Building on our technology leadership The ABB Group Annual Report 2012 Contents 02 This is ABB . 04 Chairman and CEO letter . 08 Highlights . 10 Executive Committee . 11 Regional and country managers . 13 Corporate governance report 29 Remuneration report . 43 Financial review . This is ABB ABB is one of the world’s leading power and automation technology companies. Our portfolio ranges from light switches to robots, and from huge electrical transformers to control systems that manage entire power networks and factories. We provide solutions for secure, energy-efficient generation, transmission and distribution of electricity, and for increa sing productivity in industrial, commercial and utility operations. We help our customers meet their challenges with minimum environmental impact. That’s why ABB stands for “Power and productivity for a better world.” 02 This is ABB | ABB Annual Report 2012 ABB Annual Report 2012 | This is ABB 03 Chairman and CEO letter Dear shareholders, ABB performed well in 2012, demonstrating once again its agility and resilience in a difficult environment. The economic slowdown of recent years has given us opportunities to strengthen ABB in various ways, and we can confidently say that ABB has become one of the best companies in its sector. ABB’s power and automation businesses outperformed those of most competitors in 2012 in terms of organic revenue growth and profitability (earnings before interest, taxes, depreciation and amortization, or EBITDA). Also, ABB has among the highest revenue and profitability levels per employee compared with peers. “One reason for ABB’s strength is our global reach matched with well-developed local capabilities” One reason for ABB’s strength is our global reach matched with well-developed local capabilities. We have built a strong presence in North America through acquisitions in the last three years, complementing our leading position in Europe, the Middle East and Asia. We are now a leader in most of the largest or fastest-growing markets on every continent. The positions that we have in these markets are also deep-rooted thanks to our local R&D and product development capabilities, which enable us to match and exceed local competitors when it comes to speed of product development and deployment. We therefore have a presence and insights into different markets that few can match, and we can use this to achieve consistent growth and results throughout the economic cycle. This helps to explain ABB’s resilience. We also have a truly international leadership team which gives us a real global perspective on the opportunities available. Video: Joe Hogan comments on the 2012 results. To view the clip, install QR code reader on your mobile device, scan the code and see more. 04 Chairman and CEO letter | ABB Annual Report 2012 Besides investing in acquisitions, we have committed an additional $1.9 billion since 2007 to building or expanding factories, strengthening our sales teams in growth markets, and boosting R&D. Our outstanding success at managing costs, which yielded another $1.1 billion in annual savings in 2012, has given us the flexibility to make these investments and continue building ABB for the future. Investments in R&D have risen from 3 percent of revenues in 2007 to 3.7 percent in 2012, lifting annual spending by 68 percent over this period to almost $1.5 billion. This reflects the fact that technology remains one of our most significant competitive advantages, and it is therefore essential to our success that we stay at the forefront of technological developments. “Technology remains one of our most significant competitive advantages” Technological innovation The investment is paying off as we achieve genuine technological breakthroughs and bring advanced products to the market. We are pleased that 2012 was a particularly rich year for technological achievements. After years of research, our teams were able to report the development of the first hybrid high-voltage direct current (HVDC) circuit breaker, a break- through that removes a major hurdle in the evolution of interconnected grids based on direct current and that could speed up the deployment of renewable energy on a large scale. It is arguably the most significant scientific achievement in the field since ABB developed HVDC transmission 60 years ago, an innovation that created entirely new possibilities for transporting electricity over long distances. Other technological achievements in 2012 included the development and testing of an ultrahigh voltage direct current converter transformer, the commercialization of a new type of electric motor that is highly efficient, an order for the first-ever direct current power grid on board a ship, and the construction of Europe’s largest direct current data center. These successes are important to ABB because technological leadership is a pillar of our goal to stay competitive and to push technology that drives disruptive market changes, which are priorities of our strategic plan for the years 2011–2015. This leadership and expertise is highly valued by our customers. They consistently recognize and reward our industry and application knowledge, our engineering and design capability, and the quality of our products and systems. Priorities for 2013 In 2012, we achieved local-currency growth of 7 percent in revenues and 4 percent in orders. Excluding Thomas & Betts, revenues rose 3 percent and orders were steady (in local currencies). Our results for 2012 reflected the difficult environment and the measures taken in the fourth quarter to refocus the Power Systems division, and illustrate why driving competitiveness remains our top goal for 2013. Deepening the integration of recent acquisitions will be one priority for this year. We have spent more than $10 billion on acquisitions since 2010 as part of our strategy to grow the business profitably and create value for shareholders. The value is being realized through a combination of cost and growth synergies, which in turn depend on the successful integration of the new businesses with those of ABB. With Thomas & Betts, the US low-voltage business we acquired last year, we are intensely pursuing opportunities to use T&B’s products in our ABB businesses and to sell them through our global distribution channels. We have some promising pilot projects and will be exploring how to get the most out of the opportunities that have been identified. ABB Annual Report 2012 | Chairman and CEO letter 05 We will also be looking at ways to scale up the new businesses that we have successfully developed. We have entered several new markets in recent years, such as electric vehicle infrastructure, energy storage, energy consulting and data center electrification, and we will make sure that the ones with the greatest potential have the resources and business models that will enable them to grow. A related priority will be to effectively commercialize the advances made in our R&D programs. We will keep customer satisfaction at the top of our priority list by continuing to address the areas they want us to improve, mainly responsiveness and delivery time. Importantly, we are improving in the eyes of our customers: Our Net Promoter Score (NPS) measure of customer satisfaction rose by more than 30 percent in 2012 compared with 2011. The score remains lower than we would like it to be but we are pleased at the progress we are making. As we strive to increase the satisfaction of our customers, the Executive Committee has introduced a systematic approach to addressing the top issues that they have raised, with EC members personally supervising the projects set up to address them. The project teams are responsible for determining the root causes of the issues and the measures that need to be taken, and will establish an implementation plan to ensure steady improvement. We are confident that we have the right projects in place with the right leaders to ensure that we achieve the Group targets that we have communicated. Shaping the future Looking ahead, we are confident that ABB is well placed to benefit from several long-term trends, and even to shape them through technological innovation. The major trends driving demand include the increasing use of electricity in areas such as data centers and electric vehicles; the rapid economic growth and urbanization in emerging markets; the need to use our natural resources more efficiently; and the integration of new sources of energy – such as wind and solar – into existing grids. Balancing electricity supply and demand at any time is becoming harder as renewable energy becomes more widespread, given that wind and solar power are highly intermittent as well as distributed across a very large number of sources. Ensuring frequency and voltage stability of the grid is therefore an increasingly complex challenge. In Europe, power networks will have to be better interconnected if the region is to make use of its natural power sources. Wind from the North Sea or the Atlantic, sun from the South, hydro facilities in Norway or the Alps, all need to be connected with energy-intensive industrial regions. Transmission grids need to be upgraded but they also need to become more flexible and intelligent. We expect HVDC to be deployed more widely as it is well suited to many of the emerging trends, and the hybrid HVDC breaker should pave the way for the development of an interconnected grid based on direct current. “ABB is one of the few global companies operating in the attractive sectors of power and automation” Manufacturing is also changing. Rising wages in emerging economies, higher transport and energy costs, and increasing levels of automation are driving manufacturers to look for ways to stay competitive other than by offshoring activities to markets with lower labor costs. 06 Chairman and CEO letter | ABB Annual Report 2012 Among these, the ability to respond rapidly to changing customer needs stands out. Quick customer response, the need for mass customization, short lead times and low inventories favor the location of manufacturing facilities close to the customer, and recent advances in automation enable this change. Modern factory automation systems are flexible and allow manufacturers to respond quickly to changes in demand without sacrificing quality or consistency, with fewer, more skilled workers. Further, integration of automation systems and fast communication mean that supply chains can be kept lean despite the variety of products. These trends illustrate why power and automation continue to be dynamic segments with compelling growth prospects. ABB is one of the few global companies operating in these two attractive sectors. Unique strengths We remain confident because ABB has many strengths. ABB has been resilient in the recent slowdown thanks to the way our activities are balanced across geographies and across the business cycle. We have a unique and strong presence in most of the markets in which we operate thanks to the deep roots that we have established in leading mature and emerging markets alike. “Our strong balance sheet gives us ample flexibility” We have also been resourceful, penetrating geographic markets as diverse as the US and Indonesia and new industrial ones such as data centers, developing attractive business models such as our new approach to service, and continuing to drive sustainable savings across the business through greater efficiency. We have invested extensively in technology, sharpening our technological leadership in power and automation. What’s more, our strong balance sheet gives us ample flexibility to invest where we see an opportunity to grow the business profitably while maintaining our single-A credit rating. Thanks to the company’s excellent cash generation and prospects, the Board has once again proposed an increase in the dividend to shareholders. Most importantly ABB has become a company in which integrity and sustainability have evolved from top-down activities into ways of thinking that are becoming embedded in the way we do business. Our people have a passion for technology, a pragmatic common sense, and the cultural diversity that helps us to find and exploit new opportunities. We are confident that all these factors make ABB a great company to work for, do business with and invest in, and are the promise of a great future. Hubertus von Grünberg Chairman Joe Hogan CEO March 14, 2013 ABB Annual Report 2012 | Chairman and CEO letter 07 Highlights Resilient performance through the cycle: In local currencies, orders and revenues increased despite difficult business climate Actions under way to secure higher and more consistent earnings in the power businesses More profitable service revenues grew faster than total revenues, in line with our strategic initiative to increase the total share of service business Customer satisfaction increased by 32 percent, as measured by the Net Promoter Score survey Successful execution on costs again supported profitability in line with targets Investment in research and development rose to $1.5 billion, or 3.7 percent of revenues One of the strongest balance sheets in the sector on robust cash generation; Board proposes 5 percent increase in dividend Continued technology leadership, including circuit breaker for high voltage direct current and synchronous reluc- tance motors for high-efficiency industrial applications Further strengthened our automation portfolio: Thomas & Betts, acquired in May, contributed about $280 million in operational EBITDA; integration on track Total ABB Group ($ millions unless otherwise indicated) Orders Revenues Earnings before interest and taxes (EBIT) as % of revenues Operational EBITDA(1) as % of operational revenues Net income (attributable to ABB) Basic earnings per share ($) Dividend per share in CHF (proposed for 2012) Cash flow from operating activities Free cash flow(2) as % of net income Cash return on invested capital(2) Number of employees (1) (2) Please refer to Note 23 to ABB’s Consolidated Financial Statements for a definition of operational EBITDA. Please refer to page 154 for a definition of free cash flow and cash return on invested capital. 08 Highlights | ABB Annual Report 2012 2012 40,232 39,336 4,058 10.3% 5,555 14.2% 2,704 1.18 0.68 3,779 2,555 94% 12% 2011 40,210 37,990 4,667 12.3% 6,014 15.8% 3,168 1.38 0.65 3,612 2,593 82% 14% 146,100 133,600 Revenues 2012 by division (unconsolidated) R&D expenses (% of total revenue) Power Products, 25% Power Systems, 18% Discrete Automation and Motion, 22% Low Voltage Products, 16% Process Automation, 19% 4.0 3.0 2.0 1.0 0.0 Target R&D spend 4% by 2015 2007 2008 2009 2010 2011 2012 2015 Service (% of total revenue) Orders 2012 by region Impact of service strategy Europe, 34% Americas, 30% Asia, 26% Middle East and Africa, 10% 20–25% ambition 2007 2008 2009 2010 2011* 2012** 2015 *excl. Baldor **excl. Thomas & Betts Emerging vs mature market orders 2012 Dividend payout (CHF per share) Emerging markets, 46% Mature markets, 54% 0.8 0.6 0.4 0.2 0 2005 2006 2007 2008 2009 2010 2011 2012* (*proposed) ABB Annual Report 2012 | Highlights 09 As of March 1, 2013 Executive Committee From left to right Ulrich Spiesshofer Head of Discrete Automation and Motion division Greg Scheu Head of Marketing and Customer Solutions Bernhard Jucker Head of Power Products division Prith Banerjee Chief Technology Officer Frank Duggan Head of Global Markets Eric Elzvik Chief Financial Officer Joe Hogan Chief Executive Officer Tarak Mehta Head of Low Voltage Products division Brice Koch Head of Power Systems division Diane de Saint Victor General Counsel and Head of Legal and Integrity Veli-Matti Reinikkala Head of Process Automation division Gary Steel Head of Human Resources Eric Elzvik was appointed Chief Financial Officer with effect from February 1, 2013, to succeed Michel Demaré, who is leaving ABB. 10 Executive Committee | ABB Annual Report 2012 As of March 1, 2013 Regional and country managers North America Enrique Santacana Canada Daniel Assandri Mexico Daniel Galicia United States (including US Virgin Islands) Enrique Santacana Northern Europe Trevor Gregory Denmark Claus Madsen Estonia Bo Henriksson Finland Tauno Heinola Ireland Tom O’Reilly Kazakhstan Altay Toyganbaev Latvia Bo Henriksson Lithuania Bo Henriksson Norway Steffen Waal Russian Federation Anatoliy Popov Sweden Johan Soderstrom United Kingdom Trevor Gregory North Asia Claudio Facchin China Claudio Facchin Japan Tony Zeitoun Korea Yun-Sok Han Taiwan Kayee Ding (1) New country manager as of March 1, 2013 South America Sergio Gomes Argentina Christian Newton Aruba Ramon Monras Barbados Guillermo Rodriguez Brazil Sergio Gomes Chile Jose Paiva Colombia Ramon Monras Ecuador Ramon Monras El Salvador Guillermo Rodriguez Guatemala Guillermo Rodriguez Panama Guillermo Rodriguez Peru Adolfo Samaniego Uruguay Christian Newton Venezuela Ramon Monras Central Europe Peter Terwiesch Austria Franz Chalupecky Belgium Alfons Goos Bulgaria Peter Simon Czech Republic Hannu Kasi Germany Peter Terwiesch Hungary Tanja Vainio Luxembourg Alfons Goos Netherlands Alfons Goos Poland Miroslaw Gryszka Romania Peter Simon Slovakia Marcel van der Hoek Slovenia Boris Bozic Switzerland Remo Luetolf Ukraine Dmytro Zhdanov South Asia Haider Rashid Australia Axel Kuhr Indonesia Hendrik Weiler Malaysia Stephen Pearce Myanmar Chaiyot Piyawannarat New Caledonia Axel Kuhr New Zealand Grant Gillard Papua New Guinea Axel Kuhr Philippines Min-Kyu Choi Singapore Haider Rashid Thailand Chaiyot Piyawannarat Vietnam Jian Peng Fu Mediterranean Barbara Frei Algeria Khaled Torbey Croatia Steffen Drausnigg France Pierre St-Arnaud Greece Apostolos Petropoulos Israel Ronen Aharon Italy Barbara Frei Morocco Christian Bogers Portugal Miguel Pernes Serbia Aleksandar Cosic Spain Carlos Marcos Tunisia Christian Bogers Turkey Sami Sevinc India, Middle East and Africa Frank Duggan Angola Antonio D’Oliveira Bahrain Mahmoud Shaban Bangladesh Joy-Rajarshi Banerjee Botswana Gift Nkwe Central Africa Naji Jreijiri Congo Thryphon Mungono Côte d’Ivoire Magloire Elogne Cameroon Pierre Njigui Eastern Africa Jose da Matta Egypt Naji Jreijiri Ethiopia Nikola Stojanovic Gambia Pierre Njigui Ghana Hesham Tehemer India Bazmi Husain Jordan Maroun Zakhour Kenya Jose daMatta Kuwait Richard Ledgard Lebanon Maroun Zakhour Mauritius Ajay Vij Mozambique Paulo David Namibia Hagen Seiler Nigeria Naji Jreijiri (1) Oman Saeed Fahim Pakistan Arfeen Khalid Qatar Juha Alopaeus Saudi Arabia Mahmoud Shaban Senegal Issa Guisse Southern Africa Leon Viljoen(1) Tanzania Michael Otonya Uganda Norah Kipwola United Arab Emirates Carlos Pone Zambia Russell Harawa Zimbabwe Charles Shamu ABB Annual Report 2012 | Regional and country managers 11 12 Corporate governance report | ABB Annual Report 2012 Corporate governance report Contents 14 Principles . 15 Group structure and shareholders . . 17 Capital structure 19 Shareholders’ participation 20 Board of Directors . 23 Executive Committee . 25 Business relationships . 25 Employee participation programs . 25 Duty to make a public tender offer 26 Auditors . 26 Information policy 27 Further information on corporate governance . ABB Annual Report 2012 | Corporate governance report 13 1. Principles 1.1 General principles ABB is committed to the highest international standards of corporate governance, and supports the general principles as set forth in the Swiss Code of Best Practice for Corporate Governance, as well as those of the capital markets where its shares are listed and traded. In addition to the provisions of the Swiss Code of Obliga- tions, ABB’s key principles and rules on corporate gover- nance are laid down in ABB’s Articles of Incorporation, the ABB Ltd Board Regulations and Corporate Governance Guidelines (which includes the regulations of ABB’s board committees and the ABB Ltd Related Party Transaction Policy), and the ABB Code of Conduct and the Addendum to the ABB Code of Conduct for Members of the Board of Directors and the Executive Committee. It is the duty of ABB’s Board of Directors (the Board) to review and amend or propose amendments to those documents from time to time to reflect the most recent developments and practices, as well as to ensure compliance with applicable laws and regulations. This section of the Annual Report is based on the Directive on Information Relating to Corporate Governance published by the SIX Swiss Exchange. Where an item listed in the direc- tive is not addressed in this report, it is either inapplicable to or immaterial for ABB. According to the New York Stock Exchange’s corporate governance standards (the Standards), ABB is required to disclose significant ways in which its corporate governance practices differ from the Standards. ABB has reviewed the Standards and concluded that its corporate governance practices are generally consistent with the Standards, with the following significant exceptions: – Swiss law requires that the external auditors be elected by the shareholders at the Annual General Meeting rather than by the finance and audit committee or the board of directors. – The Standards require that all equity compensation plans and material revisions thereto be approved by the share- holders. Consistent with Swiss law such matters are decided by our Board. However, the shareholders decide about the creation of new share capital that can be used in connection with equity compensation plans. 1.2 Duties of directors and officers The directors and officers of a Swiss corporation are bound, as specified in the Swiss Code of Obligations, to perform their duties with all due care, to safeguard the interests of the corporation in good faith and to extend equal treatment to shareholders in like circumstances. The Swiss Code of Obligations does not specify what standard of due care is required of the directors of a corporate board. However, it is generally held by Swiss legal scholars and jurisprudence that the directors must have the requisite capability and skill to fulfill their function, and must devote the necessary time to the discharge of their duties. Moreover, the directors must exercise all due care that a prudent and diligent director would have taken in like circumstances. Finally, the directors are required to take actions in the best interests of the corporation and may not take any actions that may be harmful to the corporation. Exercise of powers Directors, as well as other persons authorized to act on behalf of a Swiss corporation, may perform all legal acts on behalf of the corporation which the business purpose, as set forth in the articles of incorporation of the corporation, may entail. Pursuant to court practice, such directors and offi- cers can take any action that is not explicitly excluded by the business purpose of the corporation. In so doing, however, the directors and officers must still pursue the duty of due care and the duty of loyalty described above and must extend equal treatment to the corporation’s shareholders in like cir- cumstances. ABB’s Articles of Incorporation do not contain provisions concerning a director’s power, in the absence of an independent quorum, to vote on the compensation to themselves or any members of their body. Conflicts of interest Swiss law does not have a general provision on conflicts of interest and our Articles of Incorporation do not limit our directors’ power to vote on a proposal, arrangement or contract in which the director or officer is materially interested. However, the Swiss Code of Obligations requires directors and officers to safeguard the interests of the corporation and, in this connection, imposes a duty of care and loyalty on directors and officers. This rule is generally understood and so recommended by the Swiss Code of Best Practice for Corporate Governance as disqualifying directors and officers from participating in decisions, other than in the shareholders’ meeting, that directly affect them. 14 Corporate governance report | ABB Annual Report 2012 Confidentiality Confidential information obtained by directors and officers of a Swiss corporation acting in such capacity must be kept confidential during and after their term of office. 2. Group structure and shareholders 2.1 Group structure ABB Ltd, Switzerland, is the ultimate parent company of the ABB Group, which at December 31, 2012, principally comprised 380 consolidated operating and holding subsid- iaries worldwide. ABB Ltd’s shares are listed on the SIX Swiss Exchange, the NASDAQ OMX Stockholm Exchange and the New York Stock Exchange (where its shares are traded in the form of American depositary shares (ADS) – each ADS repre- senting one registered ABB share). On December 31, 2012, ABB Ltd had a market capitalization of CHF 43 billion. The only consolidated subsidiary in the ABB Group with listed shares is ABB Limited, Bangalore, India, which is listed on the Bombay Stock Exchange and the National Stock Exchange of India. On December 31, 2012, ABB Ltd, Switzer- land, directly or indirectly owned 75 percent of ABB Limited, Bangalore, India, which at that time had a market capitaliza- tion of INR 150 billion. Sanctions If directors and officers transact business on behalf of the corporation with bona fide third parties in violation of their statutory duties, the transaction is nevertheless valid, as long as it is not explicitly excluded by the corporation’s business purpose as set forth in its articles of incorporation. Directors and officers acting in violation of their statutory duties – whether transacting business with bona fide third parties or performing any other acts on behalf of the company – may, however, become liable to the corporation, its shareholders and its creditors for damages. The liability is joint and several, but the courts may apportion the liability among the directors and officers in accordance with their degree of culpability. In addition, Swiss law contains a provision under which payments made to a shareholder or a director or any person(s) associated therewith, other than at arm’s length, must be repaid to the company if the shareholder or director or any person associated therewith was acting in bad faith. If the board of directors has lawfully delegated the power to carry out day-to-day management to a different corporate body, e.g., the executive committee, it is not liable for the acts of the members of that different corporate body. Instead, the directors can be held liable only for their failure to properly select, instruct and supervise the members of that different corporate body. Stock exchange listings Stock exchange SIX Swiss Exchange NASDAQ OMX Stockholm Exchange New York Stock Exchange Bombay Stock Exchange Security ABB Ltd, Zurich, share ABB Ltd, Zurich, share ABB Ltd, Zurich, ADS ABB Limited, Bangalore, share National Stock Exchange of India ABB Limited, Bangalore, share Ticker symbol ISIN code ABBN ABB ABB ABB* ABB CH0012221716 CH0012221716 US0003752047 INE117A01022 INE117A01022 * also called Scrip ID All data as of December 31, 2012. ABB Annual Report 2012 | Corporate governance report 15 The following table sets forth, as of December 31, 2012, the name, country of incorporation, ownership interest and share capital of the significant direct and indirect subsidiaries of ABB Ltd, Switzerland: ABB Ltd’s significant subsidiaries Company name/location ABB S.A., Buenos Aires ABB Australia Pty Limited, Sydney ABB AG, Vienna ABB N.V., Zaventem ABB Ltda., Osasco ABB Bulgaria EOOD, Sofia ABB Inc., St. Laurent, Quebec ABB (China) Ltd., Beijing Asea Brown Boveri Ltda., Bogotá ABB Ltd., Zagreb ABB s.r.o., Prague ABB A/S, Skovlunde ABB Ecuador S.A., Quito Asea Brown Boveri S.A.E., Cairo ABB AS, Jüri ABB Oy, Helsinki ABB S.A., Les Ulis ABB AG, Mannheim ABB Automation GmbH, Mannheim ABB Automation Products GmbH, Ladenburg ABB Beteiligungs- und Verwaltungsges. mbH, Mannheim ABB Stotz-Kontakt GmbH, Heidelberg Busch-Jaeger Elektro GmbH, Mannheim/Lüdenscheid Asea Brown Boveri S.A., Metamorphossis Attica ABB (Hong Kong) Ltd., Hong Kong ABB Engineering Trading and Service Ltd., Budapest ABB Limited, Bangalore ABB Ltd, Dublin ABB Technologies Ltd., Tirat Carmel ABB S.p.A., Milan ABB K.K., Tokyo ABB Ltd., Seoul ABB Holdings Sdn. Bhd., Subang Jaya Asea Brown Boveri S.A. de C.V., San Luis Potosi S.L.P ABB B.V., Rotterdam ABB Finance B.V., Amsterdam ABB Holdings B.V., Amsterdam ABB Investments B.V., Amsterdam ABB Limited, Auckland ABB Holding AS, Billingstad ABB S.A., Lima ABB, Inc., Paranaque, Metro Manila ABB Sp. zo.o., Warsaw ABB (Asea Brown Boveri), S.A., Paco de Arcos Country Argentina Australia Austria Belgium Brazil Bulgaria Canada China Colombia Croatia Czech Republic Denmark Ecuador Egypt Estonia Finland France Germany Germany Germany Germany Germany Germany Greece Hong Kong Hungary India Ireland Israel Italy Japan Korea, Republic of Malaysia Mexico Netherlands Netherlands Netherlands Netherlands New Zealand Norway Peru Philippines Poland Portugal Asea Brown Boveri Ltd., Moscow Russian Federation 16 Corporate governance report | ABB Annual Report 2012 ABB Share capital interest % in thousands Currency 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 96.87 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 75.00 100.00 99.99 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 97.60 100.00 99.89 100.00 100.00 56,772 122,436 15,000 13,290 94,396 3,010 255,797 310,000 486,440 2,730 400,000 100,000 325 116,000 1,663 10,003 38,921 167,500 15,000 10,620 61,355 7,500 1,535 1,721 20,000 444,090 423,817 635 420 107,000 1,000,000 18,670,000 4,490 667,686 9,200 20 119 100 34,000 240,000 29,290 123,180 260,644 4,117 941 ARS AUD EUR EUR BRL BGN CAD USD COP HRK CZK DKK USD USD EUR EUR EUR EUR EUR EUR EUR EUR EUR EUR HKD HUF INR EUR ILS EUR JPY KRW MYR MXN EUR EUR EUR EUR NZD NOK PEN PHP PLN EUR RUB ABB Ltd’s significant subsidiaries, continued Company name/location ABB Contracting Company Ltd., Riyadh ABB Holdings Pte. Ltd., Singapore ABB Holdings (Pty) Ltd., Longmeadow Asea Brown Boveri S.A., Madrid ABB AB, Västerås ABB Norden Holding AB, Västerås ABB Asea Brown Boveri Ltd, Zurich ABB Schweiz AG, Baden ABB Technology Ltd., Zurich ABB LIMITED, Bangkok ABB Elektrik Sanayi A.S., Istanbul ABB Ltd., Kiev ABB Industries (L.L.C.), Dubai ABB Holdings Limited, Warrington ABB Limited, Warrington ABB Holdings Inc., Cary, NC ABB Inc., Cary, NC Baldor Electric Company, Fort Smith, AR Kuhlman Electric Corporation, Crystal Springs, MS Thomas & Betts Corporation, Knoxville, TN Country interest % in thousands Currency ABB Share capital Saudi Arabia Singapore South Africa Spain Sweden Sweden Switzerland Switzerland Switzerland Thailand Turkey Ukraine United Arab Emirates United Kingdom United Kingdom United States United States United States United States United States 65.00 100.00 80.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.95 100.00 49.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 40,000 32,797 4,050 33,318 400,000 2,344,783 2,768,000 55,000 100 1,034,000 13,410 85,400 5,000 203,014 60,000 2 1 0 0 0 SAR SGD ZAR EUR SEK SEK CHF CHF CHF THB TRY UAH AED GBP GBP USD USD USD USD USD ABB’s operational group structure is described in the “Finan- cial review” section of this Annual Report under “Operating and financial review and prospects – Organizational structure”. 2.2 Significant shareholders Investor AB, Sweden, held 182,030,142 ABB shares as of December 31, 2012. This holding represents approximately 7.9 percent of ABB’s total share capital and voting rights as registered in the Commercial Register on that date. The number of shares held by Investor AB does not include shares held by Mr. Jacob Wallenberg, the chairman of Investor AB, in his individual capacity. BlackRock Inc., New York, U.S., disclosed that as per July 25, 2011, it, together with its direct and indirect subsidiar- ies, held 69,702,100 ABB shares corresponding to 3.0 per- cent of ABB’s total share capital and voting rights as registered in the Commercial Register on December 31, 2012. For a full review of the disclosure report pursuant to which Black- Rock reported its ABB shareholdings, please refer to the search facility of the SIX Swiss Exchange Disclosure Office at http://www.six-swiss-exchange.com/shares/companies/ major_shareholders_en.html?fromDate=19980101&issuer =10881 To the best of ABB’s knowledge, no other shareholder held 3 percent or more of ABB’s total share capital and voting rights as registered in the Commercial Register on December 31, 2012. Under ABB’s Articles of Incorporation, each registered share represents one vote. Significant shareholders do not have different voting rights. To our knowledge, we are not directly or indirectly owned or controlled by any government or by any other corporation or person. 3. Capital structure 3.1 Ordinary share capital On December 31, 2012, ABB’s ordinary share capital (in- cluding treasury shares) as registered with the Commercial Register amounted to CHF 2,384,185,561.92, divided into 2,314,743,264 fully paid registered shares with a par value of CHF 1.03 per share. ABB Annual Report 2012 | Corporate governance report 17 3.2 Changes to the share capital In 2011, ABB issued shares out of its contingent capital in connection with ABB’s Management Incentive Plan (MIP). For further details about the MIP see note 18 to ABB’s consolidated financial statements contained in the Financial review section of this Annual Report. The resulting share capital of CHF 2,384,185,561.92, divided into 2,314,743,264 fully paid registered shares, was reflected in ABB’s Articles of Incor poration dated December 5, 2011. In 2010, ABB issued shares out of its contingent capital in connection with the MIP. The resulting share capital of CHF 2,378,045,525.92, divided into 2,308,782,064 fully paid registered shares, was reflected in ABB’s Articles of Incor- poration dated December 20, 2010. In 2010, ABB paid its dividend relating to the year 2009 by way of nominal value reduction in the par value of its shares from CHF 1.54 to CHF 1.03. Corresponding adjust- ments were made to the par value of ABB’s contingent and authorized shares. Furthermore ABB cancelled 22,675,000 shares that had been repurchased under its share buyback program. The resulting share capital of CHF 2,375,849,290.91, divided into 2,306,649,797 fully paid registered shares, was reflected in ABB’s Articles of Incorporation dated as of April 26, 2010. Except as described in this section, there were no changes to ABB’s share capital during 2012, 2011 and 2010. 3.3 Contingent share capital As at December 31, 2012, ABB’s share capital may be in- creased by an amount not to exceed CHF 206,000,000 through the issuance of up to 200,000,000 fully paid regis- tered shares with a par value of CHF 1.03 per share through the exercise of conversion rights and/or warrants granted in connection with the issuance on national or international capital markets of newly or already issued bonds or other financial market instruments. As at December 31, 2012, ABB’s share capital may be increased by an amount not to exceed CHF 10,300,000 through the issuance of up to 10,000,000 fully paid registered shares with a par value of CHF 1.03 per share through the exercise of warrant rights granted to its shareholders. The Board may grant warrant rights not taken up by shareholders for other purposes in the interest of ABB. The pre-emptive rights of the shareholders are excluded in connection with the issuance of convertible or warrant- bearing bonds or other financial market instruments or the grant of warrant rights. The then current owners of warrants will be entitled to subscribe for new shares. The conditions of the conversion rights and/or warrants will be determined by the Board. The acquisition of shares through the exercise of warrants and each subsequent transfer of the shares will be subject to the restrictions of ABB’s Articles of Incorporation (see section 4.2 in this Corporate Governance Report). In connection with the issuance of convertible or warrant- bearing bonds or other financial market instruments, the Board is authorized to restrict or deny the advance subscrip- tion rights of shareholders if such bonds or other financial market instruments are for the purpose of financing or refinanc- ing the acquisition of an enterprise, parts of an enterprise, participations or new investments or an issuance on national or international capital markets. If the Board denies advance subscription rights, the convertible or warrant- bearing bonds or other financial market instruments will be issued at the relevant market conditions and the new shares will be issued pursuant to the relevant market conditions taking into account the share price and/or other comparable instruments having a market price. Conversion rights may be exercised during a maximum ten year period, and warrants may be exercised during a maximum seven year period, in each case from the date of the respective issuance. The advance subscription rights of the shareholders may be granted indi- rectly. In addition as at December 31, 2012, ABB’s share capital may be increased by an amount not to exceed CHF 96,859,964 through the issuance of up to 94,038,800 fully paid shares with a par value of CHF 1.03 per share to employees. The pre-emptive and advance subscription rights of ABB’s shareholders are excluded. The shares or rights to subscribe for shares will be issued to employees pursuant to one or more regulations to be issued by the Board, taking into account performance, functions, level of responsibility and profitability criteria. ABB may issue shares or subscription rights to employees at a price lower than that quoted on a stock exchange. The acquisition of shares within the context of employee share ownership and each subsequent transfer of the shares will be subject to the restrictions of ABB’s Articles of Incorporation (see section 4.2 of this Corporate Gover- nance Report). 18 Corporate governance report | ABB Annual Report 2012 3.4 Authorized share capital As at December 31, 2012, ABB had an authorized share capital in the amount of up to CHF 206,000,000 through the issuance of up to 200,000,000 fully paid registered shares with a par value of CHF 1.03 each, which is valid until April 29, 2013, and the Board has decided to propose to the Share- holders at the 2013 Annual General Meeting that the authorized share capital be renewed through April 29, 2015. The Board is authorized to determine the date of issue of new shares, the issue price, the type of payment, the conditions for the exercise of pre-emptive rights and the beginning date for dividend entitlement. In this regard, the Board may issue new shares by means of a firm underwriting through a bank- ing institution, a syndicate or another third party with a sub- sequent offer of these shares to the shareholders. The Board may permit pre-emptive rights that have not been exercised by shareholders to expire or it may place these rights and/or shares as to which preemptive rights have been granted but not exercised at market conditions or use them for other purposes in the interest of the company. Furthermore, the Board is authorized to restrict or deny the pre-emptive rights of shareholders and allocate such rights to third parties if the shares are used (1) for the acquisition of an enterprise, parts of an enterprise, or participations, or for new investments, or in case of a share placement, for the financing or refinanc- ing of such transactions; or (2) for the purpose of broaden - ing the shareholder constituency in connection with a listing of shares on domestic or foreign stock exchanges. 3.5 Convertible bonds and warrants ABB does not have any bonds outstanding that are convertible into ABB shares. For information about warrants on shares issued by ABB, please refer to note 19 to ABB’s consolidated financial statements contained in the “Financial review” part of this Annual Report. 4. Shareholders’ participation 4.1 Shareholders’ voting rights ABB has one class of shares and each registered share car- ries one vote at the general meeting. Voting rights may be exercised only after a shareholder has been registered in the share register of ABB as a shareholder with the right to vote, or with Euroclear Sweden AB, which maintains a subregister of the share register of ABB. A shareholder may be represented at the Annual General Meeting by its legal representative, by another shareholder with the right to vote, a proxy nominated by ABB (Organ vertreter), an independent proxy designated by ABB (unabhängiger Stimm rechtsvertreter) or a depository institution (Depotvertreter). All shares held by one shareholder may be represented by one representative only. For practical reasons shareholders must be registered in the share register no later than 6 business days before the general meeting in order to be entitled to vote. Except for the cases described under section 4.2 below, there are no voting rights restrictions limiting ABB’s shareholders’ rights. 4.2 Limitations on transferability of shares and nominee registration ABB may decline a registration with voting rights if a shareholder does not declare that it has acquired the shares in its own name and for its own account. If the shareholder refuses to make such declaration, it will be registered as a shareholder without voting rights. A person failing to expressly declare in its registration application that it holds the shares for its own account (a nominee), will be entered in the share register with voting rights, provided that such nominee has entered into an agreement with ABB concerning its status, and further pro- vided that the nominee is subject to recognized bank or financial market supervision. In special cases the Board may grant exemptions. There were no exemptions granted in 2012. The limitation on the transferability of shares may be removed by an amendment of ABB’s Articles of Incorporation by a shareholders’ resolution requiring two-thirds of the votes represented at the meeting. ABB Annual Report 2012 | Corporate governance report 19 4.3 Shareholders’ dividend rights 5. Board of Directors ABB Ltd may pay out a dividend only if it has been proposed by a shareholder or the Board and approved at a general meeting of shareholders, and the auditors confirm that the dividend conforms to statutory law and ABB’s Articles of Incorporation. Dividends are usually due and payable in Swiss francs and the ex-date for dividends is usually two trading days after the approving shareholders’ resolution. ABB has established, for tax purposes, a dividend access facility for its shareholders who are residents of Sweden. If such shareholders have registered their shares with Euroclear Sweden AB, then they may elect to receive the dividend in Swedish kronor from ABB Norden Holding AB without deduc- tion of Swiss withholding tax. For further information on the dividend access facility, please refer to ABB’s Articles of Incorporation, a copy of which can be found in the section “Corporate governance” at www.abb.com/investorcenter 4.4 General meeting Shareholders’ resolutions at general meetings are approved with an absolute majority of the votes represented at the meeting, except for those matters described in article 704 of the Swiss Code of Obligations and for resolutions with respect to restrictions on the exercise of the right to vote and the removal of such restrictions, which all require the ap- proval of two-thirds of the votes represented at the meeting. As at December 31, 2012, shareholders representing shares of a par value totaling at least CHF 412,000 may request items to be included in the agenda of a general meeting. Any such request must be made in writing at least 40 days prior to the date of the general meeting and specify the items and the motions of such shareholder(s). ABB’s Articles of Incorporation do not contain provisions on the convocation of the general meeting of shareholders that differ from the applicable legal provisions. 