and will continue to do so as appropriate. Due to the investigation, ABB had to postpone the publication of its 2016 annual report.

ABB’s digital focus

Both the Energy Revolution and the Fourth Industrial Revolution are creating new business opportunities, and with them, new business models. These parallel revolutions are a good platform for the company to strengthen its lead in a competitive global marketplace through software and services for our customers in energy, utilities, transport and infrastructure. The company is taking a quantum leap in digital solutions with the launch of ABB Ability. ABB Ability brings together our entire portfolio of digital solutions and services, making them fully accessible and adaptable to all our customers. Interconnecting things, services and people digitally – the so-called Internet of Things, Services and People – is the basis for data analysis, boosts productivity and safety, enhances reliability, and saves energy and costs. Given the size of ABB’s installed base in the Internet of Things, Services and People – 70 million connected devices and 70,000 control systems across a range of industries – we see the potential to strengthen our position as a trusted partner to our customers as the Energy and Fourth Industrial Revolutions progress further, because they already know us and trust us to deliver the right technological solutions.

We have appointed an experienced Chief Digital Officer and created a centralized, dedicated digital organization to develop and deliver digital solutions to all our marketplaces on a global basis together with our businesses. The company is in the process of integrating digital solutions and technology into all of ABB’s future products, systems, services and business models (see ABB Ability™).

Strengthening leadership

ABB strengthened its management team in 2016 to drive and support its ongoing transformation. In addition to new leadership within the Discrete Automation and Motion (DM) division and the appointment of a new Chief Financial Officer, ABB’s Board of Directors added four new members elected at the company’s last annual general meeting. These new members bring valuable expertise in digitalization, software, finance, R&D, technology and manufacturing. With these additions, ABB’s board is now comprised of members from ten countries representing a broad range of industries.

Outlook for the year ahead

Geopolitical uncertainties persist and the market outlook for 2017 remains challenging. It is important to note that when ABB identifies a market opportunity by industry or geography, we commit for the long term. The uncertainty of 2016 did not deter us from continuing our company-wide transformation or from initiating a vital new focus on digital and customer-centricity. We are continuing to invest heavily in research and development and innovation to maintain our technological leadership. With growing momentum across ABB’s four streamlined entrepreneurial businesses the company will address customer needs in the Energy and Fourth Industrial Revolutions in a focused and agile way, with digital solutions, services and products that truly solve customer problems.

Our accelerating transformation through 2016 and into the new year makes us confident that ABB has the portfolio of businesses and the leadership team to create superior value for our customers, shareholders and employees.

Summary

The worldwide marketplace is demanding, but at the same time rich with promise and opportunity as the Energy Revolution and Fourth Industrial Revolution continue to accelerate global change. Our accelerating transformation through 2016 and into the new year makes us confident that ABB has the portfolio of businesses and the leadership team to create superior value for our customers, shareholders and employees. ABB would not exist without its dedicated and tireless employees, and their commitment and hard work remain instrumental to its success. We would like to thank them for their commitment and many accomplishments in the past year. Similarly, the ongoing support of ABB’s customers and partners makes all the company’s achievements possible. Finally, the continued trust that you, ABB’s shareholders, have bestowed on the company is the foundation upon which this enterprise has been built.

We are honored to lead this company, and know there is continued exciting and hard work to do to realize ABB’s full potential. Today’s ABB is energized and focused on the opportunities that lie ahead for its customers and partners. Let’s write the future. Together.

Sincerely,

Signature of Peter Voser, Chairman of the Board of Directors (handwriting)

Peter Voser
Chairman of the Board of Directors

Signature of Ulrich Spiesshofer, Chief Executive Officer (handwriting)

Ulrich Spiesshofer
Chief Executive Officer

March 10, 2017