5.1 Responsibilities and organization The Board defines the ultimate direction of the business of ABB and issues the necessary instructions. It determines the organization of the ABB Group and appoints, removes and supervises the persons entrusted with the management and representation of ABB. The internal organizational structure and the definition of the areas of responsibility of the Board, as well as the infor- mation and control instruments vis-à-vis the Executive Com- mittee, are set forth in the ABB Ltd Board Regulations and Corporate Governance Guidelines, a copy of which can be found in the section “Corporate governance” at www.abb.com/ investorcenter The Board meets as frequently as needed but at least four times per annual Board term. Board meetings are convened by the chairman or upon request by a director or the chief executive officer (CEO). Documentation covering the various items of the agenda for each Board meeting is sent out in advance to each Board member in order to allow each member time to study the covered matters prior to the meetings. Decisions made at the Board meetings are recorded in written minutes of the meetings. The CEO shall regularly, and whenever extraordinary circumstances so require, report to the Board about ABB’s overall business and affairs. Further, Board members are entitled to information concerning ABB’s business and affairs. Additional details are set forth in the ABB Ltd Board Regulations & Corporate Governance Guidelines which can be found in the section “Corporate governance” at www.abb.com/ investorcenter 5.2 Term and members The members of the Board are elected individually at the annual general meeting of the shareholders for a term of one year; re-election is possible. Our Articles of Incorporation, a copy of which can be found in the section “Corporate gov- ernance” at www.abb.com/investorcenter, do not provide for the retirement of directors based on their age. However, an age limit for members of the Board is set forth in the ABB Ltd Board Regulations and Corporate Governance Guide- lines (although waivers are possible and subject to Board discretion), a copy of which can be found in the section “Corpo- rate governance” at www.abb.com/investorcenter 20 Corporate governance report | ABB Annual Report 2012 As at December 31, 2012, the members of the Board (Board term April 2012 to April 2013) were: Hubertus von Grünberg has been a member and chair- man of ABB’s Board of Directors since May 3, 2007. He is a member of the supervisory boards of Allianz Versicherungs AG and Deutsche Telekom AG (both Germany). He is a member of the board of directors of Schindler Holding AG (Switzerland). Mr. von Grünberg was born in 1942 and is a German citizen. Roger Agnelli has been a member of ABB’s Board of Directors since March 12, 2002. He was previously the presi- dent and chief executive officer of Vale S.A. (Brazil). Mr. Agnelli was born in 1959 and is a Brazilian citizen. Louis R. Hughes has been a member of ABB’s Board of Directors since May 16, 2003. He is the chairman of InZero Systems (formerly GBS Laboratories LLC) (U.S.). He is also a member of the boards of directors of Akzo Nobel (the Neth- erlands) and Alcatel Lucent (France). Mr. Hughes was born in 1949 and is a U.S. citizen. Hans Ulrich Märki has been a member of ABB’s Board of Directors since March 12, 2002. He is the retired chairman of IBM Europe, Middle East and Africa (France), and a member of the board of directors of Mettler-Toledo International (U.S.) and Swiss Re Ltd and Menuhin Festival Gstaad AG (both Switzerland). He is also a member of the foundation board of Schulthess Klinik, Zurich (Switzerland) and the board of trustees of the Hermitage Museum, St. Petersburg (Russia). Mr. Märki was born in 1946 and is a Swiss citizen. Michel de Rosen has been a member of ABB’s Board of Directors since March 12, 2002. He is the chief executive officer of and a member of the board of directors of Eutelsat Communications (France). Mr. de Rosen was born in 1951 and is a French citizen. Michael Treschow has been a member of ABB’s Board of Directors since May 16, 2003. He is the chairman of the boards of directors of Unilever NV (the Netherlands), and Unilever PLC (U.K.). He is also a member of the board of directors of the Knut and Alice Wallenberg Foundation (Sweden). Mr. Treschow was born in 1943 and is a Swedish citizen. Jacob Wallenberg has been a member of ABB’s Board of Directors since June 26, 1999. From March 1999 to June 1999, he served as a member of the board of directors of ABB Asea Brown Boveri Ltd, the former parent company of the ABB Group. He is the chairman of the board of directors of Investor AB (Sweden). He is vice chairman of Telefonaktie- bolaget LM Ericsson AB, SEB Skandinaviska Enskilda Ban- ken and SAS AB (all Sweden). He is also a member of the boards of directors of the Knut and Alice Wallenberg Founda- tion and the Stockholm School of Economics (both Sweden), and The Coca-Cola Company (U.S.). Mr. Wallenberg was born in 1956 and is a Swedish citizen. Ying Yeh has been a member of ABB’s Board of Direc- tors since April 29, 2011. She is a member of the boards of directors of InterContinental Hotels Group (U.K.), Volvo AB (Sweden) and Samsonite International S.A. (Luxembourg). Ms. Yeh was born in 1948 and is a Chinese citizen. As of December 31, 2012, all Board members were non-exec- utive and independent directors (see also section 7 below), and none of ABB’s Board members held any official functions or political posts. Further information on ABB’s Board members can be found by clicking on the ABB Board of Direc- tors CV link which can be found in the section “Corporate governance” at www.abb.com/investorcenter 5.3 Board committees From among its members, the Board has appointed two Board committees: the Governance, Nomination and Compen- sation Committee (GNCC) and the Finance, Audit and Compliance Committee (FACC). The duties and objectives of the Board committees are set forth in the ABB Ltd Board Regulations and Corporate Governance Guidelines, a copy of which can be found in the section “Corporate governance” at www.abb.com/investorcenter. These commit- tees assist the Board in its tasks and report regularly to the Board. The members of the Board committees are required to be independent. 5.3.1 Governance, Nomination and Compensation Committee The GNCC is responsible for (1) overseeing corporate governance practices within ABB, (2) nominating candidates for the Board, the role of CEO and other positions on the Executive Committee, and (3) succession planning, employ- ment and compensation matters relating to the Board and the Executive Committee. The GNCC is also responsible for maintaining an orientation program for new Board mem- bers and an ongoing education program for existing Board members. The GNCC must comprise three or more independent directors. The chairman of the Board and, upon invitation by the committee’s chairman, the CEO or other members of the Executive Committee may participate in the committee meetings, provided that any potential conflict of interest is avoided and confidentiality of the discussions is maintained. ABB Annual Report 2012 | Corporate governance report 21 As at December 31, 2012, the members of the GNCC were: Hans Ulrich Märki (chairman) Michel de Rosen Michael Treschow Ying Yeh 5.3.2 Finance, Audit and Compliance Committee The FACC is responsible for overseeing (1) the integrity of ABB’s financial statements, (2) ABB’s compliance with legal, tax and regulatory requirements, (3) the independent auditors’ qualifications and independence, (4) the performance of ABB’s internal audit function and external auditors, and (5) ABB’s capital structure, funding requirements and financial risk policies. The FACC must comprise three or more independent directors who have a thorough understanding of finance and accounting. The chairman of the Board and, upon invitation by the committee’s chairman, the CEO or other members of the Executive Committee may participate in the committee meetings, provided that any potential conflict of interest is avoided and confidentiality of the discussions is maintained. In addi- tion, the Chief Integrity Officer, the Head of Internal Audit and the external auditors participate in the meetings as appro- priate. As required by the U.S. Securities and Exchange Com- mission (SEC) at least one member of the FACC has to be an audit committee financial expert. The Board has determined that each member of the FACC is an audit committee finan- cial expert. 5.4 Meetings and attendance The Board and its committees have regularly scheduled meetings throughout the year. These meetings are supple- mented by additional meetings (either in person or by conference call), as necessary. The table below shows the number of meetings held during 2012 by the Board and its committees, their average duration, as well as the attendance of the individual Board members. In addition, members of the Board and the Execu- tive Committee participated in a two-day strategic retreat. Meetings and attendance Board GNCC FACC Average duration (hours) 6.2 0.8 Regular Additional Number of meetings Meetings attended: Hubertus von Grünberg Roger Agnelli Louis R. Hughes Hans Ulrich Märki Michel de Rosen Michael Treschow Jacob Wallenberg Ying Yeh 6 6 6 6 6 6 6 6 6 3 3 3 3 3 3 3 3 3 2.3 10 – – – 10 10 10 – 10 2.9 6 – 5 6 – – – 6 – 5.5 Board Compensation and Shareholdings As at December 31, 2012, the members of the FACC were: Louis R. Hughes (chairman) Roger Agnelli Jacob Wallenberg Information about Board compensation and shareholdings can be found in sections titled “Components of compensa- tion”, “Board compensation in 2012”, and “ABB shareholding of members of the Board and EC” of the Remuneration report contained in this Annual Report. 5.6 Secretary to the Board Diane de Saint Victor is the secretary to the Board. 22 Corporate governance report | ABB Annual Report 2012 6. Executive Committee 6.1 Responsibilities and organization The Board has delegated the executive management of ABB to the CEO and the other members of the Executive Committee. The CEO and under his direction the other members of the Executive Committee are responsible for ABB’s overall business and affairs and day-to-day manage- ment. The CEO reports to the Board regularly, and whenever extraordinary circumstances so require, on the course of ABB’s business and financial performance and on all organi- zational and personnel matters, transactions and other issues relevant to the Group. Each member of the Executive Committee is appointed and discharged by the Board. 6.2 Members of the Executive Committee As at December 31, 2012, the members of the Executive Committee were: Joe Hogan joined ABB’s Executive Committee as Chief Executive Officer in September 2008. Before joining ABB, Mr. Hogan was the CEO and President of General Electric’s GE Healthcare unit from 2000 to 2008. From 1985 to 2000, Mr. Hogan held various positions at General Electric. Mr. Hogan was born in 1957 and is a U.S. citizen. Michel Demaré joined ABB’s Executive Committee as Chief Financial Officer in January 2005. From October 2008 to March 2011, he was also Head of Global Markets. From February 2008 to August 2008, he was appointed interim CEO in addition to his duties as CFO. He is also vice chairman of the board of directors of UBS AG and a board member of Syngenta AG and IMD Foundation (all Switzerland). From 2002 until 2004, Mr. Demaré was vice president and chief finan- cial officer of Baxter Europe. From 1984 until 2002, he held various positions within Dow Chemical (U.S.). Mr. Demaré was born in 1956 and is a Belgian citizen. Gary Steel joined ABB’s Executive Committee as Head of Human Resources in January 2003. Mr. Steel is a member of the board of directors of Harman International Industries Inc. (U.S.) and a director of Aquamarine Power (U.K.). In 2002, he was the human resources director, group finance at Royal Dutch Shell (the Netherlands). Between 1976 and 2002, he held several human resources and employee relations positions at Royal Dutch Shell. Mr. Steel was born in 1952 and is a British citizen. Diane de Saint Victor joined ABB’s Executive Commit- tee as General Counsel in January 2007. As of March 2013, she has been named as a non-executive director of Barclays Bank Plc. From 2004 to 2006, she was general counsel of European Aeronautic Defence and Space, EADS (France/ Germany). From 2003 to 2004, she was general counsel of SCA Hygiene Products (Germany). From 1993 to 2003, she held various legal positions with Honeywell International (France/Belgium). From 1988 to 1993, she held various legal positions with General Electric (U.S.). Ms. de Saint Victor was born in 1955 and is a French citizen. Frank Duggan was appointed Executive Committee member responsible for Global Markets in March 2011. Since 2008 he is also ABB’s region manager for India, Middle East and Africa. From 2008 to 2011, he was ABB’s country man- ager for the United Arab Emirates. From 2004 to 2007, he was head of ABB’s Group Account Management and ABB’s country manager for Ireland. Between 1986 and 2004, he held several management positions with ABB. Mr. Duggan was born in 1959 and is an Irish citizen. Greg Scheu was appointed Executive Committee mem- ber responsible for Marketing and Customer Solutions in May 2012. Mr. Scheu, a former executive at Rockwell Interna- tional, joined ABB in 2001 and was responsible for the inte- gration of Baldor Electric Co. which ABB acquired in January 2011. Mr. Scheu was born in 1961 and is a U.S. citizen. Prith Banerjee joined ABB’s Executive Committee as Chief Technology Officer in May 2012. From 2007 to 2012, Mr. Banerjee was Senior Vice President of Research Hewlett Packard and Director of HP Labs (U.S.). Prior to that, Mr. Banerjee was Professor of Electrical Engineering and Com- puter Science, as well as Dean of the College of Engineering at the University of Illinois, Chicago. Mr. Banerjee was born in 1960 and is a U.S. citizen. Bernhard Jucker was appointed Executive Committee member responsible for the Power Products division in January 2006. From 2003 to 2005, he was ABB’s country manager for Germany. From 1980 to 2003, he held various positions in ABB. Mr. Jucker was born in 1954 and is a Swiss citizen. ABB Annual Report 2012 | Corporate governance report 23 Further information about the members of the Executive Committee can be found by clicking on the Executive Committee CV link in the section “Corporate governance” at www.abb.com/investorcenter 6.3 Executive Committee Compensation and Shareholdings Information about Executive Committee compensation and shareholdings can be found in sections titled “Components of executive compensation”, “EC com pensation in 2012”, “Compensation to former members of the Board and the EC”, and “ABB shareholdings of members of the Board and the EC” of the Remuneration report contained in this Annual Report. 6.4 Management contracts There are no management contracts between ABB and companies or natural persons not belonging to the ABB Group. Brice Koch was appointed Executive Committee mem- ber responsible for the Power Systems division in March 2012. From January 2010 to March 2012, Mr. Koch was Executive Committee member responsible for Marketing and Customer Solutions. From 2007 to 2009 he was the Manager of ABB in China and of ABB’s North Asia Region. Between 1994 and 2006, he held several management positions with ABB. He is also member of the board of directors of Rector S.A. (France) and ETH Zurich Foundation (Switzerland). Mr. Koch was born in 1964 and is a French citizen. Ulrich Spiesshofer was appointed Executive Commit- tee member responsible for the Discrete Automation and Motion division in January 2010. He joined ABB in November 2005 as Executive Committee member responsible for Cor- porate Development. From 2002 until he joined ABB, he was senior partner, global head of operations practice at Roland Berger AG (Switzerland). Prior to 2002, he held various posi- tions with A.T. Kearney Ltd. and its affiliates. Mr. Spiesshofer was born in 1964 and is a German citizen. Tarak Mehta was appointed Executive Committee member responsible for the Low Voltage Products division in October 2010. From 2007 to 2010, he was head of the Transformers business. Between 1998 and 2006, he held several management positions with ABB. Mr. Mehta was born in 1966 and is a U.S. citizen. Veli-Matti Reinikkala was appointed Executive Com- mittee member responsible for the Process Automation division in January 2006. He is a member of the board of directors of UPM-Kymmene (Finland). In 2005, he was the head of the Process Automation business area. From 1993 to 2005, he held several positions with ABB. Mr. Reinikkala was born in 1957 and is a Finnish citizen. In addition, as of February 1, 2013, Michel Demaré stepped down as ABB’s Chief Financial Officer and member of the Executive Committee and Eric Elzvik has succeeded him as Chief Financial Officer and member of the Execu- tive Committee. From 2010 to 2013, Mr. Elzvik was the Chief Financial Officer of ABB’s Discrete Automation and Motion division. Mr. Elzvik joined ABB in 1984 and has held a variety of other leadership roles in Sweden, Singapore and Switzer- land, including head of Corporate Development, and head of Mergers & Acquisitions and New Ventures. Mr. Elzvik was born in 1960 and is a Swiss and Swedish citizen. 24 Corporate governance report | ABB Annual Report 2012 7. Business relationships This section describes important business relationships between ABB and its Board and Executive Committee mem- bers, or companies and organizations represented by them. This determination has been made based on ABB Ltd’s Related Party Transaction Policy. This policy is contained in the ABB Ltd Board Regulations and Corporate Governance Guidelines, a copy of which can be found in the section “Corporate governance” at www.abb.com/investorcenter Vale S.A. and its subsidiaries (Vale) and ABB have entered into a framework agreement establishing general terms and conditions for the supply of products, systems and services among their respective group subsidiaries. ABB supplies Vale primarily with process automation products for mineral systems. The total revenues recorded by ABB in 2012 relating to its contracts with Vale were approximately $140 million. Roger Agnelli was previously president and CEO of Vale. Atlas Copco AB (Atlas Copco) is an important customer of ABB. ABB supplies Atlas Copco primarily with drives and motors through its Discrete Automation and Motion division. The total revenues recorded by ABB relating to business with Atlas Copco were approximately $60 million in 2012. Jacob Wallenberg was vice chairman of Atlas Copco until April 2012. ABB has an unsecured syndicated $2-billion, revolving credit facility. As of December 31, 2012, SEB Skandinaviska Enskilda Banken AB (publ) (SEB) and UBS AG (UBS) had each committed to $71 million out of the $2-billion total. In addition, in February 2012, ABB entered into a $4-billion term credit agreement to provide bridge financing for the acquisi- tion of Thomas & Betts Corporation. SEB and UBS had each committed to lend ABB $250 million as of the completion of the primary syndication. The term credit agreement was never drawn and was cancelled in May 2012. In addition, ABB has regular banking business with UBS and SEB. Jacob Wallenberg is the vice chairman of SEB and Michel Demaré is the vice chairman of UBS. ABB has also retained Ortec Finance B.V. (Ortec) to provide pension modeling services. Michel Demaré’s spouse is an employee and the chairman of the board of directors of Ortec’s Swiss subsidiary. After comparing the share of revenues generated from ABB’s business with Vale and Atlas Copco, after reviewing the banking commitments of UBS and SEB, and after consid- ering Ortec’s business relationship with ABB, the Board has determined that ABB’s business relationships with those companies are not unusual in their nature or conditions and do not constitute material business relationships. As a result, the Board concluded that all members of the Board are considered to be independent directors. This determina- tion was made in accordance with ABB Ltd’s Related Party Transaction Policy which was prepared based on the Swiss Code of Best Practice for Corporate Governance and the independence criteria set forth in the corporate governance rules of the New York Stock Exchange. 8. Employee participation programs In order to align its employees’ interests with the business goals and financial results of the company, ABB operates a number of incentive plans, linked to ABB’s shares, such as the Employee Share Acquisition Plan, the Management Incentive Plan and the Long-Term Incentive Plan. For a more detailed description of these incentive plans, please refer to note 18 to ABB’s consolidated financial statements contained in the Financial review section of this Annual Report. 9. Duty to make a public tender offer ABB’s Articles of Incorporation do not contain any provisions raising the threshold (opting-up) or waiving the duty (opt- ing out) to make a public tender offer pursuant to article 32 of the Swiss Stock Exchange and Securities Trading Act. ABB Annual Report 2012 | Corporate governance report 25 10. Auditors 10.1 Auditors Ernst & Young are the auditors of ABB’s statutory and consolidated accounts. 10.2 Duration of the mandate and term of office of the auditor Ernst & Young assumed the auditing mandate of the ABB Group in 1994. The head auditor responsible for the mandate, Nigel Jones, began serving in this function in respect of the financial year ended December 31, 2008. Pursuant to the Articles of Incorporation, the term of office of ABB’s auditors is one year. 10.3 Auditing and additional fees paid to the auditor The audit fees charged by Ernst & Young for the legally prescribed audit amounted to approximately $28.6 million in 2012. Audit services are defined as the standard audit work performed each fiscal year necessary to allow the auditors to issue an opinion on the consolidated financial statements of ABB and to issue an opinion on the local statutory finan- cial statements. This classification may also include services that can be provided only by the auditors, such as assistance with the application of new accounting policies, pre-issuance reviews of quarterly financial results and comfort letters delivered to underwriters in connection with debt and equity offerings. In addition, Ernst & Young charged approximately $8.0 million for non-audit services performed during 2012. Non-audit services include primarily accounting consulta- tions and audits in connection with divestments, audits of pension and benefit plans, accounting advisory services, tax compliance and other tax services. In accordance with the requirements of the U.S. Sarbanes-Oxley Act of 2002 and rules issued by the SEC, ABB has, on a global basis, a process for the review and pre-approval of audit and non-audit services to be performed by Ernst & Young. 10.4 Supervisory and control instruments vis-à-vis the auditors The FACC prepares proposals to the Board for the appoint- ment and removal of the auditors. The FACC is also respon- sible for supervising the auditors to ensure their qualifications, independence and performance. It meets regularly with the auditors to obtain reports about the results of their audit procedures. The FACC reports the material elements of its supervision of the auditors to the Board. 11. Information policy ABB, as a publicly traded company, is committed to commu- nicating in a timely and consistent way to shareholders, potential investors, financial analysts, customers, suppliers, the media and other interested parties. ABB is required to disseminate material information pertaining to its businesses in a manner that complies with its obligations under the rules of the stock exchanges where its shares are listed and traded. ABB publishes an annual report that provides audited financial statements and information about business results, strategy, corporate governance, human resources, sustain- ability (including health and safety) and technology. In addition, ABB also submits an annual report on Form 20-F to the SEC. In addition, ABB publishes its results on a quarterly basis as press releases, distributed pursuant to the rules and regulations of the stock exchanges on which its shares are listed and traded. Press releases relating to financial results and material events are also filed with the SEC on Form 6-K. An archive containing Annual Reports, Form 20-F reports, quarterly results releases and related presentations can be found in the “Reports and presentations” section at www.abb.com/investorcenter. The quarterly results press releases contain unaudited financial information prepared in accordance with U.S. GAAP. To subscribe to important press releases, please click on the “Contacts and Services” and choose “Subscribe to updates” at www.abb.com/ investorcenter. Ad hoc notices can also be found in the press releases section at www.abb.com/news 26 Corporate governance report | ABB Annual Report 2012 ABB’s official means of communication is the Swiss Official Gazette of Commerce (www.shab.ch). The invitation to the company’s Annual General Meeting is sent to regis- tered shareholders by mail. Inquiries may also be made to ABB Investor Relations: Affolternstrasse 44 CH-8050 Zurich, Switzerland Telephone: +41 (0)43 317 7111 Fax: +41 (0)44 311 9817 E-mail: investorrelations@ch.abb.com ABB’s Web site is: www.abb.com 12. Further information on corporate governance The list below contains references to additional information concerning the corporate governance of ABB, which can be accessed in the section “Corporate governance” at www.abb.com/investorcenter – Articles of Incorporation – ABB Ltd Board Regulations and Corporate Governance Guidelines – Regulations of the Governance, Nomination and Compensation Committee – Regulations of the Finance, Audit and Compliance Committee – Related Party Transaction Policy – ABB Code of Conduct – Addendum to the ABB Code of Conduct for Members of the Board of Directors and the Executive Committee – Comparison of ABB’s corporate governance practices to the New York Stock Exchange rules – CVs of the Board members – CVs of the Executive Committee members ABB Annual Report 2012 | Corporate governance report 27 28 Remuneration report | ABB Annual Report 2012 Remuneration report Contents 30 Board remuneration . 32 Executive Committee remuneration . 39 Additional fees and remuneration . 39 Compensation to former members of the Board and EC 39 Change of control provisions . 39 ABB shareholdings of members of the Board and EC ABB Annual Report 2012 | Remuneration report 29 ABB’s success depends on its ability to attract and retain people who will drive the business to outperform competitors and create value for shareholders over the long term. These are important considerations behind ABB’s remuneration policy. The Remuneration report presents the principles of this policy, the mechanisms for managing remuneration, and the compensation in 2012 for members of the Board of Directors (Board) and the Executive Committee (EC). For the compensation in 2011, see Notes 10 and 11 to the ABB Ltd statutory financial statements. 1. Board remuneration 1.1 Governance and principles The Board sets and periodically reviews compensation for its members based on a comparison of the compensation of non-executive board members of publicly-traded companies in Switzerland that are part of the Swiss Market Index. The Governance, Nomination and Compensation Committee (GNCC) is responsible for making recommendations to the Board. 1.2 Components of compensation Members of the Board are paid for their service over a 12-month period that starts with their election at the annual general meeting. Payment is made in two installments, one following the first six months of the term and one at the end. Board members do not receive pension benefits and are not eligible to participate in any of ABB’s employee incen- tive programs. To align the interests of Board members with those of ABB’s shareholders, half of each member’s compensation is paid in the form of ABB shares, though Board members can alternatively choose to receive all their compensation in shares. The shares are kept in a blocked account for three years. Departing Board members are entitled to the shares when they leave the company unless agreed otherwise. The number of shares awarded is calculated prior to each semi-annual payment by dividing the sum to which the Board members are entitled by the average closing price of the ABB share over a predefined 30-day period. 30 Remuneration report | ABB Annual Report 2012 The compensation amounts per individual are listed in the table below: November May Board term 2012/2013 Board term 2011/2012 Paid in 2012 Settled in shares – Settled in shares – Total Settled number of Settled number of compen sation Name/Function in cash(1) shares received(2) in cash(1) shares received(2) paid 2012(3),(4),(5) Hubertus von Grünberg Chairman of the Board Roger Agnelli(6) Member of the Board Louis R. Hughes (6) Member of the Board and Chairman of the (CHF) – (CHF) (CHF) 23,298 – 22,685 1,200,000 75,000 2,873 75,000 2,807 300,000 Finance, Audit and Compliance Committee 100,000 3,840 100,000 3,751 400,000 Hans Ulrich Märki Member of the Board and Chairman of the Governance, Nomination and Compensation Committee Michel de Rosen(7) Member of the Board Michael Treschow(7) Member of the Board Jacob Wallenberg(6) Member of the Board Ying Yeh(7) Member of the Board Total – 75,000 75,000 75,000 75,000 475,000 10,649 2,873 – – 10,364 400,000 5,614 300,000 2,922 75,000 2,843 300,000 2,873 75,000 2,807 300,000 2,905 52,233 75,000 400,000 2,807 53,678 300,000 3,500,000 (1) (2) (3) (4) (5) (6) (7) Represents gross amounts paid, prior to deductions for social security, withholding tax etc. Number of shares per Board member is calculated based on net amount due after deductions for social security, withholding tax etc. For the 2012–2013 Board term, all members elected to receive 50% of their gross compensation in the form of ABB shares, except for Hubertus von Grünberg and Hans Ulrich Märki who elected to receive 100%. For the 2011–2012 Board term, all members elected to receive 50% of their gross compensation in the form of ABB shares, except for Hubertus von Grünberg, Hans Ulrich Märki and Michel de Rosen who elected to receive 100%. In addition to the Board remuneration stated in the above table, the Company paid CHF 211,008 in 2012 in employee social security payments. Member of the Finance, Audit and Compliance Committee. Member of the Governance, Nomination and Compensation Committee. ABB Annual Report 2012 | Remuneration report 31 1.3 Board compensation in 2012 Compensation for Board members is outlined in the table below and has been unchanged since the 2007/2008 term of office. Consistent with past practice, no loans or guarantees were granted to Board members in 2012. Function Chairman of the Board Member of the Board term 2012/2013 2011/2012 CHF CHF 1,200,000 1,200,000 Board and Committee chairman Member of the Board 400,000 300,000 400,000 300,000 2. Executive Committee remuneration 2.1 Governance and principles The Board and GNCC have direct oversight of compensation policy at ABB. The GNCC is responsible for developing the general remuneration principles and practices of the ABB Group and for recommending them to the full Board, which takes the final decisions. The Board and GNCC are actively involved in the con- tinuous development of ABB’s executive remuneration system to reflect a remuneration philosophy that is based on the following principles: – Market orientation – ABB conducts regular benchmarking reviews to ensure compensation is at a level that will attract and retain top talent. – Performance – ABB ensures that performance drives all compensation elements. Performance metrics include financial objectives, individual performance and behavior, as well as the share price performance. – Shareholder value – ABB’s compensation elements focus on rewarding the delivery of outstanding and sustainable results without inappropriate risk taking. – Retention – ABB grants a portion of its compensation through long-term oriented elements to attract and retain the key talent that ABB needs to drive its success globally. The GNCC acts on behalf of the Board in regularly review- ing the remuneration philosophy and structure, and in review- ing and approving specific proposals on executive compen- sation to ensure that they are consistent with the Group’s compensation principles. In 2012, the GNCC hired Hostettler, Kramarsch & Partner (hkp), an independent consultant specializing in performance management and compensation, to provide advice on remuneration. At the GNCC’s request, the firm helped to redesign the Long-Term Incentive Plan de- scribed in section 2.2 of this Remuneration report. Hkp has no other mandate with ABB. All senior positions in ABB have been evaluated using a consistent methodology developed by the Hay Group, whose job evaluation system is used by more than 10,000 compa- nies around the world. The Hay methodology goes beyond job titles and company size in assessing positions. It considers the know-how required to do the job, the problem-solving com - plexities involved, as well as the accountability for results and the freedom to act to achieve results. This approach provides a meaningful, transparent and consistent basis for comparing remuneration levels at ABB with those of equivalent jobs at other companies that have been evaluated using the same criteria. The Board primarily uses Hay’s data from the Euro- pean market to set EC compensation, which is targeted to be above the median values for the market. Every year, the Board reviews the CEO’s performance and decides on any change in compensation. The CEO reviews the performance of other members of the EC and makes rec- ommendations to the GNCC on their individual remuneration. The full Board takes the final decisions on compensation for all EC members, none of whom participates in the delib - erations on their remuneration. Information on the meetings held by the GNCC in 2012 can be found in section 5.4 of the Corporate governance report. 2.2 Components of EC compensation Compensation elements and performance considerations The compensation of EC members currently consists of the following elements: a base salary and benefits, a short- term variable component dependent on annual Group perfor- mance objectives, and a long-term variable component designed to reward the creation of shareholder value and an executive’s commitment to the company. 32 Remuneration report | ABB Annual Report 2012 The main components of executive compensation are summarized in the following chart and described in detail below: Base salary Cash Paid monthly Short-term variable compensation Long-term variable compensation (Long-Term Incentive Plan 2012) Competitive in respect to labor markets Annual revisions, if any, partly based on performance Cash Conditional annual payment Payout depends on performance in previous year against predefined Group objectives, with a cap on the payout for over-performance Cash and shares Performance component: Retention component: Conditional grant made annually Conditional grant made annually Payout is in cash and depends on ABB’s weighted cumulative earnings per share over a three-year period Payout is in shares (70%) and cash (30%) and requires the executive to remain at ABB for a three-year period from grant (Executives can elect to receive 100% in shares) In addition, members of the EC are required to build up a holding of ABB shares that is equivalent to a multiple of their base salary, to ensure that their interests are aligned with those of shareholders. Since 2010, the requirement has been five times base salary for the CEO and four times base salary for the other members of the EC. New members of the EC should aim to reach these multiples within four years of their appointment. These required shareholding amounts are reviewed annually, based on salary and expected share price developments. The chart below illustrates how performance consider- ations are reflected in each component of executive remunera- tion. Performance considerations in each component of remuneration Performance period Year of award or review Performance period Year –3 Year –2 Year –1 Year Year +1 Year +2 Year +3 Individual performance and behavior Corporate and individual performance LTIP Corporate and individual performance over prior three years Level of annual base pay Level of short- term variable compensation payout Size of retention component Performance component Weighted cumulative earnings per share over next three years ABB Annual Report 2012 | Remuneration report 33 The 2012 objectives, shown in the table below, were Group-wide metrics that were aligned with the Group’s 2015 strategic targets that have been communicated to share- holders. Objective(1) Orders received Revenues Operational EBITDA(2) Ratio of operating cash flow to operational EBIT(3) Net Promoter Score (NPS)(4) Cost savings Weighting 12.5% 12.5% 25% 25% 10% 15% (1) (2) (3) (4) The financial objectives exclude the impact of currency fluctuations. See definition in Note 23 to ABB’s Consolidated Financial Statements. Operating cash flow is defined as net cash provided by operating activities, reversing the impact of interest and taxes. Operational EBIT is defined as Operational EBITDA before excluding depreciation and amortization. NPS is a metric based on dividing customers into three categories: Promoters, Passives, and Detractors. This is achieved by asking customers in a one-question survey whether they would recommend ABB to a colleague. In 2012, ABB had a target to increase the number of countries that have improved their NPS score. The payout for fully achieving the predefined annual objec- tives is equivalent to 150 percent of the base salary for the CEO and 100 percent of the base salary for other mem- bers of the EC. Underperformance results in a lower payout, or none at all if performance is below a certain threshold. If the objectives are exceeded, the Board has the discretion to approve a payout that is up to 50 percent higher (repre- senting up to 225 percent of the base salary for the CEO and 150 percent of the base salary for other members of the EC). For 2012, the Board exercised its discretion and awarded a 10 percent higher payout, reflecting the company’s perfor- mance against the objectives. Annual base salary The base salary for members of the EC is set with reference to positions of equivalent responsibility outside ABB, as determined using the Hay methodology described above. It is reviewed annually principally on the basis of Hay’s annual Top Executive Compensation in Europe survey. When con- sidering changes in base salary, the executive’s performance during the preceding year against individual objectives is taken into account. Under its mandate with ABB, Hay also conducts job evaluations. Benefits Members of the EC receive pension benefits, payable into the Swiss ABB Pension Fund and ABB Supplementary Insurance Plan (the regulations are available at www.abbvorsorge.ch). The current level of pension benefits was set in 2006 on the basis of results from a survey of pension conditions for Swiss- based executives at Adecco, Ciba, Dow, Nestlé, Novartis, Roche, Serono, Syngenta and Sulzer that ABB commissioned from Towers Watson, a consultant. The survey was repeated in 2010 and a new benchmarking exercise will be conducted in 2013. Towers Watson also provides actuarial services to ABB, and pension advisory services in connection with merg- ers and acquisitions transactions. The compensation of EC members also includes social security contributions and other benefits, as outlined in the table in section 2.4 of this Remuneration report. The Board has decided to provide tax equalization for EC members resident outside Switzerland to the extent that they are not able to claim a tax credit in their country of residence for income taxes they have paid in Switzerland. Short-term variable compensation Payment of the short-term variable component is conditional on the fulfillment of predefined annual objectives that are specific, quantifiable and challenging. Short-term variable compensation for members of the EC and most other senior managers throughout the company is based on Group performance objectives. For some managers with regional or country-level responsibilities, short-term variable compen- sation is based on related objectives adapted to ABB’s goals in these markets. The CEO recommends the Group perfor- mance objectives to the GNCC, which may make or request amendments before it submits a proposal to the Board. The Board takes the final decision. 34 Remuneration report | ABB Annual Report 2012 Payout % of performance component 200% 100% 0% Lower threshold (no payout) On target Upper threshold (maximum payout) Weighted cumulative earnings per share Long-term variable compensation An important principle of executive compensation at ABB is that it should encourage the creation of value for the com- pany’s shareholders and enable EC members to participate in the company’s success. The company’s Long-Term Incen- tive Plan (LTIP) is the principal mechanism through which members of the EC and certain other executives are encour- aged to create value for shareholders. Awarded annually, LTIPs comprise a performance component and a retention component whose proportions in relation to the base salary are explained below. Performance component The performance component of the plan is designed to reward participants for increasing earnings per share(5) (EPS) over a three-year period. EPS was adopted as the perfor- mance measure in the performance component of the LTIP in 2012. EPS replaces relative total shareholder return (TSR), which was the performance measure used in previous LTIPs. EPS growth (based on net income excluding acquisitions) is one of the financial targets of ABB’s 2015 strategy and is therefore better aligned with published goals than relative TSR, which is the percentage change in ABB’s share price plus dividends over a three-year period, compared with peers. The payout of this part of the plan occurs after three years, based on the Group’s weighted cumulative EPS perfor- mance against predefined objectives. The weighted cumu- lative EPS is calculated as 33 percent of EPS in the first year plus 67 percent of EPS in the second year plus 100 percent of EPS in the third year. There is no payout if the lower thresh- old is not reached and payout is capped if performance exceeds the upper threshold. The payout factors are shown in the chart on the right. At each launch, participants are allocated a reference number of shares that is linked to a percentage of their base salary. In 2012, the percentages were 100 percent for the CEO and 42 percent for the other members of the EC. The payout at the end of the three-year period, if any, will be made in cash. Under the terms and conditions of the plan, the GNCC decides whether EC members who leave the company before the end of the three-year period forfeit the unvested award, or receive all or a portion of such awards. (5) Earnings per share is defined in the terms of the LTIP as diluted earnings per share attributable to ABB shareholders calculated using income from continuing operations, net of tax, unless the Board decides to calculate using net income for a particular year. ABB Annual Report 2012 | Remuneration report 35 Historical payout of performance component 2006 2007 2008 2009 2010 2011 2012 2013 LTIP 2006 No payout LTIP 2007 92% of shares granted LTIP 2008 No payout LTIP 2009 No payout Historical payout of performance component Of the LTIPs launched since 2006 that have also vested, the only one whose performance component has paid out is the 2007 launch, under which participants, upon vesting, were entitled to receive 92 percent of the performance shares that they had been conditionally granted (see chart above). Retention component The second component of the LTIP is designed to retain executives at ABB. Members of the EC are conditionally granted shares, which are awarded after three further years of service to the company. The reference grant size for the CEO is equivalent to 100 percent of base salary. The other EC members receive a grant from a pool whose reference size is equivalent to 65 percent of their combined base salaries. The CEO recom- mends to the Board how to allocate shares from this pool to each individual EC member, based on an assessment of their individual performance in the previous calendar year, and the Board takes the final decision. Starting with the 2012 LTIP, the reference grant size for the CEO and the pool for the other EC members for any particular launch can each be increased or decreased by the Board by up to 25 percent, based on an assessment of ABB’s performance over the three years preceding the launch of the plan. The assessment considers ABB’s perfor- mance against its peers according to financial metrics and non-financial measures related to customer satisfaction, integrity, and health and safety. Following its assessment of ABB’s performance in the period 2009–2011, the Board increased the size of the retention component in the 2012 LTIP by 20 percent for the CEO and by 10 percent in aggregate for the rest of the EC. EC members receive 70 percent of the payout in shares and the remainder in cash, unless they elect to receive 100 percent in shares. Under the terms and conditions of the plan, the GNCC decides whether EC members who leave the company before the end of the three-year period forfeit the unvested award, or receive all or a portion of such awards. Severance provisions Employment contracts for EC members contain notice periods of 12 months, during which they are entitled to com- pensation comprising their base salary, benefits and short- term variable compensation. The Board has decided that, starting January 1, 2013, contracts for new members of the EC will no longer include a provision extending compensation for up to 12 additional months if their employment is termi- nated by ABB and if they do not find alternative employment within the notice period that pays at least 70 percent of their compensation. 36 Remuneration report | ABB Annual Report 2012 2.3 Acquisition Integration Execution Plan In the past three years, ABB has invested more than $10 bil- lion in connection with acquisitions as part of its strategy to grow the business profitably and create value for ABB share- holders. The focus has been on companies that fill geo- graphic, end-market or product gaps. Strict financial criteria are applied to the investments, and the financial objectives are expected to be achieved through a combination of cost and growth synergies. Delivering these synergies depends on the successful integration of the new businesses with those of ABB. To this end, the Board has established a one-time Acquisition Integration Execution Plan (AIEP) whose goal is to maximize the return on the recent acquisitions of Baldor, Thomas & Betts and Ventyx, and to foster the collaborative behavior required to make the benefits sustainable. The plan has two parts. The first is intended to reward the achievement of predefined objectives for 2013 related to revenues, operational EBITDA, and customer and employee retention and development, at each of the three acquisitions. Each business accounts for one-third of the first part of the plan. The second part is intended to accelerate collaboration between ABB’s business, technical, functional and local experts, a step which the Board considers vital not only to integrating the acquisitions but also to providing customers with the kind of service and experience that will enable the company to meet the ambitious goals of its 2015 strategy. The plan was launched in the fourth quarter of 2012 for members of the EC who are expected to be in their positions throughout 2013, excluding the CEO who will participate in the assessment of participants. In addition, Michel Demaré, whose departure from ABB was announced in October 2012, and Eric Elzvik, who joined the EC in February 2013, are not participants in the plan. The plan consists of conditionally granted shares (capped at a maximum of 768,286 shares). The payout, if any, will occur in 2014 and will be made in shares (70 percent) and cash (30 percent), although participants can elect to receive 100 percent in shares. 2.4 EC compensation in 2012 ABB discloses the compensation elements for each member of the EC, going beyond the requirements of the Swiss Code of Obligations. The table in this section provides an overview of the total compensation of members of the EC in 2012, comprising cash compensation and the estimated value of the conditional grants awarded under the AIEP and under the three-year LTIP launched in 2012. Cash compensation includes the base salary, the short-term variable compensation for 2012 and pension benefits, as well as the amounts paid by the company to cover other benefits comprising mainly social security contributions. The performance components of LTIPs and the AIEP are valued at grant using the ABB share price and Monte Carlo modeling, an accepted simulation method under U.S. GAAP (the accounting standard used by ABB). The compensation is shown gross (before deduction of employee’s social security and pension contributions). The base salary and benefits are fixed elements of the annual compensation packages, while the other compo- nents are variable. In 2012, fixed compensation represented 27 percent of the CEO’s remuneration and an average of 34 percent for the other EC members. The ratio of fixed to variable components in any given year will depend on the performance of the individuals and of the company against predefined Group performance objectives. The total of base salary and benefits, short-term variable compensation and LTIP awards was 42.5 million Swiss francs in 2012 compared with 37.8 million Swiss francs in 2011 for individuals who were members of the EC at the end of the respective year. This change reflects the addition of one member to the EC as well as the higher award level under the 2012 LTIP. The conditional award in 2012 under the one- time AIEP resulted in an additional 8.4 million Swiss francs, bringing their total compensation to 50.9 million Swiss francs in 2012. ABB Annual Report 2012 | Remuneration report 37 e l b a i r a v m r e t - t r o h S ) 1 ( n o i t a s n e p m o c y r a l a s e s a B Name (CHF) (CHF) Joe Hogan 2,010,011 3,316,500 Michel Demaré 1,200,007 1,320,000 Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan(4) Greg Scheu (joined on 805,002 865,673 791,993 950,004 770,006 816,669 718,837 641,963 885,500 962,500 880,000 1,045,000 847,000 913,000 803,000 697,279 r e d n u d e t n a r g s d r a w a d e s a b - e r a h s f o e u l a v d e t a m i t s E ) 3 ( 2 1 0 2 n i n a P l I T L e h t (CHF) r e d n u d e t n a r g s d r a w a d e s a b ) 3 ( 2 1 0 2 n i P E I A e m i t - e n o e h t - e r a h s f o e u l a v d e t a m i t s E (CHF) l a t o t b u S 2 1 0 2 (CHF) 2 1 0 2 l a t o T (CHF) 4,115,136 10,157,801 – 3,169,425 – – 10,157,801 3,169,425 851,003 3,000,497 896,656 3,897,153 1,363,655 3,592,456 974,623 4,567,079 899,193 2,983,531 891,085 3,874,616 1,067,784 3,522,380 1,058,174 4,580,554 865,483 2,891,617 857,673 3,749,290 1,099,345 3,275,918 924,511 4,200,429 820,512 820,512 2,934,264 2,878,865 813,119 3,747,383 835,403 3,714,268 s t i f e n e b n o i s n e P (CHF) 284,870 271,450 286,938 235,680 273,583 280,372 263,892 234,425 222,181 313,377 ) 2 ( s t i f e n e b r e h t O (CHF) 431,284 377,968 172,054 164,948 138,762 179,220 145,236 212,479 369,734 405,734 May 1, 2012) 450,002 495,000 161,816 42,727 713,574 1,863,119 751,851 2,614,970 Prith Banerjee (joined ABB on May 7, 2012) 456,523 500,914 137,742 401,148 740,017 2,236,344 389,860 2,626,204 Total Executive Committee members as of Dec. 31, 2012 10,476,690 12,665,693 2,966,326 3,041,294 13,356,214 42,506,217 8,392,955 50,899,172 Peter Leupp (retired from the EC on March 1, 2012)(5) 496,694 291,960 167,900 206,794 Total former Executive Committee members as of Dec. 31, 2012 496,694 291,960 167,900 206,794 – – 1,163,348 1,163,348 – – 1,163,348 1,163,348 Total 10,973,384 12,957,653 3,134,226 3,248,088 13,356,214 43,669,565 8,392,955 52,062,520 (1) (2) (3) (4) (5) The table above shows accruals related to the short-term variable compensation for the year 2012 for all Executive Committee members, except for Peter Leupp, who received in July 2012 a pro-rata short-term variable compensation payment covering the period of his service as an EC member. For all other Executive Committee members, the short-term variable com- pensation will be paid in 2013, after the publication of the financial results. In March 2012, the current and former Executive Committee members received the 2011 short-term variable compensation payments totaling CHF 12,102,149. Short-term variable compensation is linked to the objectives defined in the ABB Group’s scorecard. Upon full achievement of these objectives, the short-term variable compensation of the CEO corresponds to 150 percent of his base salary, while for all other Executive Committee members it represents 100 percent of their respective base salary. The Board has the discretion to approve a payout that is up to 50 percent higher (representing up to 225 percent of the base salary for the CEO and 150 percent of the base salary for other members of the Executive Committee), if the objectives are exceeded. For 2012, the Board exercised its discretion and awarded a 10 percent higher payout, reflecting the Company’s performance against the objectives. Other benefits comprise payments related to social security, health insurance, children’s education, transportation, tax advice and certain other items. The estimated value of the share-based awards is subject to performance and other parameters (e. g. earnings per share) and may therefore vary in value from the above numbers at the date of vesting, January 3, 2014 (AIEP) and May 31, 2015 (LTI Plan). The above amounts have been calculated using the market value of the ABB share on the day of grant and, in the case of the AIEP and the performance component of the LTI Plan, the Monte Carlo simulation model. Frank Duggan received 20 percent of his base salary in AED and 80 percent in EUR at a fixed AED/EUR exchange rate for the period January to December 2012. All AED payments were converted into Swiss francs at a rate of 0.2491288 per AED. The above compensation figures for Peter Leupp include contractual payments for the period March 1, 2012 to July 31, 2012, but exclude payments to him, after his retirement from the Executive Committee, in his capacity as director of ABB in China and of ABB Limited, India. 38 Remuneration report | ABB Annual Report 2012 Details of the share-based compensation granted to members of the EC during 2012 are provided in a table of their share- holdings in section 6.2 below. Consistent with past practice, no loans or guarantees were granted to members of the EC in 2012. Members of the EC are eligible to participate in the Em- ployee Share Acquisition Plan (ESAP), a savings plan based on stock options, which is open to employees around the world. In addition to the above awards, seven members of the EC participated in the ninth annual launch of the plan. EC members who participated in that launch are each entitled to acquire up to 580 ABB shares, except for one who is entitled to acquire up to 570 shares, at 17.08 Swiss francs per share, the market share price at the start of that launch. Members of the EC cannot participate in the Management Incentive Plan (MIP). Any MIP instruments held by EC mem- bers (and disclosed in section 6.2 of this Remuneration report) were awarded to them as part of the compensation they received in earlier roles that they held in ABB. For a more detailed description of ESAP and MIP, please refer to Note 18 to ABB’s Consolidated Financial Statements contained in the Financial review section of this Annual Report. 3. Additional fees and remuneration In 2012, ABB did not pay any fees or remuneration to the members of the Board or the EC for services rendered to ABB other than those disclosed above. Except as disclosed in section 7 of the Corporate governance report, ABB did not pay any additional fees or remuneration in 2012 to persons closely linked to a member of the Board or the EC for ser- vices rendered to ABB. 4. Compensation to former members of the Board and EC Except as disclosed in this Remuneration report, ABB did not make any payments in 2012 to a former member of the Board or the EC in connection with such role. 5. Change of control provisions Following the spirit of ABB’s remuneration philosophy, none of ABB’s Board members, EC members or members of senior management receives “golden parachutes” or other special benefits in the event of a change of control. 6. ABB shareholdings of members of the Board and EC As of December 31, 2012, the members of our Board and EC owned less than 1 percent of ABB’s total shares outstanding. 6.1 Board ownership of ABB shares and options The table below shows the number of ABB shares held by each Board member: Name Hubertus von Grünberg Roger Agnelli Louis R. Hughes Hans Ulrich Märki Michel de Rosen Michael Treschow Jacob Wallenberg(1) Ying Yeh Total Total number of shares held Dec. 31, 2012 Dec. 31, 2011 173,370 160,672 63,928 410,192 128,595 97,506 174,882 8,909 127,387 154,992 56,337 389,179 120,108 91,741 169,202 3,197 1,218,054 1,112,143 (1) Share amounts provided in this section do not include the shares beneficially owned by Investor AB, of which Mr. Wallenberg is chairman. Except as described in this section, no member of the Board and no person closely linked to a member of the Board held any shares of ABB or options in ABB shares. ABB Annual Report 2012 | Remuneration report 39 6.2 EC ownership of ABB shares and options As of December 31, 2012, EC members held ABB shares (or ADSs representing such shares), the conditional rights to receive shares under the LTIP, options (either vested or unvested as indicated) under the MIP and unvested shares in respect of other compensation arrangements, as shown in the table below: d l e h s e r a h s f o r e b m u n l a t o T 255,046 397,772 219,365 164,191 179,189 134,118 122,763 30,424 15,771 15,803 s n o i t p o d e t s e v f o r e b m u N ) 1 ( I P M e h t r e d n u d l e h – – – – – – – – 190,850 631,930 Name Joe Hogan Michel Demaré(4) Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Greg Scheu Unvested at December 31, 2012 s n o i t p o d e t s e v n u f o r e b m u N ) 1 ( I P M e h t r e d n u d l e h 0 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 2 ( n a P l I T L e h t 1 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 2 ( n a P l I T L e h t 2 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 2 ( n a P l I T L e h t s n o i t p o d e t s e v n u f o r e b m u N ) 1 ( I P M e h t r e d n u d l e h r e d n u e l b a r e v i l e d s e r a h S ) 3 ( P E I A 2 1 0 2 e m i t - e n o e h t s u n o b n o - n g i s f o t c e p s e r n i d e t n a r g s e r a h s f o r e b m u N (vesting (vesting (vesting (vesting (vesting (vesting (vesting 2013) 2014) – – – – – – – – – – – – – – – – – – – – 2013) 87,841 41,609 23,140 23,440 21,938 27,647 20,065 21,036 12,714 14,309 – – 2014) 99,371 40,450 23,517 31,104 26,359 27,753 18,517 27,388 24,211 21,326 2015) 148,249 – 35,377 67,293 38,673 45,924 37,223 51,066 35,289 35,289 2014) – – 66,795 72,603 66,380 78,827 63,891 68,870 60,572 62,232 – – 29,664 56,008 30,763 29,042 2013) 189,682 – – – – – – – – – – – (joined on May 1, 2012) 32 544,920 201,250 221,375 Prith Banerjee (joined ABB on May 7, 2012) – – – – Total Executive Committee members as of December 31, 2012 1,534,474 1,367,700 201,250 221,375 293,739 339,996 554,810 625,220 189,682 (1) (2) (3) (4) Options may be sold or exercised/converted into shares at the ratio of 5 options for 1 share. The LTI Plan foresees to deliver 30 percent of the value of the vested retention shares in cash, but participants have the possibility to elect to receive 100 percent of the vested award in shares. The AIEP foresees to deliver 30 percent of the value of the vested shares in cash, but participants have the possibility to elect to receive 100 percent of the vested award in shares. The actual number of shares to be delivered could be increased up to a total maximum amount of 768,286 shares. Total number of shares held includes 4,500 shares held jointly with spouse. 40 Remuneration report | ABB Annual Report 2012 Furthermore, at December 31, 2012, the following members of the EC held conditionally granted ABB shares under the performance component of the LTIP 2012, 2011 and 2010, which at the time of vesting will be settled in cash. Except as described in this section, at December 31, 2012, no member of the EC and no person closely linked to a member of the EC held any shares of ABB or options in ABB shares. For comparative information about share and option ownership of EC members in 2011, see Note 12 to the ABB Ltd statutory financial statements. Maximum number of conditionally Maximum number of conditionally granted shares under the granted shares under the Reference number of shares performance component of the performance component of the under the performance component Name 2010 launch of LTI Plan 2011 launch of LTI Plan of the 2012 launch of LTI Plan Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Greg Scheu (joined on May 1, 2012) Prith Banerjee (joined ABB on May 7, 2012) Total Executive Committee members as of Dec. 31, 2012 (vesting 2013) (vesting 2014) 58,854 27,740 14,952 15,146 14,175 17,865 12,965 13,593 8,392 9,444 – – 60,526 26,967 15,196 15,460 14,194 17,933 11,965 14,158 12,516 13,780 – – (vesting 2015) 123,541 – 20,781 22,588 20,652 24,524 19,878 21,426 18,845 18,845 17,425 18,071 193,126 202,695 326,576 ABB Annual Report 2012 | Remuneration report 41 42 Financial review | ABB Annual Report 2012 Financial review Contents 44 Operating and financial review and prospects 44 About ABB 44 History of the ABB Group 44 Organizational structure 44 Business divisions 46 Management overview 48 Application of critical accounting policies 52 New accounting pronouncements 52 Acquisitions and investments 53 Exchange rates 54 Orders 54 Performance measures 55 Analysis of results of operations 62 Divisional analysis 71 Restructuring 71 Capital expenditures 71 Liquidity and capital resources 73 Financial position 75 Cash flows 76 Disclosures about contractual obligations and commitments 77 Off balance sheet arrangements 77 Related party transactions 78 Consolidated Financial Statements 84 Notes to the Consolidated Financial Statements 84 Note 1 The Company 84 Note 2 Significant accounting policies 91 Note 3 Acquisitions and increases in controlling interests 94 Note 4 Cash and equivalents and marketable securities 96 Note 5 Financial instruments 100 Note 6 Fair values 101 Note 7 Receivables, net 103 Note 8 Inventories, net 104 Note 9 Other non-current assets 104 Note 10 Property, plant and equipment, net 105 Note 11 Goodwill and other intangible assets 106 Note 12 Debt 109 Note 13 Provisions and other current 110 Note 15 Commitments and contingencies 113 Note 16 Taxes 116 Note 17 Employee benefits 121 Note 18 Share-based payment arrangements 126 Note 19 Stockholders’ equity 127 Note 20 Earnings per share 128 Note 21 Other comprehensive income 128 Note 22 Restructuring and related expenses 129 Note 23 Operating segment and geographic data 134 Note 24 Compensation 135 Report of management on internal control over financial reporting 136 Report of the Statutory Auditor on the Consolidated Financial Statements 137 Report of the Group Auditor on internal control liabilities and other non-current liabilities over financial reporting 109 Note 14 Leases 138 Financial Statements of ABB Ltd, Zurich 139 Notes to the Financial Statements 139 Note 1 General 139 Note 2 Receivables 139 Note 3 Loans – Group 139 Note 4 Participation 139 Note 5 Current liabilities 140 Note 6 Stockholders’ equity 141 Note 7 Contingent liabilities 141 Note 8 Bonds 141 Note 9 Significant shareholders 141 Note 10 Board of Directors compensation 143 Note 11 Executive Committee compensation 147 Note 12 Share ownership of ABB by Board members and members of the Executive Committee 149 Note 13 Risk assessment 150 Proposed appropriation of available earnings 151 Report of the Statutory Auditor 152 Investor information ABB Annual Report 2011 | Financial review 43 Operating and financial review and prospects About ABB Organizational structure We are a global leader in power and automation technologies committed to improving performance and lowering the environmental impact for our utility and industry customers. We provide a broad range of products, systems, solutions and services that are designed to increase power grid reliabil- ity, boost industrial productivity and enhance energy effi- ciency. Our power businesses focus on power transmission, distribution and power-plant automation, and support elec- tric, gas and water utilities, as well as industrial and commer- cial customers. Our automation businesses serve a full range of industries with measurement, control, protection and process optimization applications. Our business is international in scope and we generate rev- enues in numerous currencies. We operate in approximately 100 countries across four regions: Europe, the Americas, Asia, and the Middle East and Africa (MEA). We are head- quartered in Zurich, Switzerland. We manage our business based on a divisional structure, with five divisions: Power Products, Power Systems, Discrete Automation and Motion, Low Voltage Products and Process Automation. For a breakdown of our consolidated revenues (i) by operating division and (ii) derived from each geographic region in which we operate, see “Analysis of results of operations – Revenues.” History of the ABB Group Business divisions The ABB Group was formed in 1988 through a merger be- tween Asea AB and BBC Brown Boveri AG. Initially founded in 1883, Asea AB was a major participant in the introduction of electricity into Swedish homes and businesses and in the development of Sweden’s railway network. In the 1940s and 1950s, Asea AB expanded into the power, mining and steel industries. Brown Boveri and Cie. (later renamed BBC Brown Boveri AG) was formed in Switzerland in 1891 and initially specialized in power generation and turbines. In the early to mid-1900s, it expanded its operations throughout Europe and broadened its business operations to include a wide range of electrical engineering activities. In January 1988, Asea AB and BBC Brown Boveri AG each contributed almost all of their businesses to the newly formed ABB Asea Brown Boveri Ltd, of which they each owned 50 percent. In 1996, Asea AB was renamed ABB AB and BBC Brown Boveri AG was renamed ABB AG. In Febru- ary 1999, the ABB Group announced a group reconfigura- tion designed to establish a single parent holding company and a single class of shares. ABB Ltd was incorporated on March 5, 1999, under the laws of Switzerland. In June 1999, ABB Ltd became the holding company for the entire ABB Group. This was accomplished by having ABB Ltd issue shares to the shareholders of ABB AG and ABB AB, the two companies that formerly owned the ABB Group. The ABB Ltd shares were exchanged for the shares of those two compa- nies, which, as a result of the share exchange and certain related transactions, became wholly-owned subsidiaries of ABB Ltd. ABB Ltd shares are currently listed on the SIX Swiss Exchange, the NASDAQ OMX Stockholm Exchange and the New York Stock Exchange (in the form of American Depositary Shares). Industry background Our five divisions operate across two key markets: power and automation. Our divisions serve these markets through a global production, engineering and service base. The markets and our divisions are discussed in more detail below. Revenue figures presented in this Business divisions section are before interdivisional eliminations. Power market We serve the power market with products, systems and services designed primarily to deliver electricity. Electricity is generated in power stations of various types, including thermal, wind, solar and hydro plants and is then fed into an electricity grid, transmitted and distributed to consumers. Transmission systems link power generation sources to dis- tribution systems, often over long distances. Distribution systems then branch out over shorter distances to carry elec- tricity to end users. These electricity networks incorporate sophisticated devices to transmit electricity, control and mon- itor the power flow and ensure efficiency, reliability, quality and safety. The primary demand driver in the power market is the growing need for reliable electricity supplies to support eco- nomic growth and address the global environmental chal- lenge. This is also driving increased demand for renewable energy and high-efficiency power systems and equipment. Additional drivers vary by region. Capacity addition across the power value chain is the key market driver in emerging mar- kets mainly in Asia, Middle East, South America and Africa. In North America, the focus is on upgrading and replacing aging infrastructure, improving grid reliability and enabling 44 Financial review | ABB Annual Report 2012 smarter power networks. In Europe, the focus is on upgrad- ing the power infrastructure, integrating renewable energy sources such as wind power, and building interconnections to allow more efficient use of power and energy trading. Furthermore, as new power sources and loads are added, there is a need for grids and power networks to become more flexible, reliable and smarter. Power quality, stability and security of supply become key priorities. These requirements stimulate the need for power products and system solutions from generation through transmission and distribution. These demands are met by our two power divisions that together offer customers a comprehensive portfolio to help them be- come more competitive while lowering environmental impact. Automation market The automation market uses products, systems and services designed primarily to improve product quality, energy effi- ciency and productivity in industrial and manufacturing appli- cations. The automation market can be divided into three sectors: – Process automation refers to measurement, control, elec- trification and other applications used in processes where the main objective is continuous production, such as in the oil and gas, power, chemicals, mining, metals, and pulp and paper industries. Product lines for this market include plant electrification, instrumentation, analytical measure- ment, and control products and systems, as well as motors and drives. – Factory automation refers to discrete operations that man- ufacture individual items in applications such as foundry, metal fabrication, packaging, welding and painting. Typical industries where factory automation is used include auto- motive, consumer electronics and food and beverage. Product lines for this market include robots and application equipment, product and system services and modular manufacturing solutions, control products and systems, as well as motors, drives, and low-voltage products for control and power applications. – Building automation comprises product lines and applica- tions aimed at improving the energy efficiency of buildings through automated control of indoor climate, lighting and security. Product lines for this market include a wide range of low-voltage products. Power Systems division Our Power Systems division serves utilities, as well as industrial and commercial customers with system solutions and services for the generation, transmission and distribution of electricity. Turnkey solutions include power plant electrifi- cation and automation, bulk power transmission, substations and network management. The division had approximately 20,200 employees as of December 31, 2012, and generated $7.9 billion of revenues in 2012. Discrete Automation and Motion division The Discrete Automation and Motion division offers a wide range of products and services including drives, motors, generators, power electronics systems, rectifiers, power qual- ity and power protection products, converters, photovoltaic inverters, programmable logic controllers (PLCs), and robots. These products help customers to improve productivity, save energy, improve quality and generate energy. Key applica- tions include energy conversion, data processing, actuation, automation, standardized manufacturing cells for applications such as machine tending, welding, cutting, painting, finish- ing, palletizing and packing, and engineered systems for the automotive industry. The majority of these applications are for industrial applications, with others provided for buildings, transportation and utilities. The division also provides a full range of life-cycle services, from product and system mainte- nance to system design, including energy appraisals and preventive maintenance services. Revenues are generated both from direct sales to end users as well as from indirect sales through distributors, machine builders and OEMs, system integrators, and panel builders. In 2012, the Discrete Automation and Motion division expanded its offering and geographic scope with several acquisitions, including Newave Energy Holding SA (Newave), a Switzerland-based leader in uninterruptible power supply (UPS). The Discrete Automation and Motion division had approx- imately 29,300 employees as of December 31, 2012, and generated $9.4 billion of revenues in 2012. Power Products division Low Voltage Products division Our Power Products division primarily serves electric, gas and water utilities as well as industrial and commercial customers, with a vast portfolio of products and services across a wide voltage range to facilitate power generation, transmission and distribution. Direct sales account for a majority of the division’s total revenues, and sales through external channel partners, such as wholesalers, distributors and original equipment manufacturers (OEMs), account for the rest. Key technologies include high- and medium-voltage switchgear, circuit breakers for a range of current ratings and voltage levels, power, distribution, traction and other special transformers, as well as products to help control and protect electrical networks. The division had approximately 35,800 employees as of December 31, 2012, and generated $10.7 billion of revenues in 2012. The Low Voltage Products division helps customers to improve productivity, save energy and increase safety. The division offers a wide range of products and systems, with related services, that provide protection, control and measure- ment for electrical installations, enclosures, switchboards, electronics and electromechanical devices for industrial machines and plants. The main applications are in industry, building, infrastructures, rail and sustainable transportation, renewable energies and e-mobility applications. ABB Annual Report 2012 | Financial review 45 In May 2012, the Low Voltage Products division expanded Corporate research and development primarily covers our its product offering and geographic scope through the ac- quisition of Thomas & Betts Corporation (Thomas & Betts), a North American leader in low-voltage products. The acqui- sition supports ABB’s strategy to strengthen its position in the North American low-voltage market. The Low Voltage Products division had approximately 30,800 employees as of December 31, 2012, and generated $6.6 billion of revenues in 2012. A majority of the division’s revenues comes from sales through distributors, wholesalers, OEMs, system integrators, and panel builders, although a portion of the division’s revenues comes from direct sales to end users and utilities. research activities, as our development activities are orga- nized under the five business divisions. We have two global research laboratories, one focused on power technologies and the other focused on automation technologies, which both work on technologies relevant to the future of our five business divisions. Each laboratory works on new and emerging technologies and collaborates with universities and other external partners to support our divisions in advancing relevant technologies and in developing cross-divisional technology platforms. We have research operations in eight countries, which consist of the United States of America (United States), Sweden, Switzerland, Poland, China, Germany, Norway and India. Corporate and Other had approximately 2,000 employ- Process Automation division ees at December 31, 2012. The Process Automation division provides products, systems, and services for the automation and electrification of indus- trial processes. Our core industries are cement, paper, metals, mining, oil, gas, petrochemicals, chemicals and marine. Each industry has unique business drivers, yet share common requirements for operational productivity, safety, energy ef- ficiency, minimized project risk and environment compliance. The division’s core competence is the application of auto- mation and electrification technologies to solve these generic requirements, but tailored to the characteristics of each of its core industries. The division is organized around industry and product business along with a specialized business focusing on performance-based outsourced maintenance contracts. The division had approximately 28,000 employees as of December 31, 2012, and generated revenues of $8.2 billion in 2012. The Process Automation division offering is made available as separately sold products or as part of a total automation system. The division’s technologies are sold both through direct sales forces and third-party channels. Corporate and Other Corporate and Other comprises corporate headquarters and stewardship, corporate research and development, corporate real estate, equity investments, as well as other activities. Corporate headquarters and stewardship activities include the operations of our corporate headquarters in Zurich, Switzerland, as well as corresponding subsidiary operations in various countries. These activities cover staff functions with group-wide responsibilities, such as accounting and finan- cial reporting, corporate finance and taxes, planning and controlling, internal audit, legal affairs and compliance, risk management and insurance, corporate communications, information systems, investor relations and human resources. 46 Financial review | ABB Annual Report 2012 Management overview During 2012, we continued to deliver power and automation solutions that help our customers meet the challenges of a rapidly-changing world. Foremost among these are climate change and the need to use electrical energy more efficiently and with less impact on the environment. We addressed the challenges in several ways, as described below. One is a long-term commitment to technology leadership in areas such as high-efficiency power transmission; auto- mation and control systems to manage complex industrial processes using less energy; and technologies to capture the full potential of renewable energies, such as wind and solar power. In 2012, for example, we developed the world’s first circuit breaker for high voltage direct current (HVDC). The breakthrough removes a 100-year-old barrier to the develop- ment of direct current (DC) transmission grids, which will facilitate the efficient integration and exchange of renewable energy. DC grids will also improve grid reliability and enhance the capability of existing alternating current (AC) networks. We also continued to develop new products that allow our industrial customers to use their production assets more efficiently, such as our new synchronous reluctance motor, miniature circuit breakers and laser-cutting robots. Another is our presence in more than 100 countries around the world. This allows us to meet the needs of our customers faster and with solutions that are better suited to their local requirements. It positions us to benefit from the rapid growth expected in the emerging markets in the coming years while also supporting our large and important markets in the world’s mature economies. In 2012, we took significant actions to adjust our geographic and portfolio balance, especially with the acquisition of Thomas & Betts to further build our position in the large and growing North American market. Furthermore, our geographic scope pro- vides us with access to a large pool of talented and highly qualified people from very diverse cultural and business backgrounds – a key competitive advantage. In 2012, we generated approximately half of our revenues from emerging markets. In addition, we recorded order increases of more than 10 percent in local currencies in large markets such as Brazil, Canada, the United States, Saudi Arabia and the United Kingdom. A third way is our ability to combine both power and automation technologies into packaged solutions that meet the needs of new growth sectors, such as integrating renewable energy into existing power grids, providing high-efficiency power and automation solutions to the global rail and marine transportation industries, and providing the infrastructure needed to rapidly charge electric vehicles. For example, in 2012 we embarked on a project to bring clean solar energy to South Africa through two photovoltaic power plants equipped with ABB inverters, specialized transformers and control software. Other key orders in 2012 included rail development projects in Brazil, India and Poland, fuel-efficient propulsion and control systems for large cruise vessels, and an order to provide a national electric vehicle charging network in Estonia. We view this convergence of power and automation technologies as a long-term trend for which ABB is well positioned. Economic uncertainties continued in 2012, especially on increasing concerns surrounding sovereign debt levels in Europe and the United States, rising inflation in some emerg- ing economies and signs of economic slowdown in most regions. However, the broad scope of our business portfolio helped us mitigate some of these developments. For exam- ple, growth initiatives in Discrete Automation and Motion and in Low Voltage Products helped to offset early cycle weak- ness in these divisions. At the same time, we could build on our strong position in the later-cycle upstream oil and gas and minerals sectors to drive solid order growth in Process Auto- mation. In 2012, we stabilized Power Products margins despite the challenging market environment through successful cost savings and productivity improvement measures as well as our ability to be more selective in the orders we take, thanks to our broad product and geographic scope. In December 2012, we announced the repositioning of our Power Systems division to focus on higher-margin products, systems, ser- vices and software activities, together with revised targets for that division. Our strong positions in fast-growing emerging markets and selected mature markets, our flexible global production base and technological leadership, as well as the operational improvements we continue to make in our busi- nesses, also supported our business in 2012. Foremost among these improvements was the successful reduction of costs to adapt to changing demand. Savings in 2012 amounted to more than $1 billion and were principally achieved in three areas: making better use of global sourc- ing opportunities; eliminating operational and process ineffi- ciencies; and optimizing our global footprint to match the geographic scope of our business with changing demand patterns, such as rapid growth in emerging markets. Our cost reduction program was key to maintaining profitability in a challenging environment. Strategy 2011–2015 In November 2011, we announced an updated strategy for the period 2011 to 2015, along with financial targets to measure our success in achieving them. The strategy is based on five priorities: – Drive competitiveness in our current markets by develop- ing, producing, sourcing and selling to better match market needs, thereby profitably growing the business while increasing productivity and quality. – Capitalize on megatrends, such as the growing need for resource and energy efficiency, increasing urbanization, electrification, digitization and growth in emerging econo- mies. – Expand our core businesses to secure the next level of growth, for example, growing the service business by tap- ping opportunities in our installed base and by building the software business for our core power and automation customers. – Execute a disciplined approach to value-creating acquisi- tions that close key gaps across product, end market and geographic lines. – Find and exploit disruptive opportunities, such as the application of direct current electricity solutions to improve power efficiency and performance compared to conven- tional alternating current technologies. In addition, we provided updated financial targets at the Group and divisional levels to measure our performance. Also in 2011, we modified our previous Group operational profitability target to Operational EBITDA as a percentage of operational revenues (Operational EBITDA margin) versus the previous measure of earnings before interest and taxes (EBIT) as a percentage of revenues (EBIT margin) – for a full definition see “Performance measures” below. We believe this more accu- rately reflects the operational performance of the company during a phase of growth through acquisitions by eliminating some of the non-cash effects on earnings from acquisitions. Furthermore, we introduced a new target measure of cash return on invested capital (CROI) that we believe provides a more accurate reflection of our operational performance by focusing on cash returns, which are less prone to non- operational accounting adjustments that may be applied to EBIT from time to time. CROI is defined as the total of net cash provided by operating activities and interest paid, as a percentage of capital invested. Capital invested is defined as the total of fixed assets, net working capital and accumu- lated depreciation and amortization. Outlook Our long-term growth drivers – such as the need for greater industrial productivity, more reliable and efficient power delivery and growth in renewables – remain in place. Shorter- term trends such as industrial production growth and gov ernment policy are expected to be the main determinants of demand in 2013. ABB Annual Report 2012 | Financial review 47 In a market environment in which near-term uncertainty is likely to remain, we will continue to focus on executing our large order backlog and taking advantage of our broad product and geographic scope to capture profitable growth opportunities in line with our 2011–2015 targets. believe the following critical accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are in- herently uncertain. These policies should be considered when reading our Consolidated Financial Statements. This will be supported by our ongoing initiatives to improve margins and project selection and execution. Growing ser- vice revenues, securing the synergies from recent acquisitions, increasing customer satisfaction and successfully commer- cializing our pipeline of innovative technologies will remain important contributors to our growth and profitability targets. We will continue to strive for a 3–5 percent improvement in cost of sales every year through cost savings and pro- ductivity improvements such as supply management, better quality and higher returns on investments in sales and re- search and development. We remain committed to paying a steadily rising, sustainable annual dividend over time and improving returns on our capital investments in both organic and inorganic growth. Application of critical accounting policies General We prepare our Consolidated Financial Statements in accor- dance with U.S. GAAP and present the same in United States dollars unless otherwise stated. The preparation of our financial statements requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis, including, but not limited to, those related to: costs expected to be incurred to complete projects; costs of product guarantees and warran- ties; provisions for bad debts; recoverability of inventories, investments, fixed assets, goodwill and other intangible assets; the fair values of assets and liabilities assumed in business combinations; income tax related expenses and accruals; provisions for restructuring; gross profit margins on long-term construction-type contracts; pensions and other postretire- ment benefit assumptions and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from our estimates and assumptions. We deem an accounting policy to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the esti- mate is made and if different estimates that reasonably could have been used, or if changes in the accounting estimates that are reasonably likely to occur periodically, could materi- ally impact our Consolidated Financial Statements. We also deem an accounting policy to be critical when the application of such policy is essential to our ongoing operations. We 48 Financial review | ABB Annual Report 2012 Revenue recognition We generally recognize revenues for the sale of goods when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. With regards to the sale of products, delivery is not considered to have occurred, and therefore no revenues are recognized, until the customer has taken title to the products and assumed the risks and rewards of owner- ship of the products specified in the purchase order or sales agreement. Generally, the transfer of title and risks and re- wards of ownership are governed by the contractually-defined shipping terms. We use various International Commercial shipping terms (as promulgated by the International Chamber of Commerce) such as Ex Works (EXW), Free Carrier (FCA) and Delivered Duty Paid (DDP). Subsequent to delivery of the products, we generally have no further contractual perfor- mance obligations that would preclude revenue recognition. Revenues under long-term construction-type contracts are generally recognized using the percentage-of-completion method of accounting. We principally use the cost-to-cost method to measure progress towards completion on contracts. Under this method, progress of contracts is measured by ac- tual costs incurred in relation to management’s best estimate of total estimated costs, which are reviewed and updated routinely for contracts in progress. The cumulative effect of any change in estimate is recorded in the period when the change occurs. The percentage-of-completion method of accounting involves the use of assumptions and projections, principally relating to future material, labor and overhead costs. As a consequence, there is a risk that total contract costs will exceed those we originally estimated and the margin will decrease or the long-term construction-type contract may become unprofitable. This risk increases if the duration of a contract increases because there is a higher probability that the circumstances upon which we originally developed estimates will change, resulting in increased costs that we may not recover. Factors that could cause costs to increase include: – unanticipated technical problems with equipment supplied or developed by us which may require us to incur addi- tional costs to remedy, – changes in the cost of components, materials or labor, – difficulties in obtaining required governmental permits or approvals, – project modifications creating unanticipated costs, – suppliers’ or subcontractors’ failure to perform, – penalties incurred as a result of not completing portions of the project in accordance with agreed-upon time limits, and – delays caused by unexpected conditions or events. Changes in our initial assumptions, which we review on a regular basis between balance sheet dates, may result in revisions to estimated costs, current earnings and anticipated earnings. We recognize these changes in the period in which the changes in estimates are determined. By recognizing changes in estimates cumulatively, recorded revenue and costs to date reflect the current estimates of the stage of completion of each project. Additionally, losses on long-term contracts are recognized in the period when they are iden- tified and are based upon the anticipated excess of contract costs over the related contract revenues. Short-term construction-type contracts, or long-term construction-type contracts for which reasonably dependable estimates cannot be made or for which inherent hazards make estimates difficult, are accounted for under the com- pleted-contract method. Revenues under the completed- contract method are recognized upon substantial completion – that is: acceptance by the customer, compliance with per- formance specifications demonstrated in a factory accep- tance test or similar event. We offer multiple element arrangements to meet our customers’ needs. These arrangements may involve the de- livery of multiple products and/or performance of services (such as installation and training) and the delivery and/or per- formance may occur at different points in time or over dif- ferent periods of time. Deliverables of such multiple element arrangements are evaluated to determine the unit of account- ing and if certain criteria are met, we allocate revenues to each unit of accounting based on its relative selling price. A hierarchy of selling prices is used to determine the selling price of each specific deliverable that includes VSOE (if avail- able), third-party evidence (if VSOE is not available), or esti- mated selling price if neither of the first two is available. The estimated selling price reflects our best estimate of what the selling prices of elements would be if the elements were sold on a stand-alone basis. Revenue is allocated between the elements of an arrangement consideration at the inception of the arrangement. Such arrangements generally include industry-specific performance and termination provisions, such as in the event of substantial delays or non-delivery. For non construction-type contracts that contain customer Revenues are reported net of customer rebates and simi- acceptance provisions, revenue is deferred until customer acceptance occurs or we have demonstrated the customer- specified objective criteria have been met or the contractual acceptance period has lapsed. lar incentives. Taxes assessed by a governmental authority that are directly imposed on revenue-producing transactions between us and our customers, such as sales, use, value- added and some excise taxes, are excluded from revenues. Revenues from service transactions are recognized as services are performed. For long-term service contracts, revenues are recognized on a straight-line basis over the term of the contract or, if the performance pattern is other than straight-line, as the services are provided. Service revenues reflect revenues earned from our activities in providing services to customers primarily subsequent to the sale and delivery of a product or complete system. Such revenues consist of maintenance-type contracts, field service activities that include personnel and accompanying spare parts, and installation and commissioning of products as a stand-alone service or as part of a service contract. Revenues for software license fees are recognized when persuasive evidence of a non-cancelable license agreement exists, delivery has occurred, the license fee is fixed or deter- minable, and collection is probable. In software arrange- ments that include rights to multiple software products and/ or services, the total arrangement fee is allocated using the residual method, under which revenue is allocated to the undelivered elements based on vendor-specific objective evidence (VSOE) of fair value of such undelivered elements and the residual amounts of revenue are allocated to the delivered elements. Elements included in multiple element arrangements may consist of software products, mainte- nance (which includes customer support services and un- specified upgrades), hosting, and consulting services. VSOE is based on the price generally charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change once the element is sold separately. If VSOE does not exist for an undelivered element, the total arrangement fee will be recognized as revenue over the life of the contract or upon delivery of the undelivered element. These revenue recognition methods require the collect- ability of the revenues recognized to be reasonably assured. When recording the respective accounts receivable, allow- ances are calculated to estimate those receivables that will not be collected. These reserves assume a level of default based on historical information, as well as knowledge about specific invoices and customers. The risk remains that a dif- ferent number of defaults will occur than originally estimated. As such, the amount of revenues recognized might exceed or fall below the amount which will be collected, resulting in a change in earnings in the future. The risk of deterioration is likely to increase during periods of significant negative indus- try, economic or political trends. As a result of the above policies, judgment in the selection and application of revenue recognition methods must be made. Contingencies As more fully described in “Note 15 Commitments and con- tingencies” to our Consolidated Financial Statements, we are subject to proceedings, litigation or threatened litigation and other claims and inquiries related to environmental, labor, product, regulatory, tax (other than income tax) and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the provision required, if any, for these contingencies is made af- ter analysis of each individual issue, often with assistance from both internal and external legal counsel and technical experts. The required amount of a provision for a contingency of any type may change in the future due to new develop- ments in the particular matter, including changes in the ap- proach to its resolution. ABB Annual Report 2012 | Financial review 49 We record provisions for our contingent obligations when We use actuarial valuations to determine our pension it is probable that a loss will be incurred and the amount can be reasonably estimated. Any such provision is generally recognized on an undiscounted basis using our best esti- mate of the amount of loss or at the lower end of an estimated range when a single best estimate is not determinable. In some cases, we may be able to recover a portion of the costs relating to these obligations from insurers or other third parties; however, we record such amounts only when it is probable that they will be collected. We provide for anticipated costs for warranties when we recognize revenues on the related products or contracts. Warranty costs include calculated costs arising from imper- fections in design, material and workmanship in our prod- ucts. We generally make individual assessments on contracts with risks resulting from order-specific conditions or guaran- tees and assessments on an overall, statistical basis for similar products sold in larger quantities. There is a risk that actual warranty costs may exceed the amounts provided for, which would result in a deterioration of earnings in the future when these actual costs are determined. and postretirement benefit costs and credits. The amounts calculated depend on a variety of key assumptions, including discount rates, mortality rates and expected return on plan assets. Under U.S. GAAP, we are required to consider current market conditions in making these assumptions. In particular, the discount rates are reviewed annually based on changes in long-term, highly-rated corporate bond yields. Decreases in the discount rates result in an increase in the PBO and in pension costs. Conversely, an increase in the discount rates results in a decrease in the PBO and in pension costs. The mortality assumptions are reviewed annually by management. Decreases in mortality rates result in an increase in the PBO and in pension costs. Conversely, an increase in mortality rates results in a decrease in the PBO and in pension costs. Holding all other assumptions constant, a 0.25 percent- age-point decrease in the discount rate would have increased the PBO related to our defined benefit pension plans by $414 million, while a 0.25 percentage-point increase in the discount rate would have decreased the PBO related to our defined benefit pension plans by $391 million. We may have a legal obligation to perform environmental The expected return on plan assets is reviewed regularly clean-up activities as a result of the normal operation of our business or have other asset retirement obligations. In some cases, the timing or the method of settlement, or both are conditional upon a future event that may or may not be within our control, but the underlying obligation itself is unconditional and certain. We recognize a provision for these and other asset retirement obligations when a liability for the retirement or clean-up activity has been incurred and a reasonable estimate of its fair value can be made. These provisions are initially recognized at fair value, and subsequently adjusted for accrued interest and changes in estimates. Provisions for environmental obligations are not discounted to their present value when the timing of payments cannot be reasonably estimated. Pension and other postretirement benefits As more fully described in “Note 17 Employee benefits” to our Consolidated Financial Statements, we have a number of defined benefit pension and other postretirement plans and recognize an asset for a plan’s overfunded status or a liability for a plan’s underfunded status in our Consolidated Balance Sheets. We measure such a plan’s assets and obligations that determine its funded status as of the end of the year. Changes in the funded status are reported in “Accumulated other comprehensive loss” and as a separate component of stockholders’ equity. We recognize actuarial gains and losses gradually over time. Any cumulative unrecognized actuarial gain or loss that exceeds 10 percent of the greater of the present value of the projected benefit obligation (PBO) and the fair value of plan assets is recognized in earnings over the expected aver- age remaining working lives of the employees participating in the plan. Otherwise, the actuarial gain or loss is not recog- nized. and considered for adjustment annually based on current and expected asset allocations and represents the long-term return expected to be achieved. Decreases in the expected return on plan assets result in an increase to pension costs. An increase or decrease of 0.25 percentage-points in the expected long-term rate of asset return would have decreased or increased, respectively, the net periodic benefit cost in 2012 by $22 million. The funded status, which can increase or decrease based on the performance of the financial markets or changes in our assumptions, does not represent a mandatory short- term cash obligation. Instead, the funded status of a defined benefit pension plan is the difference between the PBO and the fair value of the plan assets. At December 31, 2012, our defined benefit pension plans were $1,781 million un- derfunded compared to an underfunding of $950 million at December 31, 2011. Our other postretirement plans were underfunded by $281 million and $260 million at December 31, 2012 and 2011, respectively. We have multiple non-pension postretirement benefit plans. Our health care plans are generally contributory with participants’ contributions adjusted annually. For purposes of estimating our health-care costs, we have assumed health- care cost increases to be 8.60 percent per annum for 2013, gradually declining to 5 percent per annum by 2028 and to remain at that level thereafter. Income taxes In preparing our Consolidated Financial Statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. Tax expense from continuing opera- tions is reconciled from the weighted-average global tax rate, rather than from the Swiss domestic statutory tax rate, as (i) the parent company of the ABB Group, ABB Ltd, is domi- ciled in Switzerland. Income which has been generated in jurisdictions outside of Switzerland (hereafter “foreign jurisdic- tions”) and has already been subject to corporate income tax 50 Financial review | ABB Annual Report 2012 in those foreign jurisdictions is, to a large extent, tax exempt in Switzerland. Therefore, generally no or only limited Swiss income tax has to be provided for on the repatriated earnings of foreign subsidiaries. There is no requirement in Switzer- land for a parent company of a group to file a tax return of the group determining domestic and foreign pre-tax income, and (ii) our consolidated income from continuing operations is predominantly earned outside of Switzerland, and therefore corporate income tax in foreign jurisdictions largely deter- mines our global tax rate. We account for deferred taxes by using the asset and liability method. Under this method, we determine deferred tax assets and liabilities based on temporary differences between the financial reporting and the tax bases of assets and liabilities. Deferred tax assets and liabilities are mea- sured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. We recognize a deferred tax asset when it is more likely than not that the asset will be realized. We regularly review our deferred tax assets for recoverability and establish a valua- tion allowance based upon historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. To the extent we increase or decrease this allowance in a period, we recognize the change in the allowance within “Provision for taxes” in the Consolidated Income Statements unless the change relates to discontinued operations, in which case the change is recorded in “Income from discontinued operations, net of tax”. Unforeseen changes in tax rates and tax laws, as well as differences in the projected taxable income as compared to the actual taxable income, may affect these estimates. Certain countries levy withholding taxes, dividend distri- bution taxes or additional corporate income taxes (hereafter “withholding taxes”) on dividend distributions. Such taxes cannot always be fully reclaimed by the shareholder, although they have to be declared and withheld by the subsidiary. Switzerland has concluded double taxation treaties with many countries in which we operate. These treaties either eliminate or reduce such withholding taxes on dividend distributions. It is our policy to distribute retained earnings of subsidiaries, in so far as such earnings are not permanently reinvested or no other reasons exist that would prevent the subsidiary from distributing them. No deferred tax liability is set up, if retained earnings are considered as permanently reinvested, and used for financing current operations as well as business growth through working capital and capital expenditure in those countries. We operate in numerous tax jurisdictions and, as a result, are regularly subject to audit by tax authorities. We provide for tax contingencies whenever it is deemed more likely than not that a tax asset has been impaired or a tax liability has been incurred for events such as tax claims or changes in tax laws. Contingency provisions are recorded based on the technical merits of our filing position, considering the appli- cable tax laws and Organisation for Economic Co-operation and Development (OECD) guidelines and are based on our evaluations of the facts and circumstances as of the end of each reporting period. Changes in the facts and circum- stances could result in a material change to the tax accruals. Although we believe that our tax estimates are reasonable and that appropriate tax reserves have been made, the final determination of tax audits and any related litigation could be different than that which is reflected in our income tax provisions and accruals. An estimated loss from a tax contingency must be ac- crued as a charge to income if it is more likely than not that a tax asset has been impaired or a tax liability has been incurred and the amount of the loss can be reasonably estimated. We apply a two-step approach to recognize and measure uncertainty in income taxes. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50 percent likely of being realized upon ultimate settlement. The required amount of provisions for contingencies of any type may change in the future due to new developments. Business combinations The amount of goodwill initially recognized in a business combination is based on the excess of the purchase price of the acquired company over the fair value of the assets ac- quired and liabilities assumed. The determination of these fair values requires us to make significant estimates and assump- tions. For instance, when assumptions with respect to the timing and amount of future revenues and expenses associ- ated with an asset are used to determine its fair value, but the actual timing and amount differ materially, the asset could become impaired. In some cases, particularly for large ac- quisitions, we engage independent third-party appraisal firms to assist in determining the fair values. Critical estimates in valuing certain intangible assets include but are not limited to: future expected cash flows of the acquired business, brand awareness, customer retention, technology obsolescence and discount rates. In addition, uncertain tax positions and tax-related valuation allowances assumed in connection with a business combination are initially estimated at the acquisition date. We reevaluate these items quarterly, based upon facts and circumstances that existed at the acquisition date with any adjustments to our preliminary estimates being recorded to goodwill provided that we are within the twelve-month measurement period. Subsequent to the measurement period or our final determination of the tax allowance’s or contingen- cy’s estimated value, whichever comes first, changes to these uncertain tax positions and tax-related valuation allowances will affect our provision for income taxes in our Consolidated Income Statements and could have a material impact on our results of operations and financial position. The fair values assigned to the intangible assets acquired are described in “Note 3 Acquisitions and increases in controlling interests” as well as “Note 11 Goodwill and other intangible assets”, to our Consolidated Financial Statements. ABB Annual Report 2012 | Financial review 51 Goodwill and other intangible assets We review goodwill for impairment annually as of October 1, or more frequently if events or circumstances indicate the carrying value may not be recoverable. In 2012, as a result of an accounting standard update, we changed our approach to determining whether goodwill is impaired. Consistent with the update, we have elected to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Based on the results of this qualitative assessment, we would only perform a two-step quantitative goodwill impairment test if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Our reporting units are the same as our business divi- sions for Power Products, Power Systems, Discrete Automa- tion and Motion, and Low Voltage Products. For Process Automation, we determined the reporting units to be one level below the division, as the different products produced or services provided by this division do not share sufficiently similar economic characteristics to permit testing of goodwill on a total division level. When performing the qualitative assessment, we first determine, for each reporting unit, factors which would affect the fair value of those reporting units including: (i) macro- economic conditions related to the business, (ii) industry and market trends, and (iii) the overall future financial perfor- mance and future opportunities in the markets in which the business operates. We then consider how these factors would impact the most recent quantitative analysis of the reporting unit’s fair value. Key assumptions in determining the value of the reporting unit include the projected level of business opera- tions, the weighted-average cost of capital, the income tax rate and the terminal growth rate. If, after performing the qualitative assessment, we con- clude that events or circumstances have occurred which would indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying value, we would perform the two-step quantitative impairment test. In the first step, we would calculate the fair value of the reporting unit (using an income approach whereby the fair value is calculated based on the present value of future cash flows applying a discount rate that represents our weighted-average cost of capital) and compare it to its carrying value. Where the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and no further testing is performed. However, if the carrying value of the net assets assigned to the reporting unit is equal to or exceeds the reporting unit’s fair value, we would per- form the second step of the impairment test. In the second step, we determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the re- porting unit’s goodwill. If the carrying value of a reporting unit’s goodwill were to exceed its implied fair value, then we would record an impairment loss equal to the difference. Any goodwill impairment losses would be recorded as a separate line item in our Consolidated Income Statements in continu- ing operations, unless related to a discontinued operation, in which case the losses would be recorded in “Income from discontinued operations, net of tax”. 52 Financial review | ABB Annual Report 2012 In 2012, we performed a qualitative assessment and determined that it was not more likely than not that the fair value for each of our reporting units was below the carrying value. As a result, we concluded that it was not necessary to perform the two-step quantitative impairment test. In 2011 and 2010, prior to adopting the accounting standard updated allowing us to perform a qualitative assessment, we per- formed the first step of the two-step impairment test on all reporting units. As the fair values of all reporting units, in both years, exceeded their carrying values, we determined that none of the reporting units was at “risk” of failing the goodwill impairment test. Consequently, the second step of the impairment test was not performed and we concluded goodwill was not impaired. We review intangible assets for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable upon the occurrence of certain triggering events, such as a decision to divest a busi- ness or projected losses of an entity. We record impairment charges in “Other income (expense), net”, in our Consolidated Income Statements, unless they relate to a discontinued operation, in which case the charges are recorded in “Income from discontinued operations, net of tax”. New accounting pronouncements For a description of accounting changes and recent account- ing pronouncements, including the expected dates of adoption and estimated effects, if any, on our Consolidated Financial Statements, see “Note 2 Significant accounting policies” to our Consolidated Financial Statements. Acquisitions and investments Acquisitions During 2012, 2011 and 2010, ABB invested $3,643 million, $3,805 million and $1,275 million in 9, 10 and 9 new busi- nesses, respectively. The amounts exclude changes in cost and equity investments. The principal acquisition in 2012 was Thomas & Betts, which was acquired in May 2012. Thomas & Betts designs, manufactures and markets components used to manage the connection, distribution, transmission and reliability of elec- trical power in industrial, construction and utility applications. The complementary combination of Thomas & Betts’ elec- trical components and ABB’s low-voltage protection, control and measurement products creates a broader low-voltage portfolio (in our Low Voltage Products division) that can be distributed through Thomas & Betts’ network of more than 6,000 distributor locations and wholesalers in North America, and through ABB’s well-established distribution channels in Europe and Asia. The principal acquisition in 2011 was Baldor Electric Company (Baldor), acquired in January 2011. Baldor markets, designs and manufactures industrial electric motors, me- chanical power transmission products, drives and generators. The acquisition broadens the product offering of our Discrete Automation and Motion division, closing the gap in our auto- mation portfolio in North America by adding Baldor’s NEMA (National Electrical Manufacturers Association) motors product line, as well as adding Baldor’s growing mechanical power transmission business. The principal acquisition in 2010 was the Ventyx group (Ventyx). In June 2010, we acquired all of the shares of Ventyx Inc., Ventyx Software Inc. and Ventyx Dutch Holding B.V., representing substantially all of the revenues, assets and liabilities of Ventyx. Ventyx provides software solutions to global energy, utility, communications and other asset intensive businesses and was integrated into the network management business within the Power Systems division to form a single unit for energy management software solutions. For more information on our acquisitions, see “Note 3 Acquisitions and increases in controlling interests” to our Consolidated Financial Statements. Increases and decreases in the value of the USD against other currencies will affect the reported results of opera- tions in our Consolidated Income Statements and the value of certain of our assets and liabilities in our Consolidated Balance Sheets, even if our results of operations or the value of those assets and liabilities have not changed in their orig- inal currency. Because of the impact foreign exchange rates have on our reported results of operations and the reported value of our assets and liabilities, changes in foreign exchange rates could significantly affect the comparability of our re- ported results of operations between periods and result in significant changes to the reported value of our assets, liabili- ties and stockholders’ equity, as has been the case during the period from 2010 through 2012. While we operate globally and report our financial results in USD, exchange rate movements between the USD and both the euro and the Swiss franc are of particular importance to us due to (i) the location of our significant operations and (ii) our corporate headquarters being in Switzerland. The exchange rates between the USD and the EUR and the USD and the CHF at December 31, 2012, 2011 and 2010, were as follows: Increase in controlling interests in India In 2010, we increased our ownership interest in ABB Limited, India (our publicly-listed subsidiary in India) from approxi- mately 52 percent to 75 percent. Cash paid in 2010, including transaction costs, amounted to $956 million. The offer of 900 rupees per share resulted in a charge to “Capital stock and additional paid-in capital” of $838 million, including expenses related to the transaction. Exchange rates We report our financial results in U.S. dollars. Due to our global operations, a significant amount of our revenues, expenses, assets and liabilities are denominated in other cur- rencies. As a consequence, movements in exchange rates between currencies may affect: (i) our profitability, (ii) the comparability of our results between periods, and (iii) the reported carrying value of our assets and liabilities. We translate non-USD denominated results of operations, assets and liabilities to USD in our Consolidated Financial Statements. Balance sheet items are translated to USD using year-end currency exchange rates. Income statement and cash flow items are translated to USD using the relevant monthly average currency exchange rate. Exchange rates into $ EUR 1.00 CHF 1.00 2012 1.32 1.09 2011 1.29 1.06 2010 1.34 1.07 The average exchange rates between the USD and the EUR and the USD and the CHF for the years ended December 31, 2012, 2011 and 2010, were as follows: Exchange rates into $ EUR 1.00 CHF 1.00 2012 1.29 1.07 2011 1.39 1.13 2010 1.33 0.97 When we incur expenses that are not denominated in the same currency as the related revenues, foreign exchange rate fluctuations could affect our profitability. To mitigate the impact of exchange rate movements on our profitability, it is our policy to enter into forward foreign exchange contracts to manage the foreign exchange transaction risk of our operations. In 2012, approximately 84 percent of our consolidated revenues were reported in currencies other than USD. The following percentages of consolidated revenues were reported in the following currencies: – Euro, approximately 21 percent, – Chinese renminbi, approximately 10 percent, – Canadian dollar, approximately 6 percent, – Swedish krona, approximately 6 percent, and – Swiss franc, approximately 5 percent. In 2012, approximately 83 percent of our cost of sales and selling, general and administrative expenses were reported in currencies other than USD. The following percentages of consolidated cost of sales and selling, general and adminis- trative expenses were reported in the following currencies: – Euro, approximately 20 percent, – Chinese renminbi, approximately 9 percent, – Canadian dollar, approximately 6 percent, and – Swedish krona, approximately 5 percent. ABB Annual Report 2012 | Financial review 53 We also incur expenses other than cost of sales and selling, general and administrative expenses in various currencies. The results of operations and financial position of many of our subsidiaries outside of the United States are reported in the currencies of the countries in which those subsidiaries are located. We refer to these currencies as “local curren- cies.” Local currency financial information is then translated into USD at applicable exchange rates for inclusion in our Consolidated Financial Statements. The discussion of our results of operations below provides certain information with respect to orders, revenues, EBIT and other measures as reported in USD (as well as in local currencies). We measure period-to-period variations in local currency results by using a constant foreign ex- change rate for all periods under comparison. Differences in our results of operations in local currencies as compared to our results of operations in USD are caused exclusively by changes in currency exchange rates. While we consider our results of operations as measured in local currencies to be a significant indicator of business performance, local currency information should not be relied upon to the exclusion of U.S. GAAP financial measures. Instead, local currencies reflect an additional measure of comparability and provide a means of viewing aspects of our operations that, when viewed together with the U.S. GAAP results and our reconciliations, provide a more complete understanding of factors and trends affecting the business. As local currency information is not standardized, it may not be possible to compare our local currency information to other companies’ financial measures that have the same or a similar title. We encourage investors to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. Orders We book and report an order when a binding contractual agreement has been concluded with a customer covering, at a minimum, the price and scope of products or services to be supplied, the delivery schedule and the payment terms. The reported value of an order corresponds to the undis- counted value of revenues that we expect to recognize follow- ing delivery of the goods or services subject to the order, less any trade discounts and excluding any value added or sales tax. The value of orders received during a given period of time represents the sum of the value of all orders received during the period, adjusted to reflect the aggregate value of any changes to the value of orders received during the period and orders existing at the beginning of the period. These adjustments, which may in the aggregate increase or decrease the orders reported during the period, may include changes in the estimated order price up to the date of contractual performance, changes in the scope of products or services ordered and cancellations of orders. The undiscounted value of revenues we expect to gener- ate from our orders at any point in time is represented by our order backlog. Approximately 16 percent of the value of total orders we recorded in 2012 were “large orders,” which we define as orders from third parties involving a value of at least $15 million for products or services. Approximately 55 percent of the total value of large orders in 2012 were recorded by our Power Systems division and approximately 29 percent in our Process Automation division. The Power Products as well as Discrete Automation and Motion divisions accounted for the remainder of the total large orders recorded during 2012. The remaining portion of total orders recorded in 2012 was “base orders,” which we define as orders from third parties with a value of less than $15 million for products or services. The level of orders fluctuates from year to year. Arrange- ments included in any particular order can be complex and unique to that order. Portions of our business involve or- ders for long-term projects that can take months or years to complete and many large orders result in revenues in periods after the order is booked. However, the level of large orders and orders generally cannot be used to accurately predict future revenues or operating performance. Orders that have been placed can be cancelled, delayed or modified by the customer. These actions can reduce or delay any future rev- enues from the order or may result in the elimination of the order. Performance measures We evaluate the performance of our divisions primarily based on orders received, revenues, Operational EBITDA and Operational EBITDA as a percentage of Operational revenues (Operational EBITDA margin). Operational EBITDA represents EBIT excluding depre- ciation and amortization, restructuring and restructuring- related expenses, adjusted for the following: (i) unrealized gains and losses on derivatives (foreign exchange, commodi- ties, embedded derivatives), (ii) realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized, (iii) unrealized foreign exchange movements on receivables/payables (and related assets/ liabilities), (iv) acquisition-related expenses and (v) certain non-operational items. Operational revenues are total revenues adjusted for the following: (i) unrealized gains and losses on derivatives, (ii) realized gains and losses on derivatives where the under- lying hedged transaction has not yet been realized, and (iii) unrealized foreign exchange movements on receivables (and related assets). See “Note 23 Operating segment and geographic data” to our Consolidated Financial Statements for a reconciliation of Operational EBITDA to EBIT. 54 Financial review | ABB Annual Report 2012 Analysis of results of operations Our consolidated results from operations were as follows: ($ in millions, except per share data in $) Orders Order backlog at December 31, 2012 40,232 29,298 2011 40,210 27,508 2010 32,681 26,193 Orders ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation 2012 2011 2010 2012 2011 % Change 11,040 11,068 9,778 7,973 9,278 7,896 9,625 6,720 8,704 9,566 5,862 5,364 4,686 8,726 7,383 – (14) 1 25 – – 13 18 63 14 18 24 n.a. 23 Operating divisions 44,062 44,002 35,605 Revenues Cost of sales Gross profit 39,336 37,990 31,589 Total 40,232 40,210 32,681 – Corporate and Other(1) (3,830) (3,792) (2,924) n.a. (27,958) (26,556) (22,060) 11,378 11,434 9,529 (1) Includes interdivisional eliminations Selling, general and administrative expenses (5,756) (5,373) (4,615) Non-order related research and development expenses Other income (expense), net Earnings before interest and (1,464) (100) (1,371) (1,082) (23) (14) taxes 4,058 4,667 3,818 Net interest and other finance expense Provision for taxes Income from continuing (220) (1,030) (117) (78) (1,244) (1,018) operations, net of tax 2,808 3,306 2,722 Income from discontinued operations, net of tax Net income Net income attributable to noncontrolling interests Net income attributable to ABB Amounts attributable to ABB shareholders: Income from continuing operations, net of tax Net income Basic earnings per share attrib utable to ABB shareholders: Income from continuing operations, net of tax Net income Diluted earnings per share attrib utable to ABB shareholders: Income from continuing operations, net of tax Net income 4 9 10 2,812 3,315 2,732 (108) 2,704 (147) 3,168 (171) 2,561 2,700 2,704 3,159 3,168 2,551 2,561 1.18 1.18 1.38 1.38 1.12 1.12 1.18 1.18 1.38 1.38 1.11 1.12 A more detailed discussion of the orders, revenues, Opera- tional EBITDA and EBIT for our divisions follows in the sec- tions of “Divisional analysis” below entitled “Power Products,” “Power Systems,” “Discrete Automation and Motion,” “Low Voltage Products,” “Process Automation” and “Corporate and Other.” Orders and revenues of our divisions include inter- divisional transactions which are eliminated in the “Corporate and Other” line in the tables below. In 2012, total order volume remained on the same level as 2011 (increased 4 percent in local currencies and was steady, in local currencies, excluding Thomas & Betts) despite challenging markets. In 2012, orders in the Power Products division were flat compared to the previous year (increased 3 percent in local currencies) as the distribution sector remained stable and industrial demand was supported by demand from the oil and gas sector. In the Power Systems division, orders declined 14 percent (10 percent in local currencies) as capital expendi- tures in power infrastructure continued to be restrained due to ongoing economic uncertainties, especially in certain mature economies. Transmission utilities are investing selectively, with emerging markets focusing on capacity addition and mature markets focusing mainly on existing grid upgrades. Order growth slowed to 1 percent (4 percent in local curren- cies) in the Discrete Automation and Motion division following a double-digit growth rate in 2011, reflecting the generally low growth in industrial production in most markets and weak- ness in the renewable energy sector in 2012. Orders were 25 percent higher in the Low Voltage Products division (29 pe r- cent in local currencies) mainly due to Thomas & Betts (flat in local currencies excluding Thomas & Betts). The Process Auto mation division’s orders reached the prior year’s level (in- crease of 4 percent in local currencies) supported by demand from the oil and gas and the mining sectors. Base orders growth slowed in the first half of the year as economic growth remained under pressure, however base orders remained on the previous year’s level primarily driven by demand for industrial automation and energy-saving equipment. In the second half of 2012, base orders increased moderately due to Thomas & Betts. During 2012, base orders grew 3 percent (6 percent in local currencies or 1 percent, in local currencies, excluding Thomas & Betts). Following the double-digit growth in 2011, large orders in 2012 decreased 11 percent (7 percent in local currencies) as fewer large projects were recorded in the power divisions. In 2011, total order volume increased 23 percent (18 per- cent in local currencies, 11 percent excluding Baldor). Customer investments to increase operational efficiency and services translated into higher orders for the automation divisions, where the pace of order growth in the second half of 2011 slowed versus the growth rates of the first half of the year. The need to strengthen power distribution networks, driven in part by industrial growth in emerging markets, as well as the integration of renewable energy supplies into power grids, lifted orders in the power businesses. ABB Annual Report 2012 | Financial review 55 We determine the geographic distribution of our orders based on the location of the customer, which may be dif- ferent from the ultimate destination of the products’ end use. The geographic distribution of our consolidated orders was as follows: ($ in millions) Europe The Americas Asia 2012 2011 2010 2012 2011 % Change 13,512 15,202 13,781 12,152 9,466 6,223 10,346 12,103 8,720 (11) 28 (15) 23 – 10 52 39 (13) 23 Middle East and Africa 4,222 3,439 3,957 Total 40,232 40,210 32,681 In 2012, orders grew 28 percent (32 percent in local curren- cies) in the Americas due to Thomas & Betts, as well as on organic growth in existing businesses. The U.S. recorded higher orders in every division. Additionally, Canada and Bra- zil remained significant growth areas in this region. In Asia, orders were down 15 percent (13 percent in local currencies) primarily on lower large orders from the power sector in China and India, as well as from the marine sector in South Korea. Europe declined 11 percent (6 percent in local curren- cies) despite increases in Finland and the U.K., as a $1 bil- lion offshore wind order in Germany received in 2011 was not repeated in 2012, as well as on lower orders in Sweden, Nor- way and Italy. Orders grew in MEA by 23 percent (28 percent in local currencies) on large orders from the power sector in Saudi Arabia, solar power orders in South Africa as well as orders from the oil and gas sector in Oman. Orders in 2011 grew in the Americas 52 percent (50 per- cent in local currencies) driven by Baldor, as well as by organic growth. The U.S., Canada and Brazil were the main growth drivers in this region, as Brazil recorded large orders in the Power Systems division, as well as in the Power Automation division from the oil and gas and minerals sectors. In Asia, orders were up 39 percent (32 percent in local currencies) on double digit growth in all divisions. In China, large orders for the Power Systems and Power Products divisions, as well as base order growth in the Discrete Automation and Motion, and Low Voltage Products divisions drove significant order growth. India returned to double-digit order growth after a con- traction in 2010 and South Korea recorded large orders from the marine sector. Europe grew 10 percent (4 percent in local currencies), on growth in the industrial sectors. Additionally, a large order for offshore wind farm connection in Germany was repeated in 2011 (at a higher amount than in 2010) and Norway won large orders in the oil and gas sector. Order volumes decreased in the MEA by 13 percent (15 percent in local cur- rencies) as large orders from the power sector in Saudi Arabia and from the oil and gas sector in Congo were offset by a lower orders level in the Power Systems division in Kuwait, Qatar and the United Arab Emirates. In 2011, orders in the Power Products division grew 13 percent (8 percent in local currencies) and were higher in all businesses. The order increase was driven primarily by continued strength in the industrial and power distribution sectors as well as large orders in the transmission sector. Continuing investments in grid upgrades and the integration of renewable energy sources fuelled an 18 percent (12 per- cent in local currencies) orders increase in the Power Systems division. In August 2011, ABB won its largest-ever power transmission order, worth around $1 billion, to supply a power link connecting offshore North Sea wind farms to the German mainland grid. The strong growth in the Discrete Automation and Motion division reflected continued demand for energy- efficient automation solutions leading to an increase in orders of 63 percent (57 percent in local currencies, 21 percent excluding Baldor). While all businesses contributed to the increase in orders in that division, Robotics and Power Electronics posted the highest growth rates. Orders were 14 percent higher in Low Voltage Products (9 percent in local currencies), mainly on increased demand for low-voltage systems to improve electrical efficiency in industry. Order growth slowed in that division in the second half of the year on a combination of more difficult comparisons with the strong growth recorded in 2010, slowing demand in most early- cycle industries and cutback in renewable investments com- pared to the previous year. The Process Automation division saw orders up 18 percent (12 percent in local currencies), mainly on continuing demand from the oil and gas and related marine industry. Service orders in Process Automation grew at a double-digit pace as well. Base orders grew significantly in the first half of 2011, as the global economic upturn continued. Although the devel- opment slowed in the second half of the year amid increased uncertainties about the global macroeconomic outlook, growth rates remained double digit. For ABB as a whole, base orders grew 21 percent (16 percent in local currencies), as all divisions reported an increase in base orders in 2011. Addi- tionally, a number of sizeable projects in the tender backlog materialized into large orders, which led to significant growth in the year. After a decline in 2010, large orders rebounded and grew 32 percent (25 percent in local currencies). 56 Financial review | ABB Annual Report 2012 Order backlog ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation December 31, % Change 2012 2011 2010 2012 2011 8,493 8,029 7,930 12,107 11,570 10,929 4,426 1,117 6,416 4,120 3,350 887 838 5,771 5,530 6 5 7 26 11 7 1 6 23 6 4 6 Operating divisions 32,559 30,377 28,577 Corporate and Other(1) (3,261) (2,869) (2,384) n.a. n.a. Total 29,298 27,508 26,193 7 5 (1) Includes interdivisional eliminations In 2012, order backlog increased 7 percent (5 percent in local currencies) compared to 2011. The order backlog in the Power Products division grew in all businesses in 2012. The Power Systems division also increased its order backlog de- spite a lower level of large orders. Although global economic conditions remained challenging, order backlog increased in 2012 in the Discrete Automation and Motion division. While the Low Voltage Products division grew, a substantial portion of the increase in the order backlog was due to Thomas & Betts. The order backlog in the Process Automation division grew on orders from the mining as well as the oil and gas sectors. In 2011, orders grew at a higher rate than revenues leading to an increase in group order backlog by 5 percent (9 percent in local currencies) compared to 2010. The increase in order backlog in the Power Systems division is largely based on large orders for grid upgrades and the integration of renewable energy sources. The order backlog in the Power Products division grew slightly in 2011 after a decline in 2010. Despite slowing growth in global industrial demand in the second half of 2011, order backlog in the Discrete Automation and Motion division, only partly driven by the Baldor acquisition, and in the Low Voltage Products division continued to grow in 2011. The Process Automation division benefited from large orders in the oil and gas related marine sectors, which increased order backlog. Revenues ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation 2012 2011 2010 2012 2011 % Change 10,717 10,869 10,199 7,852 8,101 6,786 9,405 6,638 8,156 8,806 5,617 5,304 4,554 8,300 7,432 (1) (3) 7 25 (2) 3 7 19 57 16 12 20 n.a. 20 Operating divisions 42,768 41,380 34,588 Corporate and Other(1) (3,432) (3,390) (2,999) n.a. Total 39,336 37,990 31,589 4 (1) Includes interdivisional eliminations Revenues in 2012 increased 4 percent (7 percent in local currencies) based on a solid order level recorded in the previous year, as well as on the impact of Thomas & Betts. Excluding Thomas & Betts, revenues were steady, decreas- ing 1 percent despite a difficult economic environment (increase of 3 percent in local currencies). Revenues in the Power Products division declined 1 per- cent (increased 2 percent in local currencies) impacted by lower revenues from the Transformers business. In the Power Systems division, revenues were 3 percent lower but in- creased 2 percent in local currencies, as orders recorded in the previous year were executed and translated into revenues. Revenues rose 7 percent (10 percent in local currencies) in the Discrete Automation and Motion division, as the Robotics business continued to grow at a double-digit rate in 2012. In the Low Voltage Products division, revenues grew 25 percent (29 percent in local currencies); excluding Thomas & Betts, revenues decreased 4 percent (stable in local currencies) fol- lowing double-digit growth in 2011. Revenues in the Process Automation division were 2 percent lower but increased 2 percent in local currencies supported by demand from oil and gas related sectors, while revenues declined in other businesses such as Turbochargers and Full Service. Revenues in 2011 increased 20 percent (15 percent in local currencies) on the back of strong orders recorded in the previous year, as well as on improving revenues from early- cycle business in the first half of the year. Excluding Baldor, revenues increased 14 percent (9 percent in local currencies). In 2011, revenues in the Power Products division in- creased 7 percent (2 percent in local currencies) following two years of revenue declines, mainly on growth in Medium- Voltage Products but also on higher revenues in Transformers and High Voltage Products. In the Power Systems division, revenues increased 19 percent (14 percent in local currencies) on the successful execution of large orders placed in the previous year in the Grid Systems and Power Generation busi- nesses. Revenues rose 57 percent (51 percent in local cur- rencies) in the Discrete Automation and Motion division and 22 percent (16 percent in local currencies) excluding Baldor. The Robotics business confirmed the turnaround seen in 2010 and grew at a double-digit pace in 2011. Revenues growth softened in the second half of the year in the Low Voltage Products division resulting in 16 percent higher revenues in 2011 (11 percent in local currencies) compared to the previous year. Revenues in the Process Automation division, which is later in the economic cycle, were 12 percent (6 percent in local currencies) higher, supported by solid orders received in Minerals, Pulp and Paper, Turbochargers and Oil and Gas businesses. ABB Annual Report 2012 | Financial review 57 We determine the geographic distribution of our revenues based on the location of the customer, which may be differ- ent from the ultimate destination of the products’ end use. The geographic distribution of our consolidated revenues was as follows: ($ in millions) Europe The Americas Asia 2012 2011 2010 2012 2011 % Change 14,073 14,657 12,378 10,699 9,043 6,213 10,750 10,136 8,872 (4) 18 6 (8) 4 18 46 14 1 20 Middle East and Africa 3,814 4,154 4,126 Total 39,336 37,990 31,589 In 2012, revenues in Europe decreased 4 percent (increased 2 percent in local currencies), despite growth in the Discrete Automation and Motion division, as the other divisions recorded lower revenues. Growth in Germany, Sweden, Norway and the United Kingdom was offset by declines in Italy, France and Spain. Revenues from the Americas increased 18 percent (20 percent in local currencies and 4 percent, in local curren- cies, excluding Thomas & Betts) on higher industrial demand for the automation divisions. The U.S. grew 25 percent (8 percent excluding Thomas & Betts), while Brazil recorded lower revenues than in the previous year. Revenues from Asia increased 6 percent (8 percent in local currencies) on growth in all divisions. Within this region, revenues in South Korea grew on the execution of large marine orders, while China recorded stable revenues and India recorded lower revenues. Revenues in MEA declined 8 percent (5 percent in local currencies) on lower revenues generated in the power and the oil and gas sectors in the region. In 2011, revenues in Europe grew 18 percent (11 percent in local currencies) on the execution of large Power Systems orders, as well as on demand for automation products across the region. Revenues from the Americas increased 46 percent (43 percent in local currencies and 14 percent, in local currencies, excluding Baldor). In the U.S., industrial demand grew significantly and the transmission and distri- bution markets recovered from a low level, while Brazil rev- enues grew on the execution of large orders. Revenues from Asia increased 14 percent (9 percent in local currencies) on growth from the industrial automation sector in China and India. Revenues in MEA increased 1 percent, however declined 2 percent in local currencies. Weaker large orders in the previous year lead to a decline in revenues in the utilities and oil and gas sector, which offset higher revenues from the other industrial automation sectors. 58 Financial review | ABB Annual Report 2012 Cost of sales Cost of sales consists primarily of labor, raw materials and components but also includes expenses for warranties, con- tract losses and project penalties, as well as order-related development expenses incurred in connection with projects for which corresponding revenues have been recognized. In 2012, cost of sales increased 5 percent (9 percent in local currencies) to $27,958 million. Excluding the impact from Thomas & Betts, cost of sales increased 1 percent (5 percent in local currencies). As a percentage of revenues, cost of sales increased to 71.1 percent from 69.9 percent in 2011. Higher cost of sales as a percentage of revenues is the result of price erosion on the execution of order backlog, an unfavorable business mix arising from a higher proportion of revenues generated from lower margin types of business, current period margin erosion in certain projects and charges associated with repositioning the Power Systems division. Such cost increases were partly compensated by cost saving initiatives. In 2011, cost of sales increased 20 percent (16 percent in local currencies) to $26,556 million. The increase in the cost of sales reflects the growth in revenues from existing busi- nesses and new acquisitions. Cost of sales was negatively affected by higher prices in certain commodities and an unfavorable change in business mix. The increase in the cost of sales in 2011 was partly offset by savings realized from the cost saving initiatives, mainly in the areas of supply man- agement and operational excellence. As a percentage of revenues, cost of sales remained stable at 69.9 percent, as the cost saving initiatives helped to offset continued pricing pressure on revenues. Selling, general and administrative expenses The components of selling, general and administrative expenses were as follows: ($ in millions) Selling expenses 2012 2011 2010 (3,862) (3,533) (2,947) Selling expenses as a percentage of orders received 9.6% 8.8% 9.0% General and administrative expenses (1,894) (1,840) (1,668) General and administrative expenses as a percentage of revenues Total selling, general 4.8% 4.8% 5.3% and administrative expenses (5,756) (5,373) (4,615) Total selling, general and administrative expenses as a percentage of revenues 14.6% 14.1% 14.6% Total selling, general and administrative expenses as a percentage of the average of orders received and revenues 14.5% 13.7% 14.4% In 2012, selling expenses increased 9 percent (14 percent in local currencies); excluding Thomas & Betts, selling expenses increased 4 percent (9 percent in local currencies) compared to 2011. As a percentage of orders received, selling expenses increased to 9.6 percent from 8.8 percent. The increase in selling expenses in 2012 was mainly driven by additional sales force employees to develop new markets and implement sales and marketing programs in order to secure market po- sitions in a competitive environment. In 2011, selling expenses increased 20 percent (14 per- cent in local currencies). Excluding Baldor, selling expenses were 14 percent (8 percent in local currencies) higher as compared to 2010. The increase in selling expenses in 2011 continued to be driven by a larger sales force employed by all divisions to strengthen their market presence particularly in the emerging countries. Selling expenses further increased following the growth in orders as certain elements of such expenses, in particular expenses related to order-pursuing activities and sales commissions, are variable expenses. In 2012, general and administrative expenses increased 3 percent (6 percent in local currencies). Excluding Thomas & Betts, general and administrative expenses declined 5 per- cent (2 percent in local currencies), reflecting tighter cost control throughout the organization. As a percentage of rev- enues, general and administrative expenses remained unchanged at 4.8 percent in 2012. In 2011, general and administrative expenses increased 10 percent (6 percent in local currencies). Excluding Baldor, general and administrative expenses increased 5 percent (1 percent in local currencies). The increase in general and administrative expenses in 2011 was driven primarily by initiatives to strengthen functional support areas especially in the emerging markets such as China, India and the Middle East countries. As a percentage of revenues, general and administrative expenses decreased to 4.8 percent from 5.3 percent in 2010 reflecting a strong increase in revenues on relatively stable expenses achieved through higher effi- ciency derived from continuous process improvement and improved cost management. In 2012, selling, general and administrative expenses increased 7 percent (11 percent in local currencies). Exclud- ing Thomas & Betts, selling, general and administrative expenses increased 1 percent (increased 5 percent in local currencies). As a percentage of revenues, selling, general and administrative expenses increased 0.5 percentage-points to 14.6 percent. As a percentage of the average of orders and revenues, selling, general and administrative expenses increased 0.8 percentage-points to 14.5 percent as orders intake was flat. While in 2011, selling, general and administra- tive expenses increased, the expenses as a percentage of the average of orders and revenues decreased 0.7 percent- age-points to 13.7 percent. Non-order related research and development expenses In 2012, non-order related research and development ex- penses increased 7 percent (11 percent in local currencies), mainly due to increased research and development activi- ties, as well as to the incremental costs of newly-acquired companies. In 2011, non-order related research and development ex- penses increased 27 percent (18 percent in local currencies), as we accelerated efforts to keep ahead with technology advancements in order to maintain industry leadership. The increase was also due to incremental costs of newly-acquired companies. Non-order related research and development expenses as a percentage of revenues increased slightly to 3.7 percent in 2012, after increasing to 3.6 percent in 2011 from 3.4 per- cent in 2010. Other income (expense), net ($ in millions) Restructuring expenses(1) Capital gains, net Asset impairments Income from equity-accounted companies and other income (expense) Total (1) Excluding asset impairments 2012 (54) 28 (111) 37 (100) 2011 2010 (26) 40 (29) (8) (23) (54) 51 (57) 46 (14) “Other income (expense), net”, typically consists of restruc- turing expenses, net capital gains (which include gains or losses from the sale of businesses and gains or losses from the sale or disposal of property, plant and equipment), asset impairments, as well as our share of income or loss from equity-accounted companies and license income. Restructuring and related expenses are recorded in various lines within the Consolidated Income Statements, depending on the nature of the charges. In 2012, such expenses reported in “Other income (expense), net” were $54 million, mainly related to the Power Products division’s restructuring activities in Spain, Sweden and Brazil and to restructuring in the Power Systems division. In 2011, restruc- turing expenses reported in “Other income (expense), net” amounted to $26 million. The expenses were primarily related to the Low Voltage Products division’s restructuring initiatives in Germany, France and the U.S., a Power Products division’s restructuring project in Spain and Discrete Automation and Motion division’s restructuring initiatives in the U.S. In 2010, restructuring expenses reported in “Other income (expense), net” were incurred for restructuring projects across all our divisions, principally in the Process Automation, Discrete Automation and Motion, as well as the Power Products divisions. ABB Annual Report 2012 | Financial review 59 In 2012, “Capital gains, net” was $28 million, including EBIT margins were as follows: (in %) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation Operating divisions Total 2012 12.4 0.1 15.6 12.9 11.2 10.7 10.3 2011 13.6 6.8 14.7 17.0 11.6 12.5 12.3 2010 16.0 1.7 16.2 17.3 10.2 12.2 12.1 In 2012, EBIT margin decreased 2.0 percentage-points to 10.3 percent driven by price erosion from the execution of lower-priced projects in the backlog, changes in the business and geographical mix, charges associated with the Power Systems strategic repositioning, charges relating to acquisi- tions and certain impairments. Continued investment for long-term growth in the sales and research and development areas further impacted EBIT in 2012. Cost savings helped to partly offset the impacts from the factors described above. In 2011, EBIT margin increased 0.2 percentage-points to 12.3 percent. The increase in EBIT and EBIT margin reflects the contribution from higher volumes including the $1,950 million of revenues from Baldor. Costs savings generated in 2011 further improved the EBIT and EBIT margin as the amount of those savings more than offset the impact from price pres- sure that continued particularly in the power sector. Profit- ability was affected by an unfavorable business mix, higher amortization from the intangibles from the Baldor acquisition and continued investments in sales and research and de- velopment offset by the non-recurrence of project related charges in 2010 in the Power Systems division. Net interest and other finance expense Net interest and other finance expense consists of “Interest and dividend income” offset by “Interest and other finance expense”. “Interest and other finance expense” includes interest expense on our debt, the amortization of upfront costs asso- ciated with our credit facility and our debt securities, com- mitment fees on our bank facility and exchange losses on financial items, offset by gains on marketable securities and exchange gains on financial items. ($ in millions) Interest and dividend income Interest and other finance expense Net interest and other 2012 73 (293) 2011 90 (207) 2010 95 (173) (34) finance expense (220) (117) (78) $25 million net gain from the sales of land and buildings mainly in Switzerland, Austria, the Netherlands and Sweden. In 2011, “Capital gains, net” amounted to $40 million and included a $45 million net gain from the sales of land and buildings mainly in Venezuela, Nigeria, Sweden, Brazil and Switzerland. “Capital gains, net”, in 2010, consisted mainly of $35 million in gains on the sales of land and buildings, mainly in Sweden, Norway and Austria, as well as a $13 mil- lion gain on the sale of an equity-accounted company in Colombia. In 2012, “Asset impairments” totaled $111 million, which primarily consisted of $87 million impairments of investments in equity-accounted companies. In 2011, “Asset impairments” amounted to $29 million, reflecting a total of $20 million impairments of tangible and intangible assets related mainly to restructuring projects in various countries, and a $9 million impairment on the investment in the shares of a listed com- pany. “Asset impairments” in 2010, included $23 million for the impairment, prior to sale, of two equity-accounted compa- nies in the Ivory Coast, and other impairments of tangible and intangible assets, primarily related to Russia, Thailand, the Czech Republic and the United States. In 2012, “Income from equity-accounted companies and other income (expense)” amounted to $37 million, consist- ing mainly of the release of a compliance-related provision in Germany and income from an insurance claim in Italy that were partially offset by a provision for certain pension claims in the United States. “Income from equity-accounted com- panies and other income (expense)” in 2011 amounted to a net loss of $8 million mainly due to charges related to the deconsolidation of a Russian subsidiary, partly offset by income from equity-accounted companies and income from license fees. In 2010, “Income from equity-accounted companies and other income (expense)” primarily consisted of a $22 mil- lion release of provisions and income of $13 million from a break-fee related to the bid to acquire Chloride Group PLC. Earnings before interest and taxes % Change 2011 2010 2012 2011 ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation 2012 1,328 1,476 1,636 7 548 114 1,469 1,294 856 912 904 963 911 788 759 Operating divisions 4,572 5,185 4,208 Corporate and Other (516) (538) (402) Intersegment elimination 2 20 12 (10) 381 42 15 27 23 (10) (99) 14 (5) (5) (12) (4) Total 4,058 4,667 3,818 (13) 22 In 2012 and 2011, the EBIT changes were a result of the factors discussed above. 60 Financial review | ABB Annual Report 2012 In 2012, “Interest and dividend income” declined compared to 2011, due primarily to the impact of lower market interest rates for certain currencies, mainly the euro. In 2011, “Interest and dividend income” declined com- pared to 2010, primarily due to the lower average aggregate level of “Cash and equivalents” and “Marketable securities and short-term investments” in 2011 compared to 2010, as the funds were used to finance the acquisition of businesses such as Baldor (a cash outflow of $4,276 million in January 2011 – see “Note 3 Acquisitions and increases in controlling interests” to our Consolidated Financial Statements). In 2012, “Interest and other finance expense” increased compared to 2011, primarily reflecting (i) the net increase in long-term debt including current maturities (from $3,307 mil- lion at December 31, 2011, to $8,540 million at December 31, 2012) as a result of bonds issued in 2012 (see “Liquidity and capital resources” for a further discussion), partially off- set by (ii) the impact of a net release of provisions for expected interest due on tax penalties, primarily due to the favorable resolution of a tax dispute – see “Note 16 Taxes” to our Consolidated Financial Statements. In 2011, “Interest and other finance expense” increased compared to 2010, primarily reflecting (i) the increase in long- term debt including current maturities (from $2,058 million at December 31, 2010, to $3,307 million at December 31, 2011) as a result of the bonds issued in 2011, (ii) the increase in EUR-denominated interest rates and (iii) movements in foreign exchange rates that have resulted in higher foreign exchange losses on financial items in 2011 than in 2010. The provision for taxes in 2010 represented an effective tax rate of 27.2 percent and included: – a net increase in valuation allowance on deferred taxes of $60 million, as we determined it was no longer more likely than not that such deferred tax assets would be realized. This amount included $44 million related to certain of our operations in Central Europe. Income from continuing operations, net of tax As a result of the factors discussed above, income from continuing operations, net of tax, decreased $498 million to $2,808 million in 2012 compared to 2011, and increased $584 million to $3,306 million in 2011 compared to 2010. Net income attributable to ABB As a result of the factors discussed above, net income attributable to ABB decreased $464 million to $2,704 million in 2012 compared to 2011 and increased $607 million to $3,168 million in 2011 compared to 2010. Earnings per share attributable to ABB shareholders Provision for taxes ($ in millions) Income from continuing operations, before taxes Provision for taxes Effective tax rate for the year (%) 2012 2011 2010 (in $) Income from continuing operations, net of tax: Basic Diluted Net income attributable to ABB: 3,838 (1,030) 26.8 4,550 (1,244) 27.3 3,740 (1,018) 27.2 Basic Diluted 2012 2011 2010 1.18 1.18 1.18 1.18 1.38 1.38 1.38 1.38 1.12 1.11 1.12 1.12 Basic earnings per share is calculated by dividing income by the weighted-average number of shares outstanding during the year. Diluted earnings per share is calculated by dividing income by the weighted-average number of shares outstanding during the year, assuming that all potentially dilutive securities were exercised, if dilutive. Potentially dilu- tive securities comprise: outstanding written call options; outstanding options and shares granted subject to certain conditions under our share-based payment arrangements. See “Note 20 Earnings per share” to our Consolidated Finan- cial Statements. The provision for taxes in 2012 represented an effective tax rate of 26.8 percent and included: – tax credits, arising in foreign jurisdictions, for which the technical merits did not allow a benefit to be taken, and – a net increase in valuation allowance on deferred taxes of $44 million, as we determined it was not more likely than not that such deferred tax assets would be realized. This amount included $36 million related to certain of our operations in Central Europe. The provision for taxes in 2011 represented an effective tax rate of 27.3 percent and included: – tax credits, arising in foreign jurisdictions, for which the technical merits did not allow a benefit to be taken, and – the net reduction in valuation allowance on deferred taxes of approximately $22 million, as we determined it was more likely than not that such deferred tax assets would be realized. ABB Annual Report 2012 | Financial review 61 Divisional analysis The geographic distribution of orders for our Power Products division was as follows: Power Products (in %) Europe The financial results of our Power Products division were as follows: The Americas Asia Middle East and Africa 2012 2011 2010 33 27 29 11 32 26 33 9 35 26 29 10 % Change Total 100 100 100 ($ in millions, except Operational EBITDA margin %) 2012 2011 2010 2012 2011 Orders 11,040 11,068 9,778 Order backlog at Dec. 31, 8,493 8,029 7,930 Revenues 10,717 10,869 10,199 Operational EBITDA 1,585 1,782 1,861 Operational EBITDA margin %(1) EBIT 14.8 16.3 18.2 1,328 1,476 1,636 – 6 (1) (11) n.a. (10) 13 1 7 (4) n.a. (10) (1) Operational EBITDA margin % is calculated as Operational EBITDA divided by Operational revenues. Reconciliation to Financial Statements ($ in millions) 2012 2011 2010 Operational revenues 10,702 10,901 10,202 FX/commodity timing differences on revenues(1) 15 (32) (3) 10,717 1,585 10,869 10,199 1,782 1,861 Revenues (as per Financial Statements) Operational EBITDA FX/commodity timing differences on EBIT(1) Restructuring-related costs Acquisition-related expenses and certain non-operational items Depreciation and amortization EBIT (as per Financial In 2012, the contribution of orders from MEA increased as a result of power transmission infrastructure orders. The share of the Americas was driven by grid upgrades in North America and capacity-related investments in South America. Asia’s share declined in comparison to 2011 which included a large order in China. Europe was steady despite continued economic challenges restraining large scale investments. In 2011, the contribution of orders from the Americas re- mained at the same level, but volumes were higher than in 2010, mainly driven by demand for distribution- and transmis- sion-related products. Europe’s share declined due to slow- down in investments as a result of the macroeconomic situa- tion. We saw a growth in Asia’s contribution with significant large order wins in China as well as higher base orders. The share of MEA remained around the same level as in 2010. Order backlog In 2012, order backlog increased 6 percent (4 percent in local currencies) compared to 2011. The increase was mainly driven by transmission orders, which have a longer order-to- revenue conversion cycle, and steady base orders. 18 (65) (1) (209) (36) (70) – (200) (4) (44) – (177) In 2011, order backlog increased 1 percent (4 percent in local currencies) compared to 2010. The increase in order backlog in 2011 reflects the higher order intake from the power distribution and industry sectors as well as some sig- nificant large orders in the transmission sector. Statements) 1,328 1,476 1,636 (1) For further details of FX/commodity derivative timing differences, see “Note 23 Operating segment and geographic data.” Orders In 2012, order intake was maintained at the level of 2011 (increased 3 percent in local currencies) despite challenging economic and market conditions. Order intake was driven by steady demand in the industrial and distribution sectors and selective investments in the power transmission sector. In 2011, orders were up 13 percent (8 percent in local currencies) driven by investments in the power distribution and industry sectors. Both large and base orders grew during the year. Revenues In 2012, revenues decreased 1 percent (increased 2 percent in local currencies) reflecting the timing of order backlog conversion and market conditions. Revenues from distribution- and industry-related businesses were steady while the de- crease in transmission-related volumes reflected the order backlog conversion. Service revenues grew and represented an increased share of total division revenues. In 2011, revenues grew 7 percent (2 percent in local cur- rencies) due to higher volumes in the short- and mid-cycle business such as medium-voltage equipment and distribution transformers. Revenues from late-cycle businesses such as large power transformers were flat partly as a result of the lower transmission-related order backlog. Service revenues saw a double-digit growth. 62 Financial review | ABB Annual Report 2012 The geographic distribution of revenues for our Power Products division was as follows: Power Systems (in %) Europe The Americas Asia Middle East and Africa Total 2012 2011 2010 The financial results of our Power Systems division were as follows: 32 27 32 9 34 27 30 9 34 26 31 9 ($ in millions, except Operational EBITDA margin %) 100 100 100 Orders 2012 7,973 % Change 2011 2010 2012 2011 9,278 7,896 (14) In 2012, Asia increased its share of revenues reflecting the timing of order execution. The share of Europe declined due to continued economic uncertainty and selective capital in- vestments by customers. The Americas maintained its share of revenues due to higher demand in the U.S. In 2011, the regions maintained their share of total rev- enues. The Americas showed a small increase due to growth in the U.S. Asia’s share was slightly lower due to a lower transmission related backlog. Operational EBITDA In 2012, Operational EBITDA and Operational EBITDA margin were lower, reflecting the execution of lower-margin order backlog as a result of pricing pressure. Cost saving initiatives helped to partially reduce the impact. In 2011, Operational EBITDA and Operational EBITDA margin were lower primarily due to the execution of lower margin orders from the backlog, reflecting the continued pricing pressure in an extremely competitive market across all businesses. However, cost savings partly mitigated this price impact. EBIT In 2012, EBIT was lower than 2011, primarily due to the explanations in the “Operational EBITDA” section above. In part this was offset by lower restructuring-related charges and a positive effect from FX/commodity derivatives timing differences. In 2011, EBIT was lower than 2010. In addition to the ef- fects described in the “Operational EBITDA” section, EBIT was lower as a result of higher restructuring-related charges, depreciation and amortization and a negative effect from FX/commodity derivatives timing differences. Fiscal year 2013 outlook The overall investment climate remains cautious with sev- eral major geographical areas still experiencing economic challenges. Emerging markets are still growing, although at a slower pace. The outlook for China continues to be some- what uncertain with some optimistic signs emerging. Industrial investment remains largely focused in sectors like oil and gas and mining. The power transmission utility sector is still seeing selective project investments while distribution demand seems to be leveling out in some regions driven by a decelera- tion in electricity consumption growth rates. Based on the current level of demand and the overall capacity situation in the transmission sector, pricing pressure persists, but is higher in some markets and leveling out in others. 18 6 19 Order backlog at Dec. 31, 12,107 11,570 10,929 Revenues 7,852 8,101 6,786 5 (3) Operational EBITDA 290 743 304 (61) 144 Operational EBITDA margin %(1) EBIT 3.7 7 9.1 548 4.5 114 n.a. (99) n.a. 381 (1) Operational EBITDA margin % is calculated as Operational EBITDA divided by Operational revenues. Reconciliation to Financial Statements ($ in millions) Operational revenues 2012 7,812 2011 8,128 2010 6,783 FX/commodity timing differences on revenues(1) 40 (27) 3 Revenues (as per Financial Statements) Operational EBITDA FX/commodity timing differences on EBIT(1) Restructuring-related costs Acquisition-related expenses and certain non-operational items Depreciation and amortization EBIT (as per Financial 7,852 290 8,101 743 6,786 304 13 (52) (70) (174) 3 (54) – (144) (58) (48) – (84) Statements) 7 548 114 (1) For further details of FX/commodity derivative timing differences, see “Note 23 Operating segment and geographic data.” Orders Order intake in 2012 decreased 14 percent (10 percent in local currencies) mainly due to a lower volume of large orders compared with 2011, which had included a $1 billion offshore wind farm order in Germany and an Ultrahigh Voltage Direct Current (UHVDC) power transmission order in India of around $900 million. The level of base orders was slightly lower than 2011, with decreases in all businesses except Network Management where software orders increased. Power infra- structure spending was restrained due to economic uncertain- ties, especially in some mature economies with high debt levels. Transmission utilities continue to invest selectively, with emerging markets focusing on capacity addition and mature markets mainly on grid upgrades. Large orders secured in 2012 included a $260 million converter station upgrade from the U.S. to improve power reliability in Oregon, a $170 mil- lion contract for a power link between an oil and gas field in the North Sea and the Norwegian grid, and multiple power infrastructure-related orders in Saudi Arabia and Iraq with a combined value of around $700 million. ABB Annual Report 2012 | Financial review 63 Continued pricing pressure in some of our key geograph- ical markets negatively impacted the order intake in 2012 as in 2011. Mincom (an Australia-based software company specializing in solutions for mining and other asset-intensive industries, acquired in the third quarter of 2011) contributed $137 million to orders in 2012, compared with $47 million in 2011. There was marginal order contribution in 2012 from Tropos Networks Inc. (a U.S.-based company offering wire- less mesh communication technology solutions) acquired in the third quarter of 2012. Order intake in 2011 increased 18 percent (12 percent in local currencies) with growth in both large and base orders. Customers in emerging countries continued to invest in infrastructure development and new capacity, while mature markets focused on grid upgrades and the integration of renewable energy sources. Demand for power solutions to support industrial growth and distribution networks also contributed to the growth. Large orders secured in 2011 in- cluded a HVDC Light® transmission link to connect offshore North Sea wind farms to the German mainland grid with a value of approximately $1 billion, and another HVDC Light® power transmission link between Norway and Denmark, with a value of approximately $180 million. Large orders in 2011 also included an UHVDC transmission order from India to supply hydropower across 1,700 kilometers, with a value of around $900 million. The geographic distribution of orders for our Power Systems division was as follows: (in %) Europe The Americas Asia Middle East and Africa Total 2012 2011 2010 30 31 18 21 40 17 27 16 47 14 15 24 100 100 100 Europe In 2012, the Americas was the largest region in terms of order intake attributable to strong order growth in the U.S., Canada and Brazil. The order share of Europe decreased in 2012 compared with 2011, reflecting the $1 billion order in Germany booked in 2011. Growth in the MEA region was mainly driven by large orders in Saudi Arabia and Iraq. Asia’s share of orders in 2012 was lower than in the previous year, mainly due to a lower level of large orders from India, where the $900 million order was booked in 2011. In 2011, Europe was the largest region in terms of or- der intake. As in 2010, the strong political commitment in Europe to increase the share of renewables in the energy mix contributed to order growth. We saw a substantial growth in orders from Asia in 2011, mainly on the timing of large order awards from India. The share of orders from the Americas increased in 2011, driven by the United States, Canada and Brazil. The 2011 order share from the MEA region decreased in 2011, due to the timing of large order awards, combined with increased competitiveness and pricing pressure. 64 Financial review | ABB Annual Report 2012 Order backlog Order backlog at December 31, 2012, reached a record level of $12,107 million, corresponding to an increase of 5 percent (2 percent in local currencies) compared with 2011. Order backlog at December 31, 2011, increased 6 percent (11 percent in local currencies) to $11,570 million. Whereas the share of large orders in our order backlog remained fairly consistent, we had an increased proportion of large projects with more than 2 years execution time in the mix. Revenues Revenues in 2012 decreased 3 percent (increased 2 percent in local currencies), mainly reflecting the scheduled execution of our order backlog. Lower revenues in the Power Genera- tion business could not be fully offset by revenue growth in our Network Management business. Revenues in Grid Systems and Substations were marginally down in U.S. dollar terms, but showed a small increase in local currencies. Revenues in 2012 included $138 million from Mincom. Revenues in 2011 increased 19 percent (14 percent in local currencies). Among our businesses, the revenue growth was led by Grid Systems, reflecting the strong order backlog at the beginning of the year. Revenue growth in Power Gen- eration resulted from a substantial order backlog and a higher book and bill ratio in 2011 than in 2010 (orders that can be converted to revenues within the same calendar year). A rev- enue increase in Network Management was helped by the software businesses acquired in 2011 and 2010. Revenues in 2011 included $47 million from Mincom since the date of acquisition. The geographic distribution of revenues for the Power Systems division was as follows: (in %) 2012 2011 2010 The Americas Asia Middle East and Africa Total 40 19 19 22 40 20 18 22 34 21 17 28 100 100 100 The regional distribution of revenues reflects the geographical end-user markets of the projects we are executing, and consequently varies with time. In 2012, Europe remained the largest region in terms of revenues, partly reflecting the ex- ecution of offshore wind projects. The share of revenues from MEA was stable, despite a minor revenue decline in the re- gion compared to 2011, caused by a revenue decrease in the United Arab Emirates and Qatar which could only partly be compensated by growth in Saudi Arabia and Iraq. Revenues grew in Asia, mainly driven by Australia, while the Americas saw a drop due to the timing of execution of some projects in Brazil. In 2011, the share of revenues from Europe, the largest region for the division, increased. Revenues from MEA, the second largest region, were lower, reflecting scheduled project execution. Revenues grew in the Americas, mainly driven by Brazil, while the revenue growth from Asia was led by Australia and India. Operational EBITDA In 2012, Operational EBITDA decreased 61 percent (57 per- cent in local currencies), mainly due to the execution of lower margin projects from the order backlog, as well as a charge of approximately $250 million relating to a repositioning of the Power Systems division (announced in December 2012) to secure higher and more consistent future profitability. An in- crease in sales expenses as well as research and development spending related mainly to the acquisitions of Mincom and Tropos Networks Inc. In addition to the impact from acquisi- tions, sales expenses were also affected by increased tender activity. General and administrative expenses in 2012 remained approximately on the same level as in 2011. The impact from lower prices on past orders, now flowing through to revenues, were mitigated by cost savings from supply chain manage- ment and operational excellence activities. In 2011, Operational EBITDA increased 144 percent (132 percent in local currencies). The higher Operational EBITDA and Operational EBITDA margin in 2011 was mainly the result of higher revenues, the non-recurrence of project- related charges in the cables business, as well as successful claims management. Sales expenses, as well as general and administrative expenses increased mainly following the acquisitions of Ventyx and Mincom. The increase in sales expenses also reflected higher doubtful debt provisions than in 2010. Higher research and development spending, as well as the impact from lower prices on past orders now flowing through to revenues, were largely offset by cost savings. EBIT In 2012, EBIT decreased to $7 million. In addition to the impacts disclosed in the “Operational EBITDA” section, EBIT was negatively impacted by further charges of approximately $100 million (presented in the reconciliation table above as restructuring-related costs, and acquisition-related expenses and certain operational items) related to the repositioning of the Power Systems division. These charges related to certain impairments and the closure of low value-adding contracting operations in a number of countries. Overall, restructuring- related expenses in 2012 were marginally lower than the $54 million in 2011. EBIT was also impacted by higher depre - ciation and amortization expenses of $174 million in 2012, compared to $144 million in 2011, mainly resulting from the Mincom acquisition. There was a small positive impact related to FX/commodity derivative timing differences of $13 million in 2012 compared to $3 million in 2011. Fiscal year 2013 outlook Fundamental market drivers for the Power Systems division remain intact; these include power infrastructure investments in emerging markets to add capacity, aging infrastructure upgrades in mature markets, a focus on renewables, energy efficiency, and the development of more reliable, flexible and smarter grids. There is, however, uncertainty in terms of timing of investments, stemming from continued macroeco- nomic challenges in several economies, as well as execution risks surrounding the repositioning of the division. Discrete Automation and Motion The financial results of our Discrete Automation and Motion division were as follows: ($ in millions, except Operational EBITDA margin %) Orders Order backlog at Dec. 31, Revenues Operational EBITDA Operational EBITDA margin %(1) EBIT % Change 2012 9,625 4,426 9,405 1,735 2011 2010 2012 2011 9,566 5,862 4,120 3,350 8,806 5,617 1,664 1,026 1 7 7 4 63 23 57 62 18.4 18.9 1,469 1,294 18.3 911 n.a. 14 n.a. 42 (1) Operational EBITDA margin % is calculated as Operational EBITDA divided by Operational revenues. Reconciliation to Financial Statements ($ in millions) Operational revenues 2012 9,405 2011 8,817 2010 5,613 FX/commodity timing differences on revenues(1) – (11) 4 Revenues (as per Financial Statements) Operational EBITDA FX/commodity timing differences on EBIT(1) Restructuring-related costs Acquisition-related expenses and certain non-operational items Depreciation and amortization EBIT (as per Financial 9,405 1,735 8,806 1,664 5,617 1,026 1 4 (8) (263) (19) (10) (90) (251) (2) (35) – (78) In 2011, EBIT increased to $548 million. In addition to Statements) 1,469 1,294 911 (1) For further details of FX/commodity derivative timing differences, see “Note 23 Operating segment and geographic data.” the impacts disclosed in the “Operational EBITDA” section, EBIT was impacted by higher depreciation and amortization expenses of $144 million in 2011, compared to $84 million in 2010, mainly resulting from the Ventyx and Mincom acqui- sitions. This negative impact was offset by a positive con- tribution from FX/commodity derivative timing differences of $3 million in 2011 compared to a negative impact of $58 mil- lion in 2010. Restructuring-related expenses were $54 million in 2011 compared to $48 million in 2010. ABB Annual Report 2012 | Financial review 65 The geographic distribution of orders for our Discrete The Americas Automation and Motion division was as follows: Asia Middle East and Africa (in %) Europe 2012 2011 2010 37 33 27 3 38 32 27 3 48 14 34 4 2012 2011 2010 Total 100 100 100 Revenues In 2012, revenues grew due to higher execution from the backlog in the Robotics business as well as in the Power Electronics and Medium Voltage Drives business. Motors and Generators business reported single-digit growth in rev- enues compared to 2011, while revenues in the Low Voltage Drives business were lower, as orders declined due to weak- ening market demand. Revenues in 2011 increased at a similar pace to orders, on the solid execution of the strong order backlog and due to the Baldor acquisition (which accounted for approximately 60 percent of the division’s revenue growth). The highest growth was achieved in Motors and Generators business, due to Baldor, and the Robotics business as a result of the strong order growth. The geographic distribution of revenues for our Discrete Automation and Motion division was as follows: In 2012, the share of revenues from the Americas increased due to higher orders. Revenues in Europe grew due to the solid execution of the order backlog but Europe’s share was lower as revenues in the other regions grew faster. Asia achieved single-digit revenue growth but its share remained at the same level as 2011, as the revenues in other regions grew faster. The geographic distribution of revenues changed sub- stantially in 2011 with the integration of Baldor causing the share of the Americas to more than double compared to 2010. All regions increased revenues on higher orders as demand increased in most markets. Operational EBITDA In 2012, Operational EBITDA increased 4 percent while the Operational EBITDA margin was 18.4 percent compared to 18.9 percent in 2011. The improved Operational EBITDA was due to higher revenues. The margin was slightly lower mainly due to changes in the business mix as the share of high- margin businesses such as Low Voltage Drives was lower than in 2011. All businesses, except Low Voltage Drives, increased their Operational EBITDA, with the highest increase in the Robotics business. Revenue growth supported an increase in Operational EBITDA in the Motors and Generators business while the Power Electronics and Medium Voltage Drives busi- ness benefited from solid execution of the order backlog. Operational EBITDA in the Low Voltage Drives business was lower than in 2011, due to a decline in revenues caused by the weakening market conditions, as well as higher sales ex- penses and research and development spending. Orders In 2012, orders were flat due to slower industrial growth globally in a more challenging macroeconomic environment. Lower demand from the renewable energy sector was off- set by increased volumes from large orders in other sectors. The highest growth was achieved in the Robotics business due to several larger automotive orders. Our Motors and Generators business as well as our Power Electronics and Medium Voltage Drives business recorded single-digit growth, while orders in our Low Voltage Drives business were lower as a result of weaker demand in renewables. In 2011, orders increased 63 percent (57 percent in local currencies) reflecting both increased demand for energy- efficient automation solutions, as well as the contribution from the U.S.-based industrial motor manufacturer Baldor, acquired in January 2011 (approximately half of the division’s order growth related to Baldor). The highest order growth was achieved in Motors and Generators due to the Baldor integration while Robotics orders increased due to improving demand in automotive and general industry sectors. (in %) Europe The Americas Asia Middle East and Africa Total 37 34 26 3 37 32 28 3 46 16 34 4 100 100 100 In 2012, the share of orders in the Americas increased due to double-digit growth in South America, as well as due to single-digit growth in North America. The share of orders in Europe was unchanged compared to 2011, as double- digit growth in the U.K. and Finland was offset by a decline in Germany and Spain. The share in Asia declined due to slower industrial growth and the weakening of the renewable energy business. Orders from MEA showed double-digit growth while its share of total orders remained at the same level, compared to 2011, as orders in other regions also in- creased. All regions increased orders in 2011, with the highest growth in the Americas due to Baldor. With Baldor’s substan- tial presence in the U.S., the Americas’ share of the divi- sion’s total orders doubled in 2011, compared to 2010, and therefore all other regions’ shares declined, resulting in a more balanced global presence with three equally strong regions – Europe, the Americas and Asia. Order backlog Order backlog in 2012 grew 7 percent (6 percent in local currencies) as the order intake from large orders increased in our Robotics and Motors and Generators businesses, which have a longer execution time. The backlog for the Power Electronics and Medium Voltage Drives business was 3 percent higher, compared to 2011. Order backlog in 2011 increased as orders were higher than revenues during the year. The highest increase came from the Robotics business, due to the high level of orders to be delivered in 2012 or later. 66 Financial review | ABB Annual Report 2012 In 2011, Operational EBITDA increased 62 percent (54 percent in local currencies) while the Operational EBITDA margin of 18.9 percent increased compared to 18.3 percent in 2010. The increase is based on a combination of higher revenues and the positive contribution from Baldor (approxi- mately 23 percent of the division’s Operational EBITDA). All businesses, except Power Electronics and Medium Voltage Drives, improved, with the largest increase in the Robotics business due to the continued turnaround from the low level of 2009. The Motors and Generators business benefited from the Baldor integration, while higher revenues in the Low Volt- age Drives business further increased Operational EBITDA. EBIT In 2012, EBIT grew 14 percent compared to 2011. Acquisition- related expenses and certain non-operational items were mainly transaction costs relating to the acquisition of Newave in Switzerland. Such acquisition-related expenses were sub- stantially lower than in 2011, which included expenses related to the acquisition of Baldor. Depreciation and amortization increased mainly due to the acquisition of Newave. In 2011, the difference between Operational EBITDA and EBIT was substantially higher than in 2010 due to acqui- sition-related expenses and certain non-operational items related to the acquisition of Baldor. These costs primarily in- cluded additional cost of sales resulting from the fair value adjustments of acquired inventories and transaction costs. Depreciation and amortization was substantially higher in 2011, compared to 2010, impacted by the acquisition of Baldor. Fiscal year 2013 outlook The uncertainty around the short-term prospects for Western Europe, the U.S. and China, which has influenced the short- cycle business growth in the latter part of 2012, is also likely to impact demand during 2013. We expect most markets to continue on lower growth rates in 2013. Despite this, we expect growth in orders and revenues, especially in emerging markets in Asia and South America. Furthermore, the need for improved energy efficiency and productivity in a wide range of industries will support the demand for automation solu- tions and energy efficient products provided by the Discrete Automation and Motion division. Low Voltage Products The financial results of our Low Voltage Products division were as follows: ($ in millions, except Operational EBITDA margin %) Orders Order backlog at Dec. 31, Revenues Operational EBITDA Operational EBITDA margin %(1) EBIT % Change 2012 6,720 1,117 6,638 1,219 2011 2010 2012 2011 5,364 4,686 887 838 5,304 4,554 1,059 926 25 26 25 15 14 6 16 14 18.4 856 19.9 904 20.3 788 n.a. (5) n.a. 15 (1) Operational EBITDA margin % is calculated as Operational EBITDA divided by Operational revenues. Reconciliation to Financial Statements ($ in millions) Operational revenues 2012 6,626 2011 5,315 2010 4,554 FX/commodity timing differences on revenues(1) 12 (11) – Revenues (as per Financial Statements) Operational EBITDA FX/commodity timing differences on EBIT(1) Restructuring-related costs Acquisition-related expenses and certain non-operational items Depreciation and amortization EBIT (as per Financial 6,638 1,219 5,304 1,059 4,554 926 16 (23) (106) (250) (19) (20) – (116) 3 (36) – (105) Statements) 856 904 788 (1) For further details of FX/commodity derivative timing differences, see “Note 23 Operating segment and geographic data.” Orders Orders increased 25 percent (29 percent in local currencies) in 2012 and increased 14 percent (9 percent in local curren- cies) in 2011. Order growth in 2012 was driven by the contribution from Thomas & Betts, which was acquired in May 2012. Excluding Thomas & Betts, orders decreased 4 percent (flat in local currencies). There was moderate growth in the systems busi- ness, while the product businesses decreased. The order growth in 2011 was driven by demand from both the industrial and construction markets. Order growth was recorded across most product businesses, with a strong re- covery in the systems business as market conditions improved. The renewables sector (mainly solar and wind) weakened as governmental subsidies expired in several countries reducing the demand for such investments. ABB Annual Report 2012 | Financial review 67 The geographic distribution of orders for our Low Voltage Products division was as follows: (in %) Europe The Americas Asia Middle East and Africa Total 2012 2011 2010 43 26 24 7 55 9 28 8 56 9 26 9 100 100 100 In 2012, orders in North America increased significantly due to Thomas & Betts, resulting in a more balanced geographic distribution of orders worldwide. Excluding Thomas & Betts, orders increased in Northern Europe and South Asia, but at the same time the division faced weaker demand in indus- trial and construction sectors in several of ABB’s largest markets, such as Central and Southern Europe. In 2011, orders continued to grow across all regions in absolute terms. The share of orders from Asia continued to grow, driven by product demand in China and strong growth in the systems business in South Asia. The Americas’ share of orders remained fairly stable, with growth in South America, and despite difficult market conditions in the United States. Although its share of orders decreased, Europe remains the largest region in absolute terms. Order backlog Excluding Thomas & Betts, order backlog increased 5 percent (4 percent in local currencies) in 2012. The higher backlog was driven by both product and systems businesses. In 2011, order backlog, compared to 2010, increased 6 percent (9 percent in local currencies). The higher backlog was mainly driven by a strong market recovery in the sys- tems business. Revenues In 2012, revenues increased by 25 percent (29 percent in local currencies). Excluding Thomas & Betts, revenues decreased 4 percent (flat in local currencies), as lower revenues from the product businesses were not fully offset by increased sys- tems business revenues. In 2012, the share of revenues from the Americas increased significantly due to Thomas & Betts. Excluding Thomas & Betts, the geographical distribution of revenue reflects the weaker demand in certain key markets, such as Central and Southern Europe. In 2011, the geographic distribution of revenues followed a similar trend to orders. The share of revenues from Asia continued to increase as a result of our global footprint shift to sourcing and producing locally in the emerging markets, thereby maintaining our competitiveness and ensuring shorter delivery times. Revenues in all regions grew compared to the previous year. Europe remained the largest region, despite economic downturn in several European countries. Operational EBITDA In 2012, Operational EBITDA increased 15 percent (18 per- cent in local currencies), primarily due to the contribution from Thomas & Betts. Excluding Thomas & Betts, Operational EBITDA declined 11 percent (7 percent in local currencies) due to an increased proportion of revenues from the lower margin system business, and lower volumes in certain key markets. In 2011, Operational EBITDA increased 14 percent (8 per- cent in local currencies). Higher revenues and price increases offset the negative impact from commodity price increases, the change in product mix and additional research and devel- opment investments. The higher share of systems revenues (which have lower margins) during the year resulted in a declin- ing Operational EBITDA margin. EBIT In 2012, EBIT decreased 5 percent (2 percent in local curren- cies). Acquisition-related expenses and certain non-opera- tional items (which included mainly certain employee-related expenses and transaction costs) related to Thomas & Betts negatively impacted EBIT. Depreciation and amortization ex- pense was substantially higher in 2012, compared to 2011, due to Thomas & Betts. In 2011, EBIT increased 15 percent (8 percent in local currencies), which was mainly driven by a revenues increase of about the same magnitude. In 2011, revenues increased 16 percent (11 percent in local currencies) due to the fast conversion cycle of the high orders received in the product business and due to the con- version of the stronger opening backlog in the Low Voltage Systems business. The geographic distribution of revenues for our Low Fiscal year 2013 outlook The outlook for 2013 continues to be uncertain, depending on the market. Despite an improvement in Asia, it is unclear how sustainable the current order rates will be in 2013. Certain key markets in Europe remain challenging, especially the Mediterranean countries. Voltage Products division was as follows: (in %) Europe The Americas Asia Middle East and Africa Total 2012 2011 2010 43 26 24 7 56 9 28 7 57 9 26 8 100 100 100 68 Financial review | ABB Annual Report 2012 Process Automation The geographic distribution of orders for our Process Automation division was as follows: The financial results of our Process Automation division were as follows: (in %) Europe % Change The Americas Asia 2011 2010 2012 2011 Middle East and Africa 2012 2011 2010 37 25 27 11 39 23 30 8 39 22 29 10 ($ in millions, except Operational EBITDA margin %) Orders Order backlog at Dec. 31, Revenues Operational EBITDA Operational EBITDA margin %(1) EBIT 2012 8,704 6,416 8,156 1,003 8,726 7,383 5,771 5,530 8,300 7,432 1,028 925 12.3 912 12.4 963 12.5 759 – 11 (2) (2) n.a (5) 18 4 12 11 n.a. 27 (1) Operational EBITDA margin % is calculated as Operational EBITDA divided by Operational revenues. Reconciliation to Financial Statements ($ in millions) Operational revenues 2012 8,134 2011 8,318 2010 7,427 FX/commodity timing differences on revenues(1) 22 (18) 5 Revenues (as per Financial Statements) Operational EBITDA FX/commodity timing differences on EBIT(1) Restructuring-related costs Acquisition-related expenses and certain non-operational items Depreciation and amortization EBIT (as per Financial Statements) 8,156 1,003 8,300 1,028 7,432 925 21 (28) (2) (82) 912 26 (8) – (83) (46) (44) – (76) 963 759 (1) For further details of FX/commodity derivative timing differences, see “Note 23 Operating segment and geographic data.” Orders Despite economic uncertainty across many parts of the world, orders in 2012 reached the same level as 2011 (increased 4 percent in local currencies) driven by key markets in marine, mining, and oil and gas. The Pulp and Paper, and Metals businesses were weaker however, especially in Europe, China and India. Certain short-cycle product businesses, such as Measurement Products, also recorded lower volumes in the second half of the year. Orders in 2011 grew 18 percent, led by Oil and Gas, Marine, Metals, and Pulp and Paper businesses. Large orders were strong, mainly in the Marine, and Oil and Gas busi- nesses, where major automation and offshore projects were recorded, while base orders also grew. Product orders were also strong, led by our Measurement Products business. Life-cycle services grew strongly, driven by several small- and medium-sized upgrade projects. Total 100 100 100 From a regional demand perspective, growth in 2012 was driven by MEA and the Americas, while Europe retained its high share of total orders. Growth in MEA was driven by several oil and gas investments across the region, as well as harbor cranes investments in the United Arab Emirates and a mining investment in Mozambique. In the Americas, South America recorded the strongest growth, driven by several mining investments in Chile and Peru, as well as a large marine order in Brazil. North America also continued to be strong, largely driven by mining investments in Canada. Growth in Europe was overall low, as growth in Central Europe, driven by the marine and cranes sector, was offset by declines in Northern Europe. Asia recorded lower orders as the histori- cally high activity level in the South Korean marine sector in 2011 was not repeated, while China grew moderately. In 2011, from a regional demand perspective, Asia and the Americas recorded strong growth. In Asia the growth was led by large projects in South Korea in the shipbuilding sector, and investments in the metals industry in China. In the Americas several large projects in oil and gas, minerals, and pulp and paper sectors were recorded in South America, while growth in the U.S. was driven by our products and services business. Orders in Europe were also at a high level, driven by oil and gas investment in an offshore gas platform for Statoil in Norway. In MEA, orders were lower as fewer large projects were recorded. Order backlog Order backlog at December 31, 2012, was 11 percent higher (8 percent in local currencies) than 2011. Order backlog growth was largely driven by our Marine, Mining, and Oil, Gas and Petrochemical businesses. Order backlog at December 31, 2011, increased 4 per- cent (8 percent in local currencies) compared to 2010. Order backlog growth was primarily driven by our Marine, and Pulp and Paper businesses. Revenues In 2012, revenues were down 2 percent (up 2 percent in local currencies) compared to 2011. We continued to execute from a strong order backlog. Revenue growth was led by the systems business, where our Marine, and Pulp and Paper businesses recorded strong growth, while Metals and Miner- als businesses were lower. Our Oil and Gas business was flat. Product businesses grew moderately, where growth in our Measurement Products business was offset by a decline in our Turbo Products business. Life-cycle services contin- ued to be strong and recorded a moderate growth, while our Full Service business was down, as we continued to refocus our portfolio towards higher value-added activities. ABB Annual Report 2012 | Financial review 69 In 2011, revenues increased, driven by our products and In 2011, EBIT and EBIT margin improved significantly, services businesses. Life-cycle services recorded strong growth. Systems revenues were also higher, driven by our Oil and Gas, Pulp and Paper, and Metals and Minerals businesses, while revenues in our Marine business were lower as a result of lower backlog to execute. The geographic distribution of revenues for our Process Automation division was as follows: (in %) Europe The Americas Asia Middle East and Africa Total 2012 2011 2010 37 23 30 10 39 22 27 12 39 19 27 15 100 100 100 In 2012, revenue growth was led by Asia and the Americas. In Asia, strong growth was recorded in South Korea, driven by the Marine business, as well as growth in Singapore and Australia. China and India however declined. In the Americas, revenue growth was driven by the mining sector in Chile, as well as the oil and gas sector in Canada. Europe’s share of revenues decreased, although still at high levels, as growth in the Oil and Gas, and Marine businesses in Northern Europe was offset by lower growth in Central Europe. In 2011, revenues increased across all regions, with the exception of MEA. Revenue growth was strongest in the Americas driven by the U.S., Canada and Brazil. Europe remained at a high level, while in Asia high growth in several economies was partly offset by lower revenues in South Korea, due to the lower opening order backlog to execute. MEA declined as revenues in Congo and Algeria were lower than in the prior year. Operational EBITDA In 2012, Operational EBITDA and operational EBITDA margin declined slightly. The biggest driver of the decline was lower profitability in the Turbocharging business which was impacted by difficult market conditions. In the systems busi- ness, the margin was on the same level as in 2011, while in the services business, life-cycle services continued to be strong and improved their margin. partly due to operational improvements in our products business, particularly Measurement Products, as well as a favorable currency impact compared to the previous year. Restructuring expenses were also lower. Fiscal year 2013 outlook We expect 2013 to be a challenging year. Activity is still quite strong in the key Oil and Gas, Mining and Marine busi- nesses, however some investment decisions and tender awards are being delayed by customers. The Pulp and Paper, and Metals businesses continue to be weak, especially in Europe, China and India. Some of our short-cycle product businesses are experiencing lower volumes in recent quarters which can potentially indicate further weakening in market demand. Corporate and Other EBIT for Corporate and Other was as follows: ($ in millions) Corporate headquarters and stewardship Corporate research and development Corporate real estate Equity investments Other Total Corporate and Other 2012 2011 2010 (323) (331) (284) (192) (202) 50 – (49) (514) 56 – (41) (120) 48 (11) (23) (518) (390) In 2012, corporate headquarters and stewardship costs decreased $8 million, mainly resulting from the release of compliance-related provisions, partially offset by a provision for certain pension claims in the U.S. In 2011, Corporate headquarters and stewardship costs increased driven by charges related to the deconsolidation of a Russian subsid- iary and the sale of another subsidiary in Russia, certain expenses in the countries and higher spending to strengthen corporate functional areas as business volumes increased. Corporate research and development costs decreased In 2011, Operational EBITDA was higher compared to 2010, as a result of higher revenues, while Operational EBITDA margin remained flat. The margin was stronger in products, led by Measurement Products, and life-cycle services, while it was slightly lower in our systems business. $10 million in 2012, as the amount spent on the special growth fund was lower in 2012 than in 2011, when corporate research and development costs increased $82 million mainly due to the establishment of the growth fund to finance the acceleration of the research and development programs. Corporate real estate consists primarily of rental income EBIT In 2012, EBIT and EBIT margin declined compared to the previous year. The biggest driver for the decline was lower profitability in the Turbocharging business which was impacted by tough market conditions, as well as additional restructur- ing expenses to further align our business structure to pre- vailing market conditions. Most of the restructuring expenses were recorded in the Turbocharging and Full Service busi- nesses, as well as Metals, and Pulp and Paper businesses. and gains from the sale of real estate properties. In 2012, Corporate real estate reported $50 million EBIT including gains of $26 million from the sales of real estate properties mainly in Switzerland, Austria, Sweden and the Netherlands. In 2011, the Corporate real estate result included $37 million gains from the sale of real estate properties mainly in Venezuela, Sweden, Brazil and Switzerland. In 2010, Corporate real estate reported gains of $33 million from the sale of land and buildings, mainly in Sweden, Norway, Austria and Venezuela. In 2012, EBIT from “Other” was primarily related to charges from the impairments of investments in technology ventures, the closure of business lines in certain countries and operational costs of our Global Treasury Operations. In 70 Financial review | ABB Annual Report 2012 2011, EBIT from “Other” consists mainly of operational costs of our Global Treasury Operations, losses from the non-core distributed energy business in the U.K. and an impairment of our investment in the shares of a listed company. EBIT from “Other”, in 2010, included operational costs of our Global Treasury Operations and losses from our distributed energy business in the U.K. Restructuring Cost savings initiative Construction in progress for property, plant and equip- ment at December 31, 2012, was $627 million, mainly in Sweden, the United States, Switzerland, Germany and Brazil. Construction in progress for property, plant and equipment at December 31, 2011, was $548 million, mainly in Sweden, Switzerland, the United States, Brazil and China. Construction in progress for property, plant and equipment at December 31, 2010, was $447 million, mainly in Switzerland, Sweden, Germany, the United States, China and Poland. In 2013, we plan to decrease our capital expenditures but estimate the amount will be higher than our annual depre- ciation and amortization charge. We anticipate investments will be higher in the Americas and Asia but will decrease in Europe. In 2012, we continued cost saving measures to sustainably reduce ABB’s costs and protect our profitability. Costs asso- ciated with these measures amounted to $180 million and $164 million in 2012 and 2011, respectively. For further details of these cost saving measures and our cost take-out program (which was substantially completed in 2010) see “Note 22 Restructuring and related expenses” to our Consolidated Financial Statements. In both 2012 and 2011, estimated cost savings initiatives Liquidity and capital resources Principal sources of funding amounted to around $1.1 billion. These savings were achieved by optimizing global sourcing (excluding changes in com- modity prices), through reductions to general and administra- tive expenses, as well as adjustments to our global manu- facturing and engineering footprint. In 2012, 2011 and 2010, we met our liquidity needs principally using cash from operations, proceeds from the issuance of debt instruments (bonds and commercial paper), short-term bank borrowings and the proceeds from sales of marketable securities. Capital expenditures Total capital expenditures for property, plant and equipment and intangible assets (excluding intangibles acquired through business combinations) amounted to $1,293 million, $1,021 million and $840 million in 2012, 2011 and 2010, respectively. In 2012, 2011 and 2010, capital expenditures exceeded total depreciation and amortization expenses for the respective year. Capital expenditures in 2012 remained at a significant level in mature markets, reflecting the geographic distribution of our existing production facilities. Capital expenditures in Europe and North America in 2012 were driven primarily by upgrades and maintenance of existing production facilities, mainly in the United States, Sweden, Switzerland and Germany, as well as by new facilities, principally in Sweden, the United States and Switzerland. Capital expenditures in emerging markets increased in 2012 from 2011, with expenditures high- est in China, Brazil, India and Poland, mainly for new facili- ties. Capital expenditures in emerging markets were mostly made to expand or build new facilities to increase the pro- duction capacity. The share of emerging markets capital ex- penditures as a percentage of total capital expenditures in 2012 and 2011 was 31 percent and 34 percent, respectively. In 2010, capital expenditures in Europe were primarily driven by maintenance and upgrades of existing production facilities to improve productivity, mainly in Switzerland, Sweden and Germany. During 2012, 2011 and 2010, our financial position was strengthened by the positive cash flow from operating activities of $3,779 million, $3,612 million and $4,197 million, respectively. Our net (debt) cash is shown in the table below: December 31, ($ in millions) Cash and equivalents Marketable securities 2012 6,875 2011 4,819 and short-term investments 1,606 948 Short-term debt and current maturities of long-term debt Long-term debt Net (debt) cash (2,537) (7,534) (765) (3,231) (defined as the sum of the above lines) (1,590) 1,771 Despite the cash generated by operations during 2012 of $3,779 million, the net cash position at December 31, 2011, had become a net debt position at December 31, 2012, primarily due to the cash outflow for the acquisition of busi- nesses ($3,694 million), purchases of property, plant and equipment, including intangible assets, ($1,293 million) and the payment of dividends ($1,626 million) during 2012. See “Financial position”, “Net cash used in investing activities” and “Net cash used in financing activities” for further details. Our Group Treasury Operations is responsible for pro- viding a range of treasury management services to our group companies, including investing cash in excess of current business requirements. At December 31, 2012 and 2011, the proportion of our aggregate “Cash and equivalents” and “Marketable securities and short-term investments” managed by our Group Treasury Operations amounted to approxi- mately 65 percent and 60 percent, respectively. ABB Annual Report 2012 | Financial review 71 Throughout 2012 and 2011, the investment strategy for cash (in excess of current business requirements) has been to predominantly invest in short-term time deposits with maturities of less than 3 months, supplemented at times by investments in corporate commercial paper, AAA-rated money market liquidity funds and U.S. government securities. Since late summer 2011, as credit risk concerns in the euro- zone economic area increased, we diversified out of eurozone bank exposures. As the crisis deepened and uncertainty grew, we restricted the counterparties with whom we were prepared to place cash, such that we reduced our deposits with banks in the eurozone. During 2012, these restrictions have continued. We actively monitor credit risk in our invest- ment portfolio and hedging activities. Credit risk exposures are controlled in accordance with policies approved by our senior management to identify, measure, monitor and control credit risks. We closely monitor developments in the credit markets and make appropriate changes to our investment policy as deemed necessary. The rating criteria we require for our counterparts have remained unchanged during 2012 (compared to 2011) as follows – a minimum rating of A/A2 for our banking counterparts, while the minimum required rat- ing for investments in short-term corporate paper is A-1/P-1. In addition to rating criteria, we have specific investment parameters and approved instruments as well as restricting the types of investments we make. These parameters are closely monitored on an ongoing basis and amended as we consider necessary. We believe the cash flows generated from our business, supplemented, when necessary, through access to the capital markets (including short-term commercial paper) and our credit facilities are sufficient to support business opera- tions, capital expenditures, business acquisitions, the payment of dividends to shareholders and contributions to pension plans. Due to the nature of our operations, our cash flow from operations generally tends to be weaker in the first half of the year than in the second half of the year. Consequently, we believe that our ability to obtain funding from these sources will continue to provide the cash flows necessary to satisfy our working capital and capital expenditure requirements, as well as meet our debt repayments and other financial commit- ments for the next 12 months. See “Disclosures about con- tractual obligations and commitments”. The increase in short-term debt in 2012 was primarily due to the reclassification to short-term debt of our EUR 700 million 4.625% Instruments due 2013 and the increase in issued commercial paper ($1,019 million at December 31, 2012, com- pared to $435 million outstanding at December 31, 2011). The increase in long-term debt in 2012 was primarily due to the new bonds issued during 2012 and bonds assumed in the Thomas & Betts acquisition (see “Note 12 Debt” to our Consolidated Financial Statements). Our debt has been obtained in a range of currencies and maturities and on various interest rate terms. We use derivatives to reduce the interest rate exposures arising on certain of our debt. For example, we use interest rate swaps to effectively convert fixed rate debt into floating rate lia bilities. After con- sidering the effects of interest rate swaps, the effective average interest rate on our floating rate long-term debt (including current maturities) of $2,353 million and our fixed rate long- term debt (including current maturities) of $6,187 million was 1.6 percent and 3.1 percent, respectively. This compares with an effective rate of 1.6 percent for floating rate long-term debt of $1,875 million and 3.7 percent for fixed-rate long- term debt of $1,432 million at December 31, 2011. For a discussion of our use of derivatives to modify the interest characteristics of certain of our individual bond issuances, see “Note 12 Debt” to our Consolidated Financial Statements. Credit facility We have a $2 billion multicurrency revolving credit facility, maturing in 2015. No amount was drawn under the credit fa- cility at December 31, 2012 and 2011. The facility is for gen- eral corporate purposes and serves as a back-stop facility to our commercial paper programs to the extent that we issue commercial paper under the programs described below. The facility contains cross-default clauses whereby an event of default would occur if we were to default on indebtedness, as defined in the facility, at or above a specified threshold. The credit facility does not contain significant covenants that would restrict our ability to pay dividends or raise ad- ditional funds in the capital markets. For further details of the credit facility, see “Note 12 Debt” to our Consolidated Finan- cial Statements. Debt and interest rates Total outstanding debt was as follows: Commercial paper December 31, ($ in millions) 2012 2011 Short-term debt including current maturities of long-term debt (including bonds) 2,537 765 Long-term debt: We have in place three commercial paper programs: – a $2 billion commercial paper program for the private placement of USD-denominated commercial paper in the United States (replacing the $1 billion program that existed at December 31, 2011), – bonds (excluding portion due within – a $1 billion Euro-commercial paper program for the one year) – other long-term debt Total debt 7,380 154 10,071 3,059 172 issuance of commercial paper in a variety of currencies, and 3,996 – a 5 billion Swedish krona program (equivalent to approxi- mately $768 million, using December 31, 2012, exchange rates), allowing us to issue short-term commercial paper in either Swedish krona or euro. 72 Financial review | ABB Annual Report 2012 At December 31, 2012, $1,019 million was outstanding under the $2 billion program in the United States, compared to $435 million outstanding under the $1 billion program at De- cember 31, 2011. No amounts were outstanding under either the $1 billion Euro-commercial paper program or the 5 billion Swedish krona program at either December 31, 2012 or 2011. European program for the issuance of debt At December 31, 2012 and 2011, $2,579 million and $910 mil- lion, respectively, of our total debt outstanding, represented debt issuances under this program that allows the issuance of up to (the equivalent of) $8 billion in certain debt instruments. The terms of the program do not obligate any third party to extend credit to us and the terms and possibility of issuing any debt under the program are determined with respect to, and as of the date of issuance of, each debt instrument. Australian program for the issuance of debt During 2012, we set up a program for the issuance of up to AUD 1 billion (equivalent to approximately $1,038 million, using December 31, 2012 exchange rates) of medium-term notes and other debt instruments. The terms of the program do not obligate any third party to extend credit to us and the terms and possibility of issuing any debt under the pro - gram are determined with respect to, and as of the date of issuance of, each debt instrument. At December 31, 2012, $413 million of our total debt represented a debt issuance under this program. Credit ratings Credit ratings are assessments by the rating agencies of the credit risk associated with ABB and are based on information provided by us or other sources that the rating agencies consider reliable. Higher ratings generally result in lower bor- rowing costs and increased access to capital markets. Our ratings are of “investment grade” which is defined as Baa3 (or above) from Moody’s and BBB− (or above) from Standard & Poor’s. At December 31, 2012 and 2011, our long-term company ratings were A2 and A from Moody’s and Standard & Poor’s, respectively. Limitations on transfers of funds Currency and other local regulatory limitations related to the transfer of funds exist in a number of countries where we operate, including Algeria, China, Egypt, India, Korea, Kuwait, Malaysia, Russia, South Africa, Taiwan, Thailand, Turkey and Venezuela. Funds, other than regular dividends, fees or loan repayments, cannot be readily transferred offshore from these countries and are therefore deposited and used for working capital needs locally. In addition, there are certain countries where, for tax reasons, it is not considered optimal to transfer the cash offshore. As a consequence, these funds are not available within our Group Treasury Operations to meet short-term cash obligations outside the relevant country. The above described funds are reported as cash in our Consolidated Balance Sheets, but we do not consider these funds immediately available for the repayment of debt outside the respective countries where the cash is situated, including those described above. At December 31, 2012 and 2011, the balance of “Cash and equivalents” and “Marketable secu- rities and other short-term investments” under such limita- tions (either regulatory or sub-optimal from a tax perspective) totaled approximately $1,905 million and $1,530 million, respectively. During 2012, we continued to direct our subsidiaries in countries with restrictions to place such cash with our core banks or investment grade banks, in order to minimize credit risk on such cash positions. We continue to closely monitor the situation to ensure bank counterparty risks are minimized. Financial position Balance sheets Current assets December 31, ($ in millions) Cash and equivalents Marketable securities and short-term investments Receivables, net Inventories, net Prepaid expenses Deferred taxes Other current assets Total current assets 2012 6,875 1,606 11,575 6,182 311 869 584 2011 4,819 948 10,773 5,737 227 932 351 28,002 23,787 For a discussion on cash and equivalents and marketable securities and short-term investments, see “Liquidity and capital resources – Principal sources of funding” for further details. Receivables increased 7.4 percent (6.2 percent in local currencies) compared to 2011, primarily due to Thomas & Betts, and an increase in trade receivables due to certain de- layed customer payments. Inventories increased 7.8 percent (5.0 percent in local currencies) compared to 2011, driven by an increasing order backlog and Thomas & Betts. Prepaid expenses increased $84 million compared to the prior year also due to Thomas & Betts and prepayments for projects in South America and Northern Europe. For a discussion of deferred taxes see “Note 16 Taxes” to our Consolidated Financial Statements. The increase in other current assets primarily reflects higher income tax receivables. ABB Annual Report 2012 | Financial review 73 Property, plant and equipment increased 20.8 percent (17.6 percent in local currencies), primarily due to Thomas & Betts, and increased investment across all divisions and most regions. The investments in new manufacturing facilities and upgrades to existing facilities helps to secure our tech- nological competitiveness in the growth markets we serve and increases our capacity to meet our customers’ delivery re- quirements. The increase in goodwill and other intangible assets was mainly due to Thomas & Betts (see “Note 11 Goodwill and other intangible assets” to our Consolidated Financial State- ments). The decrease in prepaid pension and other employee benefits reflects the change in the funded status of our overfunded pension plans (see “Note 17 Employee benefits” to our Consolidated Financial Statements). Noncurrent liabilities December 31, ($ in millions) Long-term debt Pension and other employee benefits Deferred taxes Other non-current liabilities Total noncurrent liabilities 2012 7,534 2,290 1,260 1,566 12,650 2011 3,231 1,487 537 1,496 6,751 The increase in our long-term debt was largely due to new bond issuances. See “Liquidity and capital resources – Debt and interest rates” for further explanation of the increase in our long-term debt. The increase in pension and other employee benefits was due to increases in the underfunded status of our defined benefit pension plans, mainly as a result of changes in actuarial assumptions affecting estimated projected benefit obliga- tions (see “Note 17 Employee benefits” to our Consolidated Financial Statements). The increase in deferred taxes was mostly related to Thomas & Betts (see “Note 3 Acquisitions and increases in controlling interests”). For further explana- tion regarding deferred taxes, refer to “Note 16 Taxes” to our Consolidated Financial Statements. Current liabilities December 31, ($ in millions) Accounts payable, trade Billings in excess of sales Employee and other payables Short-term debt and current maturities of long-term debt Advances from customers Deferred taxes Provisions for warranties Provisions and other current liabilities Accrued expenses Total current liabilities 2012 4,992 2,035 1,449 2,537 1,937 270 1,291 2,367 2,096 2011 4,789 1,819 1,361 765 1,757 305 1,324 2,619 1,822 18,974 16,561 Total current liabilities at December 31, 2012, increased primarily due to bonds maturing in June 2013 which were reclassified to short-term debt, as well as an increase in commercial paper outstanding. Accounts payable increased 4.2 percent (1.8 percent in local currencies) compared to 2011, mainly due to Thomas & Betts. Billings in excess of sales increased 11.9 percent (8.5 percent in local currencies) compared to 2011 due to the timing of billings and collections for contracts under the percentage-of-completion or completed-contract method of accounting. Employee and other payables increased 6.5 per- cent (4.4 percent in local currencies) on increases in em- ployee-related liabilities such as payroll, vacation, bonus, as well as on increases in value-added tax (VAT), sales and simi- lar taxes. Advances from customers increased 10.2 percent (10.3 percent in local currencies) compared to the prior year, with the largest increases in the Power Systems division. Provisions for warranties decreased 2.5 percent (4.8 percent in local currencies) compared to 2011, primarily due to re- vised risk assessments and the completion of various projects. Provisions and other current liabilities decreased 9.6 percent (11.9 percent in local currencies) primarily driven by a de- crease in the market value of derivative liabilities, as well as due to a reduction in certain compliance provisions. Accrued expenses increased 15.0 percent (12.3 percent in local cur- rencies) primarily due to Thomas & Betts, higher accrued interest as a result of bonds issued in 2012 and increases in certain employee-related accruals. Noncurrent assets December 31, ($ in millions) Property, plant and equipment, net Goodwill Other intangible assets, net Prepaid pension and other employee benefits Investments in equity-accounted companies Deferred taxes Other non-current assets Total noncurrent assets 2012 5,947 10,226 3,501 71 213 334 776 2011 4,922 7,269 2,253 139 156 318 804 21,068 15,861 74 Financial review | ABB Annual Report 2012 Cash flows Net cash used in investing activities In the Consolidated Statements of Cash Flows, the effects of discontinued operations are not segregated. ($ in millions) 2012 2011 2010 Purchases of marketable securities (available-for-sale) (2,288) (2,809) (3,391) The Consolidated Statements of Cash Flows can be Purchases of marketable securities summarized as follows: ($ in millions) Net cash provided by operating activities Net cash used in investing activities (held-to-maturity) Purchases of short-term – – (65) 2012 2011 2010 investments (67) (142) (2,165) Purchases of property, plant and 3,779 3,612 4,197 equipment and intangible assets (1,293) (1,021) (840) (5,575) (3,253) (2,747) of cash acquired) and changes in Acquisition of businesses (net Net cash provided by (used in) cost and equity investments (3,694) (4,020) (1,313) financing activities 3,762 (1,208) (2,530) Proceeds from sales of marketable Effects of exchange rate changes securities (available-for-sale) 1,655 3,717 on cash and equivalents 90 (229) (142) Proceeds from maturity of market- Net change in cash and equiva able securities (available-for-sale) lents – continuing operations 2,056 (1,078) (1,222) Proceeds from maturity of market- Net cash provided by operating activities able securities (held-to-maturity) Proceeds from short-term investments Other investing activities – – 27 85 483 – 529 10 807 531 290 3,276 123 2010 Net cash used in investing 2,732 activities (5,575) (3,253) (2,747) ($ in millions) Net income Depreciation and amortization Total adjustments to reconcile net income to net cash provided by operating activities (excluding 2012 2,812 1,182 2011 3,315 995 depreciation and amortization) 196 (23) Total changes in operating assets and liabilities (411) (675) Net cash provided by operating 702 164 599 activities 3,779 3,612 4,197 Operating activities in 2012 provided net cash of $3,779 mil- lion, an increase from 2011 of 4.6 percent. The increase was primarily driven by a lower increase in working capital re- quirements offset by the cash impacts of lower net income. Net cash provided by operating activities in 2011 of $3,612 million declined by 13.9 percent from the prior year. This decline was driven by higher trade receivables and inventories in line with the 20 percent increase in revenues. The decrease can be further attributed to a lower increase in trade payables than in the prior year. Provisions were also lower due to payments related to environmental remediation liabilities in the United States and restructuring-related payments. In 2010, operating activities provided net cash of $4,197 million, reflecting our working capital management. Stable levels of working capital were achieved despite in- creasing order volumes, as cash outlays for higher inventories and trade receivables could be offset through increased levels of trade payables. Net cash used in investing activities in 2012 increased com- pared to 2011 due to the sustained high level of cash outflow for the acquisition of businesses, primarily Thomas & Betts. In addition, there were net cash outflows from marketable se- curities and short-term investments of $673 million compared to net inflows in the prior year of $1,778 million as acquisi- tions in 2012 were primarily financed through new corporate bonds issued, whereas in 2011, acquisitions were funded mainly by our excess liquidity. Capital expenditures for new plant, property and equipment were also higher in 2012, to support business growth. Total cash disbursements for the purchase of property, plant and equipment and intangibles in 2012 of $1,293 million included $885 million for construction in progress, $248 mil- lion for the purchase of machinery and equipment, $83 million for the purchase of land and buildings, and $77 million for the purchase of intangible assets. The net cash inflow from marketable securities and short- term investments in 2011 reflected the use of our excess liquidity in funding primarily the acquisition of businesses. Total cash disbursements for the purchase of property, plant and equipment and intangibles in 2011, included $268 million for the purchase of machinery and equipment, $128 million for the purchase of land and buildings, $57 mil- lion for the purchase of intangible assets and $568 million for construction in progress. Acquisition of businesses (net of cash acquired) and changes in cost and equity investments in 2011, primarily related to the acquisition of Baldor, Mincom, Trasfor and Lorentzen & Wettre Group and other smaller acquisitions. Net cash used in investing activities during 2010 was $2,747 million. Aggregate purchases of marketable securities and short-term investments amounted to $5,621 million in 2010. Aggregate proceeds from the sales and maturities of marketable securities and short-term investments during 2010 amounted to $4,904 million. ABB Annual Report 2012 | Financial review 75 During 2012, $1,104 million of debt was repaid, mainly reflecting the repayment of part of the debt assumed from the acquisition of Thomas & Betts (approximately $320 million) and of other debt (primarily short-term bank borrowings). Dur- ing 2011, $2,576 million of bonds and other debt was repaid, primarily reflecting the repayment of $1.2 billion in debt assumed upon the acquisition of Baldor in January 2011 and the repayment at maturity of 650 million euro of 6.5% EUR Instruments, due 2011, (equivalent to $865 million at date of repayment). During 2010, $497 million of debt was repaid at maturity. During 2010, we purchased, on the open market, 12.1 mil- lion of our own shares for use in connection with our em- ployee share-based programs, resulting in a cash outflow of $228 million. During 2012 and 2011, there were no purchases or sales of treasury stock on the open market. The acquisition of noncontrolling interests in 2010 of $956 million represented the cost of increasing our ownership interest in ABB Limited, India (our publicly-listed subsidiary in India) from approximately 52 percent to 75 percent. Disclosures about contractual obligations and commitments The contractual obligations presented in the table below represent our estimates of future payments under fixed con- tractual obligations and commitments. The amounts in the table may differ from those reported in our Consolidated Balance Sheet at December 31, 2012. Changes in our busi- ness needs, cancellation provisions and changes in interest rates, as well as actions by third parties and other factors, may cause these estimates to change. Therefore, our actual payments in future periods may vary from those presented in the table. The following table summarizes certain of our contractual obligations and principal and interest payments under our debt instruments, leases and purchase obligations at December 31, 2012: Less than 1–3 3–5 More than Payments due by period Total 1 year years years 5 years ($ in millions) Long-term debt obligations 8,529 998 52 2,099 5,380 Interest payments related to long-term debt obligations Operating lease obligations Capital lease obligations(1) 2,389 2,139 188 269 527 31 Purchase obligations 6,029 4,751 446 799 52 986 407 518 23 252 1,267 295 82 40 Total 19,274 6,576 2,335 3,299 7,064 (1) Capital lease obligations represent the total cash payments to be made in the future and include interest expense of $83 million and executory cost of $2 million. Total cash disbursements for the purchase of property, plant and equipment and intangibles in 2010 amounted to $840 million, including $164 million for the purchase of machinery and equipment, $175 million for the purchase of land and buildings, $54 million for the purchase of intangi- ble assets and $447 million capital expenditures for construc- tion in progress. Acquisition of businesses (net of cash acquired), in 2010, primarily related to the acquisition of Ventyx and certain smaller acquisitions such as K-TEK in the United States and Jokab Safety in Sweden. Net cash provided by (used in) financing activities ($ in millions) 2012 2011 2010 Net changes in debt with maturities of 90 days or less Increase in debt Repayment of debt Purchase of shares Delivery of shares Dividends paid Dividends paid in the form of nominal value reduction Acquisition of noncontrolling interests Dividends paid to noncontrolling shareholders Other financing activities Net cash provided by (used in) 570 5,986 (1,104) – 90 450 2,580 (2,576) – 110 (1,626) (1,569) 52 277 (497) (228) 78 – – (9) (121) (24) – (1,112) (13) (956) (157) (33) (193) 49 financing activities 3,762 (1,208) (2,530) Our financing activities primarily include debt transactions (both from the issuance of debt securities and borrowings directly from banks), share transactions, and dividends paid. The 2012 and 2011 net cash inflow from changes in debt with maturities of 90 days or less, primarily reflects the net issuance of commercial paper under our commercial paper program in the United States. During the third quarter of 2012, the program was increased to $2 billion, replacing the pre vious $1 billion program. In 2012, the cash inflows from increases in debt primarily related to the issuance of the following bonds: EUR 1,250 million aggregate principal, 2.625 percent, due 2019; $1,250 million aggregate principal, 2.875 percent, due 2022; $750 million aggregate principal, 4.375 percent, due 2042; $500 million aggregate principal, 1.625 percent, due 2017; AUD 400 million aggregate principal, 4.25 percent, due 2017; and CHF 350 million aggregate principal, 1.50 per- cent, due 2018. In 2011, the cash inflows from increases in debt principally related to the issuance of the following bonds: $600 million aggregate principal, 2.5 percent, due 2016; $650 million aggregate principal, 4.0 percent, due 2021; CHF 500 million aggregate principal, 1.25 percent, due 2016; and CHF 350 million aggregate principal, 2.25 percent, due 2021. In 2010, the increase in debt primarily related to short-term borrowings. 76 Financial review | ABB Annual Report 2012 In the table above, the long-term debt obligations reflect the cash amounts to be repaid upon maturity of those debt obli- gations. As we have designated interest rate swaps as fair value hedges of certain debt obligations, the cash obligations above will differ from the long-term debt balance reflected in “Note 12 Debt” to our Consolidated Financial Statements. We have determined the interest payments related to long-term debt obligations by reference to the payments due under the terms of our debt obligations at the time such obligations were incurred. However, we use interest rate swaps to modify the interest characteristics of certain of our debt obligations. The net effect of these swaps may be to increase or decrease the actual amount of our cash interest payment obligations, which may differ from those stated in the above table. For further details on our debt obligations and the related hedges, see “Note 12 Debt” to our Consoli- dated Financial Statements. Of the total of $774 million unrecognized tax benefits (net of deferred tax assets) at December 31, 2012, it is expected that $41 million will be paid within less than a year. However, we cannot make a reasonably reliable estimate as to the related future payments for the remaining amount. The carrying amounts of liabilities recorded in the Consoli- dated Balance Sheets in respect of the above guarantees were not significant at December 31, 2012 and 2011, and reflect our best estimate of future payments, which we may incur as part of fulfilling our guarantee obligations. For additional descriptions of our performance, financial and indemnification guarantees see “Note 15 Commitments and contingencies” to our Consolidated Financial Statements. Related party transactions Affiliates and associates In the normal course of our business, we purchase products from, sell products to and engage in other transactions with entities in which we hold an equity interest. The amounts involved in these transactions are not material to ABB Ltd. Also, in the normal course of our business, we engage in transactions with businesses that we have divested. We be- lieve that the terms of the transactions we conduct with these companies are negotiated on an arm’s length basis. Key management personnel Details of important business relationships between ABB and its Board and Executive Committee members, or companies and organizations represented by them, are described in section “7. Business relationships” of the Corporate gover- nance report contained in this Annual Report. Off balance sheet arrangements Commercial commitments We disclose the maximum potential exposure of certain guarantees, as well as possible recourse provisions that may allow us to recover from third parties amounts paid out un- der such guarantees. The maximum potential exposure does not allow any discounting of our assessment of actual expo- sure under the guarantees. The information below reflects our maximum potential exposure under the guarantees, which is higher than our assessment of the expected exposure. Guarantees The following table provides quantitative data regarding our third-party guarantees. The maximum potential payments represent a worst-case scenario, and do not reflect our expected results. December 31, ($ in millions) Performance guarantees Financial guarantees Indemnification guarantees Total Maximum potential payments 2012 2011 149 83 190 422 148 85 194 427 ABB Annual Report 2012 | Financial review 77 Consolidated Financial Statements 2012 2011 32,979 31,875 6,357 6,115 39,336 37,990 (23,838) (22,649) (4,120) (3,907) 2010 26,291 5,298 31,589 (18,607) (3,453) (27,958) (26,556) (22,060) 11,378 (5,756) (1,464) (100) 4,058 73 (293) 3,838 (1,030) 2,808 4 2,812 (108) 2,704 11,434 (5,373) (1,371) (23) 4,667 90 (207) 4,550 (1,244) 3,306 9 3,315 (147) 3,168 9,529 (4,615) (1,082) (14) 3,818 95 (173) 3,740 (1,018) 2,722 10 2,732 (171) 2,561 2,700 2,704 3,159 3,168 2,551 2,561 1.18 1.18 1.18 1.18 1.38 1.38 1.38 1.38 1.12 1.12 1.11 1.12 2,293 2,295 2,288 2,291 2,287 2,291 Consolidated Income Statements Year ended December 31 ($ in millions, except per share data in $) Sales of products Sales of services Total revenues Cost of products Cost of services Total cost of sales Gross profit Selling, general and administrative expenses Non-order related research and development expenses Other income (expense), net Earnings before interest and taxes Interest and dividend income Interest and other finance expense Income from continuing operations before taxes Provision for taxes Income from continuing operations, net of tax Income from discontinued operations, net of tax Net income Net income attributable to noncontrolling interests Net income attributable to ABB Amounts attributable to ABB shareholders: Income from continuing operations, net of tax Net income Basic earnings per share attributable to ABB shareholders: Income from continuing operations, net of tax Net income Diluted earnings per share attributable to ABB shareholders: Income from continuing operations, net of tax Net income Weighted-average number of shares outstanding (in millions) used to compute: Basic earnings per share attributable to ABB shareholders Diluted earnings per share attributable to ABB shareholders See accompanying Notes to the Consolidated Financial Statements 78 Financial review | ABB Annual Report 2012 Consolidated Statements of Comprehensive Income Year ended December 31 ($ in millions) Net income Other comprehensive income (loss), net of tax: Foreign currency translation adjustments Available-for-sale securities: Net unrealized gains (losses) arising during the year Reclassification adjustments for net (gains) losses included in net income Unrealized gains (losses) on available-for-sale securities Pension and other postretirement plans: Prior service costs arising during the year Net actuarial gains (losses) arising during the year Amortization of prior service costs included in net income Amortization of net actuarial losses included in net income Amortization of transition liability included in net income Pension and other postretirement plan adjustments Cash flow hedge derivatives: Net unrealized gains (losses) arising during the year Reclassification adjustments for net (gains) losses included in net income Unrealized gains (losses) of cash flow hedge derivatives Total other comprehensive income (loss), net of tax Total comprehensive income, net of tax Comprehensive income attributable to noncontrolling interests, net of tax Total comprehensive income, net of tax, attributable to ABB See accompanying Notes to the Consolidated Financial Statements 2012 2,812 2011 3,315 2010 2,732 383 (275) 370 3 1 4 (36) (601) 30 70 — (3) 5 2 (23) (593) 22 44 1 (537) (549) 53 (28) 25 (125) 2,687 (98) 2,589 (19) (61) (80) (902) 2,413 (136) 2,277 13 (15) (2) (54) 124 12 62 1 145 91 (19) 72 585 3,317 (189) 3,128 ABB Annual Report 2012 | Financial review 79 Consolidated Balance Sheets December 31 ($ in millions, except share data) Cash and equivalents Marketable securities and short-term investments Receivables, net Inventories, net Prepaid expenses Deferred taxes Other current assets Total current assets Property, plant and equipment, net Goodwill Other intangible assets, net Prepaid pension and other employee benefits Investments in equity-accounted companies Deferred taxes Other non-current assets Total assets Accounts payable, trade Billings in excess of sales Employee and other payables Short-term debt and current maturities of long-term debt Advances from customers Deferred taxes Provisions for warranties Provisions and other current liabilities Accrued expenses Total current liabilities Long-term debt Pension and other employee benefits Deferred taxes Other non-current liabilities Total liabilities Commitments and contingencies Stockholders’ equity: Capital stock and additional paid-in capital (2,314,743,264 issued shares at December 31, 2012 and 2011) Retained earnings Accumulated other comprehensive loss Treasury stock, at cost (18,793,989 and 24,332,144 shares at December 31, 2012 and 2011, respectively) Total ABB stockholders’ equity Noncontrolling interests Total stockholders’ equity Total liabilities and stockholders’ equity See accompanying Notes to the Consolidated Financial Statements 80 Financial review | ABB Annual Report 2012 2012 6,875 1,606 11,575 6,182 311 869 584 2011 4,819 948 10,773 5,737 227 932 351 28,002 23,787 5,947 10,226 3,501 71 213 334 776 4,922 7,269 2,253 139 156 318 804 49,070 39,648 4,992 2,035 1,449 2,537 1,937 270 1,291 2,367 2,096 4,789 1,819 1,361 765 1,757 305 1,324 2,619 1,822 18,974 16,561 7,534 2,290 1,260 1,566 3,231 1,487 537 1,496 31,624 23,312 1,691 18,066 (2,523) (328) 1,621 16,988 (2,408) (424) 16,906 15,777 540 17,446 49,070 559 16,336 39,648 Consolidated Statements of Cash Flows Year ended December 31 ($ in millions) Operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Pension and other employee benefits Deferred taxes Net gain from sale of property, plant and equipment Loss (income) from equity-accounted companies Other Changes in operating assets and liabilities: Trade receivables, net Inventories, net Trade payables Billings in excess of sales Provisions, net Advances from customers Other assets and liabilities, net Net cash provided by operating activities Investing activities: Purchases of marketable securities (available-for-sale) Purchases of marketable securities (held-to-maturity) Purchases of short-term investments Purchases of property, plant and equipment and intangible assets Acquisition of businesses (net of cash acquired) and changes in cost and equity investments Proceeds from sales of marketable securities (available-for-sale) Proceeds from maturity of marketable securities (available-for-sale) Proceeds from maturity of marketable securities (held-to-maturity) Proceeds from short-term investments Other investing activities Net cash used in investing activities Financing activities: Net changes in debt with maturities of 90 days or less Increase in debt Repayment of debt Purchase of shares Delivery of shares Dividends paid Dividends paid in the form of nominal value reduction Acquisition of noncontrolling interests Dividends paid to noncontrolling shareholders Other financing activities Net cash provided by (used in) financing activities Effects of exchange rate changes on cash and equivalents Net change in cash and equivalents – continuing operations Cash and equivalents, beginning of period Cash and equivalents, end of period Supplementary disclosure of cash flow information: Interest paid Taxes paid See accompanying Notes to the Consolidated Financial Statements 2012 2011 2010 2,812 3,315 2,732 1,182 (13) 64 (26) (1) 172 (310) 61 (57) 152 (109) 181 (329) 3,779 995 (49) (34) (47) (4) 111 (731) (600) 213 150 (391) 47 637 702 (51) 151 (39) (3) 106 (407) (264) 678 89 (69) (25) 597 3,612 4,197 (2,288) (2,809) (3,391) – (67) (1,293) (3,694) 1,655 – – 27 85 – (142) (1,021) (4,020) 3,717 483 – 529 10 (65) (2,165) (840) (1,313) 807 531 290 3,276 123 (5,575) (3,253) (2,747) 570 5,986 (1,104) – 90 450 2,580 (2,576) – 110 (1,626) (1,569) – (9) (121) (24) – (13) (157) (33) 52 277 (497) (228) 78 – (1,112) (956) (193) 49 3,762 (1,208) (2,530) 90 2,056 4,819 6,875 (229) (142) (1,078) (1,222) 5,897 4,819 7,119 5,897 189 1,211 165 1,305 94 884 ABB Annual Report 2012 | Financial review 81 Consolidated Statements of Changes in Stockholders’ Equity Years ended December 31, 2012, 2011 and 2010 ($ in millions) Balance at January 1, 2010 Comprehensive income: Net income Foreign currency translation adjustments Effect of change in fair value of available-for-sale securities, net of tax Unrecognized income (expense) related to pensions and other postretirement plans, net of tax Change in derivatives qualifying as cash flow hedges, net of tax Total comprehensive income Changes in noncontrolling interests Dividends paid to noncontrolling shareholders Dividends paid in the form of nominal value reduction Cancellation of shares repurchased under buyback program Purchase of shares Share-based payment arrangements Delivery of shares Call options Balance at December 31, 2010 Comprehensive income: Net income Foreign currency translation adjustments Effect of change in fair value of available-for-sale securities, net of tax Unrecognized income (expense) related to pensions and other postretirement plans, net of tax Change in derivatives qualifying as cash flow hedges, net of tax Total comprehensive income Changes in noncontrolling interests Dividends paid to noncontrolling shareholders Dividends paid Share-based payment arrangements Delivery of shares Call options Replacement options issued in connection with acquisition Balance at December 31, 2011 Comprehensive income: Net income Foreign currency translation adjustments Effect of change in fair value of available-for-sale securities, net of tax Unrecognized income (expense) related to pensions and other postretirement plans, net of tax Change in derivatives qualifying as cash flow hedges, net of tax Total comprehensive income Changes in noncontrolling interests Dividends paid to noncontrolling shareholders Dividends paid Share-based payment arrangements Delivery of shares Call options Replacement options issued in connection with acquisition Other Balance at December 31, 2012 See accompanying Notes to the Consolidated Financial Statements 82 Financial review | ABB Annual Report 2012 Accumulated other comprehensive loss Foreign Unrealized gains Pension and Unrealized gains Total accu- currency (losses) on other post- (losses) of mulated other Total ABB Non- Total stock- translation available-for-sale retirement plan cash flow hedge compre- Treasury stockholders’ controlling holders’ adjustment securities adjustments derivatives hensive loss (1,056) 20 (1,068) 20 (2,084) stock (897) equity 13,790 interests 683 349 (2) 148 349 (2) 148 72 72 Capital stock and additional paid-in capital 3,943 Retained earnings 12,828 2,561 (836) (1,112) (619) 66 13 (1) 1,454 15,389 (707) 18 (920) 92 (1,517) (441) 14,885 3,168 (1,569) (3) 67 93 (9) 19 1,621 16,988 (968) 20 (1,472) 12 (2,408) (424) 15,777 2,704 (1,626) 60 (6) 10 5 1 1,691 18,066 (580) 24 (2,004) 37 (2,523) (328) 16,906 540 17,446 equity 14,473 2,732 370 (2) 145 72 3,317 (946) (189) (1,112) (228) — 66 78 (1) 15,458 3,315 (275) (549) (80) 2,413 2 4 (157) (1,569) 67 110 (9) 19 16,336 2,812 383 4 (537) 25 2,687 6 (123) (1,626) 60 90 10 5 1 171 21 (3) 189 (110) (189) 573 147 (14) 3 7 136 (157) 559 108 (5) (5) 98 6 (123) 2,561 349 (2) 148 72 3,128 (836) (1,112) (228) — — 66 78 (1) 3,168 (261) 2 (552) (80) 2,277 (3) — 67 110 (9) 19 (1,569) 2,704 388 4 (532) 25 2,589 (1,626) — — 60 90 10 5 1 619 (228) 65 17 96 (261) 388 2 4 (552) (80) (532) 25 (261) 2 (552) (80) 388 4 (532) 25 Years ended December 31, 2012, 2011 and 2010 ($ in millions) Balance at January 1, 2010 Comprehensive income: Net income Foreign currency translation adjustments Effect of change in fair value of available-for-sale securities, net of tax Unrecognized income (expense) related to pensions and other postretirement plans, net of tax Change in derivatives qualifying as cash flow hedges, net of tax Capital stock and additional paid-in capital 3,943 Retained earnings 12,828 2,561 Total comprehensive income Changes in noncontrolling interests Dividends paid to noncontrolling shareholders Dividends paid in the form of nominal value reduction Cancellation of shares repurchased under buyback program Purchase of shares Share-based payment arrangements Delivery of shares Call options Balance at December 31, 2010 Comprehensive income: Net income Total comprehensive income Changes in noncontrolling interests Dividends paid to noncontrolling shareholders Share-based payment arrangements Dividends paid Delivery of shares Call options Replacement options issued in connection with acquisition Balance at December 31, 2011 Comprehensive income: Net income Total comprehensive income Changes in noncontrolling interests Dividends paid to noncontrolling shareholders Share-based payment arrangements Dividends paid Delivery of shares Call options Replacement options issued in connection with acquisition Other Balance at December 31, 2012 See accompanying Notes to the Consolidated Financial Statements (836) (1,112) (619) 66 13 (1) (3) 67 93 (9) 19 60 (6) 10 5 1 3,168 (1,569) 2,704 (1,626) Accumulated other comprehensive loss Foreign Unrealized gains Pension and Unrealized gains Total accu- currency (losses) on other post- (losses) of mulated other Total ABB Non- Total stock- translation available-for-sale retirement plan cash flow hedge compre- Treasury stockholders’ controlling holders’ adjustment securities adjustments derivatives hensive loss (1,056) 20 (1,068) 20 (2,084) stock (897) equity 13,790 interests 683 349 (2) 148 349 (2) 148 72 72 2,561 349 (2) 148 72 3,128 (836) — (1,112) — (228) 66 78 (1) 619 (228) 65 1,454 15,389 (707) 18 (920) 92 (1,517) (441) 14,885 Foreign currency translation adjustments Effect of change in fair value of available-for-sale securities, net of tax Unrecognized income (expense) related to pensions and other postretirement plans, net of tax Change in derivatives qualifying as cash flow hedges, net of tax (261) 2 (552) (261) 2 (552) (80) (80) 3,168 (261) 2 (552) (80) 2,277 (3) — (1,569) 67 110 (9) 19 17 1,621 16,988 (968) 20 (1,472) 12 (2,408) (424) 15,777 Foreign currency translation adjustments Effect of change in fair value of available-for-sale securities, net of tax Unrecognized income (expense) related to pensions and other postretirement plans, net of tax Change in derivatives qualifying as cash flow hedges, net of tax 388 4 (532) 388 4 (532) 25 25 2,704 388 4 (532) 25 2,589 — — (1,626) 60 90 10 5 1 96 171 21 (3) 189 (110) (189) 573 147 (14) 3 136 7 (157) 559 108 (5) (5) 98 6 (123) equity 14,473 2,732 370 (2) 145 72 3,317 (946) (189) (1,112) — (228) 66 78 (1) 15,458 3,315 (275) 2 (549) (80) 2,413 4 (157) (1,569) 67 110 (9) 19 16,336 2,812 383 4 (537) 25 2,687 6 (123) (1,626) 60 90 10 5 1 1,691 18,066 (580) 24 (2,004) 37 (2,523) (328) 16,906 540 17,446 ABB Annual Report 2012 | Financial review 83 Notes to the Consolidated Financial Statements Note 1 The Company ABB Ltd and its subsidiaries (collectively, the Company) together form a leading global company in power and automation technologies that enable utility and industry customers to improve their performance while lowering environmental impact. The Company works with customers to engineer and install networks, facilities and plants with particular empha- sis on enhancing efficiency, reliability and productivity for customers who generate, convert, transmit, distribute and consume energy. The Company has a global integrated risk management process. Once a year, the board of directors of ABB Ltd performs a risk assessment in accordance with the Company’s risk management processes and discusses appropriate actions, if necessary. Note 2 Significant accounting policies The following is a summary of significant accounting policies followed in the preparation of these Consolidated Financial Statements. Basis of presentation Scope of consolidation Reclassifications Operating cycle Use of estimates The Consolidated Financial Statements are prepared in accordance with United States of America (United States or U.S.) generally accepted accounting principles (U.S. GAAP) and are presented in United States dollars ($ or USD) unless otherwise stated. The par value of capital stock is denominated in Swiss francs. The Consolidated Financial Statements include the accounts of ABB Ltd and companies which are directly or indirectly controlled by ABB Ltd. Additionally, the Company consolidates variable interest entities if it has determined that it is the primary beneficiary. Intercompany accounts and transactions are eliminated. Investments in joint ventures and affili- ated companies in which the Company has the ability to exercise significant influence over operating and financial policies (generally through direct or indirect ownership of 20 percent to 50 percent of the voting rights), are recorded in the Consolidated Financial Statements using the equity method of accounting. Certain amounts reported for prior years in the Consolidated Financial Statements and Notes have been reclassified to conform to the current year’s presentation. A portion of the Company’s activities (primarily long-term construction activities) has an operating cycle that exceeds one year. For classification of current assets and liabilities related to such activities, the Company elected to use the duration of the individual contracts as its operating cycle. Accordingly, there are accounts receivable, inventories and provisions related to these contracts which will not be realized within one year that have been classified as current. The preparation of financial statements in conformity with U.S. GAAP requires management to make assumptions and estimates that directly affect the amounts reported in the Consolidated Financial Statements and the accompanying Notes. The most significant, difficult and subjective of such accounting assumptions and estimates include: – assumptions and projections, principally related to future material, labor and project-related overhead costs, used in determining the percentage-of-completion on projects, – estimates of loss contingencies associated with litigation or threatened litigation and other claims and inquiries, environ- mental damages, product warranties, regulatory and other proceedings, – assumptions used in the calculation of pension and postretirement benefits and the fair value of pension plan assets, – recognition and measurement of current and deferred income tax assets and liabilities (including the measurement of uncertain tax positions), – growth rates, discount rates and other assumptions used in testing goodwill for impairment, – assumptions used in determining inventory obsolescence and net realizable value, – estimates and assumptions used in determining the fair values of assets and liabilities assumed in business combinations, – growth rates, discount rates and other assumptions used to determine impairment of long-lived assets, and – assessment of the allowance for doubtful accounts. The actual results and outcomes may differ from the Company’s estimates and assumptions. Cash and equivalents Cash and equivalents include highly liquid investments with maturities of three months or less at the date of acquisition. Marketable securities and short-term investments Currency and other local regulatory limitations related to the transfer of funds exist in a number of countries where the Company operates. Funds, other than regular dividends, fees or loan repayments, cannot be readily transferred abroad from these countries and are therefore deposited and used for working capital needs locally. These funds are included in cash and equivalents as they are not considered restricted. Management determines the appropriate classification of held-to-maturity and available-for-sale securities at the time of purchase. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for accretion of discounts or amortization of premiums to maturity computed under the effective interest method. Such accretion or amortization is included in “Interest and dividend income”. Marketable debt securities not classified as held-to-maturity and equity secu- rities that have readily determinable fair values are classified as available-for-sale and reported at fair value. 84 Financial review | ABB Annual Report 2012 Note 2 Significant accounting policies, continued Unrealized gains and losses on available-for-sale securities are excluded from the determination of earnings and are instead recognized in the “Accumulated other comprehensive loss” component of stockholders’ equity, net of tax, until realized. Realized gains and losses on available-for-sale securities are computed based upon the historical cost of these securities, using the specific identification method. Accounts receivable and allowance for doubtful accounts Concentrations of credit risk Marketable debt securities are generally classified as either “Cash and equivalents” or “Marketable securities and short-term investments” according to their maturity at the time of acquisition. Marketable equity securities are generally classified as “Marketable securities and short-term investments”, however any marketable securities held as a long-term investment rather than as an investment of excess liquidity, are classified as “Other non-current assets”. The Company performs a periodic review of its debt and equity securities to determine whether an other-than-temporary impairment has occurred. Generally, when an individual security has been in an unrealized loss position for an extended period of time, the Company evaluates whether an impairment has occurred. The evaluation is based on specific facts and circumstances at the time of assessment, which include general market conditions, and the duration and extent to which the fair value is below cost. If the fair value of a debt security is less than its amortized cost, then an other-than-temporary impairment for the dif- ference is recognized if (i) the Company has the intent to sell the security, (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost base or (iii) a credit loss exists in so far as the Company does not expect to recover the entire recognized amortized cost of the security. Such impairment charges are generally recognized in “Interest and other finance expense”. If the impairment is due to factors other than credit losses, and the Company does not intend to sell the security and it is not more likely than not that it will be required to sell the security before recovery of the security’s amortized cost, such impairment charges are recorded in “Accumulated other comprehensive loss”. In addition, for equity securities, the Company assesses whether the cost value will recover within the near-term and whether the Company has the intent and ability to hold that equity security until such recovery occurs. If an other-than- temporary impairment is identified, the security is written down to its fair value and the related losses are recognized in “Interest and other finance expense”, unless the impairment relates to equity securities classified as “Other non-current assets”, in which case the impairment is reported in “Other income (expense), net”. Accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in existing accounts receivable. The Company determines the allow- ance based on historical write-off experience and customer specific data. If an amount has not been settled within its contractual payment term then it is considered past due. The Company reviews the allowance for doubtful accounts regularly and past due balances are reviewed for collectability. Information on the management of credit risk and the methodology used to assess the creditworthiness of customers is presented in Note 7. Account balances are charged off against the allowance when the Company believes that the amount will not be recovered. The Company, in its normal course of business, transfers receivables without recourse to third parties. The transfer is accounted for as a sale when the Company has surrendered control over the receivables. Control is deemed to have been surrendered when (i) the transferred receivables have been put presumptively beyond the reach of the Company and its creditors, even in bankruptcy or other receivership, (ii) the third-party transferees have the right to pledge or exchange the transferred receivables, and (iii) the Company has relinquished effective control over the transferred receivables and does n ot retain the ability or obligation to repurchase or redeem the transferred receivables. At the time of sale, the sold receivables are removed from the Consolidated Balance Sheets and the related cash inflows are classified as oper- ating activities in the Consolidated Statements of Cash Flows. Costs associated with the sale of receivables, including the related gains and losses from the sales, are included in “Interest and other finance expense”. Transfers of receivables that do not meet the requirements for treatment as sales are accounted for as secured borrowings and the related cash flows are classified as financing activities in the Consolidated Statements of Cash Flows. The Company sells a broad range of products, systems and services to a wide range of industrial, commercial and utility customers as well as various government agencies and quasi-governmental agencies throughout the world. Concen- trations of credit risk with respect to accounts receivable are limited, as the Company’s customer base is comprised of a large number of individual customers. Ongoing credit evaluations of customers’ financial positions are performed to determine whether the use of credit support instruments such as guarantees, letters of credit or credit insurance are nec- essary; collateral is not generally required. The Company maintains reserves for potential credit losses as discussed above in “Accounts receivable and allowance for doubtful accounts”. Such losses, in the aggregate, are in line with the Company’s expectations. It is the Company’s policy to invest cash in deposits with banks throughout the world with certain minimum credit ratings and in high quality, low risk, liquid investments. The Company actively manages its credit risk by routinely reviewing the creditworthiness of the banks and the investments held, as well as maintaining such investments in time deposits or other liquid investments. The Company has not incurred significant credit losses related to such investments. The Company’s exposure to credit risk on derivative financial instruments is the risk that the counterparty will fail to meet its obligations. To reduce this risk, the Company has credit policies that require the establishment and periodic review of credit limits for individual counterparties. In addition, the Company has entered into close-out netting agreements with most derivative counterparties. Close-out netting agreements provide for the termination, valuation and net settlement of some or all outstanding transactions between two counterparties on the occurrence of one or more pre-defined trigger events. In the Consolidated Financial Statements derivative transactions are presented on a gross basis. ABB Annual Report 2012 | Financial review 85 Note 2 Significant accounting policies, continued Revenue recognition The Company generally recognizes revenues for the sale of goods when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured. With regards to the sale of products, delivery is not considered to have occurred, and therefore no revenues are recognized, until the cus- tomer has taken title to the products and assumed the risks and rewards of ownership of the products specified in the purchase order or sales agreement. Generally, the transfer of title and risks and rewards of ownership are governed by the contractually-defined shipping terms. The Company uses various International Commercial shipping terms (as promulgated by the International Chamber of Commerce) in its sales of products to third-party customers, such as Ex Works (EXW), Free Carrier (FCA) and Delivered Duty Paid (DDP). Subsequent to delivery of the products, the Company generally has no further contractual performance obligations that would preclude revenue recognition. Revenues under long-term construction-type contracts are generally recognized using the percentage-of-completion method of accounting. The Company principally uses the cost-to-cost method to measure progress towards completion on contracts. Under this method, progress of contracts is measured by actual costs incurred in relation to the Com- pany’s best estimate of total estimated costs, which are reviewed and updated routinely for contracts in progress. The cumulative effect of any change in estimate is recorded in the period when the change in estimate is determined. Short-term construction-type contracts, or long-term construction-type contracts for which reasonably dependable estimates cannot be made or for which inherent hazards make estimates difficult, are accounted for under the completed- contract method. Revenues under the completed contract method are recognized upon substantial completion – that is: acceptance by the customer, compliance with performance specifications demonstrated in a factory acceptance test or similar event. For non construction-type contracts that contain customer acceptance provisions, revenue is deferred until customer acceptance occurs or the Company has demonstrated the customer-specified objective criteria have been met or the contractual acceptance period has lapsed. Revenues from service transactions are recognized as services are performed. For long-term service contracts, revenues are recognized on a straight-line basis over the term of the contract or, if the performance pattern is other than straight- line, as the services are provided. Service revenues reflect revenues earned from the Company’s activities in providing services to customers primarily subsequent to the sale and delivery of a product or complete system. Such revenues consist of maintenance-type contracts, field service activities that include personnel and accompanying spare parts, and installation and commissioning of products as a stand-alone service or as part of a service contract. Revenues for software license fees are recognized when persuasive evidence of a non-cancelable license agreement exists, delivery has occurred, the license fee is fixed or determinable, and collection is probable. In software arrangements that include rights to multiple software products and/or services, the total arrangement fee is allocated using the resid- ual method. Under this method revenue is allocated to the undelivered elements based on vendor-specific objective evidence (VSOE) of the fair value of such undelivered elements and the residual amounts of revenue are allocated to the delivered elements. Elements included in multiple element arrangements may consist of software products, mainte- nance (which includes customer support services and unspecified upgrades), hosting, and consulting services. VSOE is based on the price generally charged when an element is sold separately or, in the case of an element not yet sold sep- arately, the price established by management, if it is probable that the price, once established, will not change once the element is sold separately. If VSOE does not exist for an undelivered element, the total arrangement fee will be recog- nized as revenue over the life of the contract or upon delivery of the undelivered element. The Company offers multiple element arrangements to meet its customers’ needs. These arrangements may involve the delivery of multiple products and/or performance of services (such as installation and training) and the delivery and/or performance may occur at different points in time or over different periods of time. Deliverables of such multiple element arrangements are evaluated to determine the unit of accounting and if certain criteria are met, the Company allocates revenues to each unit of accounting based on its relative selling price. A hierarchy of selling prices is used to determine the selling price of each specific deliverable that includes VSOE (if available), third-party evidence (if VSOE is not avail- able), or estimated selling price if neither of the first two is available. The estimated selling price reflects the Company’s best estimate of what the selling prices of elements would be if the elements were sold on a stand-alone basis. Revenue is allocated between the elements of an arrangement consideration at the inception of the arrangement. Such arrange- ments generally include industry-specific performance and termination provisions, such as in the event of substantial delays or non-delivery. Revenues are reported net of customer rebates and similar incentives. Taxes assessed by a governmental authority that are directly imposed on revenue-producing transactions between the Company and its customers, such as sales, use, value-added and some excise taxes, are excluded from revenues. Contract loss provisions Losses on contracts are recognized in the period when they are identified and are based upon the anticipated excess of contract costs over the related contract revenues. Shipping and handling costs Shipping and handling costs are recorded as a component of cost of sales. Inventories Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method, the weighted- average cost method, or in certain circumstances (for example, where the completed-contract method of revenue rec- ognition is used) the specific identification method. Inventoried costs are stated at acquisition cost or actual production cost, including direct material and labor and applicable manufacturing overheads. Adjustments to reduce the cost of inventory to its net market value are made, if required, for decreases in sales prices, obsolescence or similar reductions in the estimated net realizable value. 86 Financial review | ABB Annual Report 2012 Note 2 Significant accounting policies, continued Impairment of long-lived assets Long-lived assets that are held and used are assessed for impairment when events or circumstances indicate that the carrying amount of the asset may not be recoverable. If the asset’s net carrying value exceeds the asset’s net undis- counted cash flows expected to be generated over its remaining useful life including net proceeds expected from dispo- sition of the asset, if any, the carrying amount of the asset is reduced to its estimated fair value. The estimated fair value is determined using a market, income and/or cost approach. Property, plant and equipment Property, plant and equipment is stated at cost, less accumulated depreciation and is depreciated using the straight- line method. The estimated useful lives of the assets are generally as follows: – factories and office buildings: 30 to 40 years, – other facilities: 15 years, – machinery and equipment: 3 to 15 years, – furniture and office equipment: 3 to 8 years, – leasehold improvements are depreciated over their estimated useful life or, for operating leases, over the lease term, if shorter. Goodwill and other intangible assets Goodwill is reviewed for impairment annually as of October 1, or more frequently if events or circumstances indicate that the carrying value may not be recoverable. Goodwill is evaluated for impairment at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment. For the annual impairment review in 2012, the reporting units were the same as the operating segments for Power Products, Power Systems, Discrete Automation and Motion and Low Voltage Products, while for the Process Automation operating segment, the reporting units were determined to be one level below the operating segment. When evaluating goodwill for impairment, the Company first performs an assessment of its reporting units to determine, based on an evaluation of qualitative factors, if it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is determined to be more likely than not that the reporting unit’s fair value is less than its carrying value, the two-step quantitative impairment test is performed. The two-step quantitative impairment test calculates the fair value of each reporting unit (based on the income approach whereby the fair value of each reporting unit is calculated based on the present value of future cash flows) and com- pares it to the reporting unit’s carrying value. If the carrying value of the net assets of a reporting unit exceeds the fair value of the reporting unit then the Company performs the second step of the impairment test to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of the reporting unit’s goodwill exceeds its implied fair value, the Company records an impairment charge equal to the difference. The cost of acquired intangible assets with a finite life is amortized using a method of amortization that reflects the pattern of intangible assets’ expected contributions to future cash flows. If that pattern cannot be reliably determined, the straight-line method is used. The amortization periods range from 3 to 5 years for software and from 5 to 20 years for customer-, technology- and marketing-related intangibles. Intangible assets with a finite life are tested for impairment upon the occurrence of certain triggering events. Capitalized software costs Software for internal use Costs incurred in the application development stage until the software is substantially complete are capitalized and are amortized on a straight-line basis over the estimated useful life of the software, typically ranging from 3 to 5 years. Software to be sold Costs incurred after the software has demonstrated its technological feasibility until the product is available for general release to the customers are capitalized and amortized on a straight-line basis over the estimated life of the product. The Company periodically performs an evaluation to determine that the unamortized cost of software to be sold does not exceed the net realizable value. If the unamortized cost of software to be sold exceeds its net realizable value, the Company records an impairment charge equal to the difference. Derivative financial instruments and hedging activities The Company uses derivative financial instruments to manage currency, commodity, interest rate and equity exposures, arising from its global operating, financing and investing activities (see Note 5). The Company recognizes all derivatives, other than certain derivatives indexed to the Company’s own stock, at fair value in the Consolidated Balance Sheets. Derivatives that are not designated as hedging instruments are reported at fair value with derivative gains and losses reported through earnings and classified consistent with the nature of the under- lying transaction. If the derivatives are designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivatives will either be offset against the change in fair value of the hedged item attributable to the risk being hedged through earnings (in the case of a fair value hedge) or recognized in “Accumulated other comprehensive loss” until the hedged item is recognized in earnings (in the case of a cash flow hedge). The ineffective portion of a deriv- ative’s change in fair value is immediately recognized in earnings consistent with the classification of the hedged item. Gains or losses from derivatives designated as hedging instruments in a fair value hedge are reported through earnings and classified consistent with the nature of the underlying hedged transaction. Where derivative financial instruments have been designated as cash flow hedges of forecasted transactions and such forecasted transactions are no longer probable of occurring, hedge accounting is discontinued and any derivative gain or loss previously included in “Accumulated other comprehensive loss” is reclassified into earnings consistent with the nature of the original fore- casted transaction. ABB Annual Report 2012 | Financial review 87 Note 2 Significant accounting policies, continued Certain commercial contracts may grant rights to the Company or the counterparties, or contain other provisions that are considered to be derivatives. Such embedded derivatives are assessed at inception of the contract and depending on their characteristics, accounted for as separate derivative instruments and shown at their fair value in the balance sheet with changes in their fair value reported in earnings consistent with the nature of the commercial contract to which they relate. Leases Sale-leasebacks Translation of foreign currencies and foreign exchange transactions Income taxes Derivatives are classified in the Consolidated Statements of Cash Flows in the same section as the underlying item. Cash flows from the settlement of undesignated derivatives used to manage the risks of different underlying items on a net basis, are classified within “Net cash provided by operating activities”, as the underlying items are primarily operational in nature. The Company leases primarily real estate and office equipment. Rental expense for operating leases is recorded on a straight-line basis over the life of the lease term. Lease transactions where substantially all risks and rewards incident to ownership are transferred from the lessor to the lessee are accounted for as capital leases. All other leases are accounted for as operating leases. Amounts due under capital leases are recorded as a liability. The interest in assets acquired under capital leases is recorded as property, plant and equipment. Depreciation and amortization of assets recorded under capital leases is included in depreciation and amortization expense. The Company occasionally enters into transactions accounted for as sale-leasebacks, in which fixed assets, generally real estate and/or equipment, are sold to a third party and then leased for use by the Company. Under certain circum- stances, the necessary criteria to recognize a sale of these assets may not occur and then the transaction is reflected as a financing transaction, with the proceeds received from the transaction reflected as a borrowing or deposit liability. When the necessary criteria have been met to recognize a sale, gains or losses on the sale of the assets are generally deferred and amortized over the term of the transaction, except in certain limited instances when a portion of the gain or loss may be recognized upon inception. The lease of the asset is accounted for as either an operating lease or a capital lease, depending upon its specific terms. The functional currency for most of the Company’s subsidiaries is the applicable local currency. The translation from the applicable functional currencies into the Company’s reporting currency is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for income statement accounts using average exchange rates prevailing during the year. The resulting translation adjustments are excluded from the determination of earnings and are recognized in “Accumulated other comprehensive loss” until the subsidiary is sold, substantially liquidated or evaluated for impairment in anticipation of disposal. Foreign currency exchange gains and losses, such as those resulting from foreign currency denominated receivables or payables, are included in the determination of earnings, except as they relate to intercompany loans that are equity-like in nature with no reasonable expectation of repayment, which are recognized in “Accumulated other comprehensive loss”. Exchange gains and losses recognized in earnings are included in “Total revenues”, “Total cost of sales”, “Selling, general and administrative expenses” or “Interest and other finance expense” consistent with the nature of the under- lying item. The Company uses the asset and liability method to account for deferred taxes. Under this method, deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and the tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The Company records a deferred tax asset when it deter- mines that it is more likely than not that the deduction will be sustained based upon the deduction’s technical merit. A valuation allowance is recorded to reduce deferred tax assets to the amount that is more likely than not to be realized. Deferred taxes are provided on unredeemed retained earnings of the Company’s subsidiaries. However, deferred taxes are not provided on such unredeemed retained earnings to the extent it is expected that the earnings are permanently reinvested. Such earnings may become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. The Company operates in numerous tax jurisdictions and, as a result, is regularly subject to audit by tax authorities. The Company provides for tax contingencies whenever it is deemed more likely than not that a tax asset has been impaired or a tax liability has been incurred for events such as tax claims or changes in tax laws. Contingency provisions are recorded based on the technical merits of the Company’s filing position, considering the applicable tax laws and Organisation for Economic Co-operation and Development (OECD) guidelines and are based on its evaluations of the facts and circumstances as of the end of each reporting period. Changes in the facts and circumstances could result in a material change to the tax accruals. The Company applies a two-step approach to recognize and measure uncertainty in income taxes. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50 percent likely of being realized upon ultimate settlement. Expense related to tax penalties is classified in the Consolidated Income Statements as “Provision for taxes”, while interest thereon is classified as “Interest and other finance expense”. Research and development Research and development costs not related to specific customer orders are generally expensed as incurred. 88 Financial review | ABB Annual Report 2012 Note 2 Significant accounting policies, continued Earnings per share Basic earnings per share is calculated by dividing income by the weighted-average number of shares outstanding dur- ing the year. Diluted earnings per share is calculated by dividing income by the weighted-average number of shares outstanding during the year, assuming that all potentially dilutive securities were exercised, if dilutive. Potentially dilutive securities comprise: outstanding written call options, outstanding options and shares granted subject to certain con- ditions under the Company’s share-based payment arrangements. See further discussion related to earnings per share in Note 20 and of potentially dilutive securities in Note 18. Share-based payment arrangements Fair value measures Contingencies and asset retirement obligations The Company has various share-based payment arrangements for its employees, which are described more fully in Note 18. Such arrangements are accounted for under the fair value method. For awards that are equity-settled, total compensation is measured at grant date, based on the fair value of the award at that date, and recorded in earnings over the period the employees are required to render service. For awards that are cash-settled, compensation is initially measured at grant date and subsequently remeasured at each reporting period, based on the fair value and vesting percentage of the award at each of those dates, with changes in the liability recorded in earnings. The Company uses fair value measurement principles to record certain financial assets and liabilities on a recurring basis and, when necessary, to record certain non-financial assets at fair value on a non-recurring basis, as well as to determine fair value disclosures for certain financial instruments carried at amortized cost in the financial statements. Financial assets and liabilities recorded at fair value on a recurring basis include foreign currency, commodity and inter- est rate derivatives, as well as cash-settled call options and available-for-sale securities. Non-financial assets recorded at fair value on a non-recurring basis include long-lived assets that are reduced to their estimated fair value due to impairments. Fair value is the price that would be received when selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation techniques including the market approach (using observable market data for identical or similar assets and liabilities), the income approach (discounted cash flow models) and the cost approach (using costs a market participant would incur to develop a comparable asset). Inputs used to determine the fair value of assets and liabilities are defined by a three level hierarchy, depending on the reliability of those inputs. The Company has categorized its financial assets and liabili- ties and non-financial assets measured at fair value within this hierarchy based on whether the inputs to the valuation technique are observable or unobservable. An observable input is based on market data obtained from independent sources, while an unobservable input reflects the Company’s assumptions about market data. The levels of the fair value hierarchy are as follows: Level 1: Valuation inputs consist of quoted prices in an active market for identical assets or liabilities (observable quoted prices). Assets and liabilities valued using Level 1 inputs include exchange-traded equity securities, listed de- rivatives which are actively traded such as commodity futures, interest rate futures and certain actively traded debt securities. Level 2: Valuation inputs consist of observable inputs (other than Level 1 inputs) such as actively quoted prices for similar assets, quoted prices in inactive markets and inputs other than quoted prices such as interest rate yield curves, credit spreads, or inputs derived from other observable data by interpolation, correlation, regression or other means. The adjustments applied to quoted prices or the inputs used in valuation models may be both observable and unobservable. In these cases, the fair value measurement is classified as Level 2 unless the unobservable portion of the adjustment or the unobservable input to the valuation model is significant, in which case the fair value measurement would be classified as Level 3. Assets and liabilities valued using Level 2 in- puts include investments in certain funds, certain debt securities that are not actively traded, interest rate swaps, commodity swaps, cash-settled call options, as well as foreign exchange forward contracts and foreign exchange swaps as well as financing receivables and debt. Level 3: Valuation inputs are based on the Company’s assumptions of relevant market data (unobservable input). The impairments of certain equity-method investments were calculated using Level 3 inputs. Whenever quoted prices involve bid-ask spreads, the Company ordinarily determines fair values based on mid-market quotes. However, for the purposes of determining the fair value of cash-settled call options serving as hedges of the Company’s management incentive plan (MIP), bid prices are used. When determining fair values based on quoted prices in an active market, the Company considers if the level of transac- tion activity for the financial instrument has significantly decreased, or would not be considered orderly. In such cases, the resulting changes in valuation techniques would be disclosed. If the market is considered disorderly or if quoted prices are not available, the Company is required to use another valuation technique, such as an income approach. Disclosures about the Company’s fair value measurements of assets and liabilities are included in Note 6. The Company is subject to proceedings, litigation or threatened litigation and other claims and inquiries, related to environmental, labor, product, regulatory, tax (other than income tax) and other matters, and is required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the provision required, if any, for these contingencies is made after analysis of each individual issue, often with assistance from both internal and external legal counsel and technical experts. The required amount of a provision for a contingency of any type may change in the future due to new developments in the particular matter, including changes in the approach to its resolution. The Company records a provision for its contingent obligations when it is probable that a loss will be incurred and the amount can be reasonably estimated. Any such provision is generally recognized on an undiscounted basis using the Company’s best estimate of the amount of loss incurred or at the lower end of an estimated range when a single best estimate is not determinable. In some cases, the Company may be able to recover a portion of the costs relating to these obligations from insurers or other third parties; however, the Company records such amounts only when it is probable that they will be collected. ABB Annual Report 2012 | Financial review 89 Note 2 Significant accounting policies, continued The Company provides for anticipated costs for warranties when it recognizes revenues on the related products or con- tracts. Warranty costs include calculated costs arising from imperfections in design, material and workmanship in the Company’s products. The Company makes individual assessments on contracts with risks resulting from order-specific conditions or guarantees and assessments on an overall, statistical basis for similar products sold in larger quantities. The Company may have a legal obligation to perform environmental clean-up activities as a result of the normal opera- tion of its business or have other asset retirement obligations. In some cases, the timing or the method of settlement, or both, are conditional upon a future event that may or may not be within the control of the Company, but the underlying obligation itself is unconditional and certain. The Company recognizes a provision for these and other asset retirement obligations when a liability for the retirement or clean-up activity has been incurred and a reasonable estimate of its fair value can be made. Asset retirement provisions are initially recognized at fair value, and subsequently adjusted for accrued interest and changes in estimates. Provisions for environmental obligations are not discounted to their present value when the timing of payments cannot be reasonably estimated. Pensions and other postretirement benefits The Company has a number of defined benefit pension and other postretirement plans. The Company recognizes an asset for such a plan’s overfunded status or a liability for such a plan’s underfunded status in its Consolidated Balance Sheets. Additionally, the Company measures such a plan’s assets and obligations that determine its funded status as of the end of the year and recognizes the changes in the funded status in the year in which the changes occur. Those changes are reported in “Accumulated other comprehensive loss” and as a separate component of stockholders’ equity. The Company uses actuarial valuations to determine its pension and postretirement benefit costs and credits. The amounts calculated depend on a variety of key assumptions, including discount rates and expected return on plan assets. Current market conditions are considered in selecting these assumptions. The Company’s various pension plan assets are assigned to their respective levels in the fair value hierarchy in accor- dance with the valuation principles described in the “Fair value measures” section above. See Note 17 for further discussion of the Company’s employee benefit plans. Business combinations Assets acquired and liabilities assumed in business combinations are accounted for using the acquisition method and recorded at their respective fair values. Contingent consideration is recorded at fair value as an element of purchase price with subsequent adjustments recognized in income. New accounting pronouncements Identifiable intangibles consist of intellectual property such as trademarks and trade names, customer relationships, patented and unpatented technology, in-process research and development, order backlog and capitalized software; these are amortized over their estimated useful lives. Such intangibles are subsequently subject to evaluation for potential impairment if events or circumstances indicate the carrying amount may not be recoverable. See the “Goodwill and other intangible assets” section above. Acquisition-related costs are recognized separately from the acquisition and expensed as incurred. Restructuring costs are generally expensed in periods subsequent to the acquisition date. Upon gaining control of an entity in which an equity method or cost basis investment was held by the Company, the carrying value of that investment is adjusted to fair value with the related gain or loss recorded in income. Deferred tax assets and liabilities based on temporary differences between the financial reporting and the tax base of assets and liabilities as well as uncertain tax positions and valuation allowances on acquired deferred tax assets assumed in connection with a business combination are initially estimated as of the acquisition date based on facts and circumstances that existed at the acquisition date. These estimates are subject to change within the measurement period (a period of up to 12 months after the acquisition date during which the acquirer may adjust the provisional acqui- sition amounts) with any adjustments to the preliminary estimates being recorded to goodwill. Changes in deferred taxes, uncertain tax positions and valuation allowances on acquired deferred tax assets that occur after the measure- ment period are recognized in income. Applicable in current period Amendments to achieve common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs As of January 2012, the Company adopted an accounting standard update which provides guidance that results in common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Stan- dards. These amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the amendments in this update are not intended to result in a change in the application of the requirements of U.S. GAAP. Some of the amendments clarify the application of existing fair value measurement requirements, while other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The adoption of this update did not have a significant impact on the Consolidated Financial Statements. Presentation of comprehensive income As of January 2012, the Company adopted two accounting standard updates regarding the presentation of comprehen- sive income. Under the updates, the Company is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income and a total amount for comprehensive income either in a single continuous statement of comprehensive income or in two sep- arate but consecutive statements. These updates are effective retrospectively and resulted in the Company presenting two separate but consecutive statements. See Note 21 for the income tax expense or benefit related to each component of other comprehensive income. Testing goodwill for impairment As of January 2012, the Company adopted an accounting standard update regarding the testing of goodwill for impair- ment under which the Company has elected the option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Consequently, the Company is not required to calculate the fair value of a reporting unit unless it determines, based on the qualitative assessment, that it is more likely 90 Financial review | ABB Annual Report 2012 Note 2 Significant accounting policies, continued than not that the reporting unit’s fair value is less than its carrying amount. The adoption of this update did not have a significant impact on the Consolidated Financial Statements. Applicable for future periods Disclosures about offsetting assets and liabilities In December 2011, an accounting standard update was issued regarding disclosures about amounts of certain finan- cial and derivative instruments recognized in the statement of financial position that are either (i) offset or (ii) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset. The scope of the update, as clarified by an update in January 2013, covers derivatives (including bifurcated embedded derivatives), repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending arrange- ments. This update is effective for the Company for annual and interim periods beginning January 1, 2013, and is appli- cable retrospectively. The Company does not expect that this update will have a significant impact on its Consolidated Financial Statements. Reporting of amounts reclassified out of accumulated other comprehensive income In February 2013, an accounting standard update was issued regarding the presentation of amounts reclassified out of accumulated other comprehensive income. Under the update, the Company is required to present, either in a single note or parenthetically on the face of the financial statements, significant amounts reclassified out of accumulated other comprehensive income by the respective income statement line item (if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the reporting period). If a component is not required to be reclas- sified to net income in its entirety, the Company would instead cross-reference to other U.S. GAAP required disclosures that provide additional information about the amounts. This update is effective for the Company for annual and interim periods beginning January 1, 2013, and is applicable prospectively. The Company does not expect that this update will have a significant impact on its Consolidated Financial Statements. Parent’s accounting for the cumulative translation adjustments upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity In March 2013, an accounting standard update was issued regarding the release of cumulative translation adjustments of a parent when it ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity (for the Company, a foreign entity is an entity having a functional currency other than U.S. dollars). Under the update, the Company would recognize cumulative translation adjustments in net income when it ceases to have a controlling financial interest in a subsidiary or group of assets within a consolidated foreign entity and if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For foreign equity-accounted companies, a pro rata portion of the cumulative translation adjustment would be recognized in net income upon a partial sale of the equity-accounted company. This update is effective for the Company for annual and interim periods beginning January 1, 2014, and is applicable prospectively. The impact of this update on the Consolidated Financial Statements is dependent on future transactions resulting in derecognition of foreign assets, subsidiaries or foreign equity-accounted companies completed on or after adoption. Note 3 Acquisitions and increases in controlling interests Acquisitions Acquisitions were as follows: ($ in millions, except number of acquired businesses) Acquisitions (net of cash acquired)(1) Aggregate excess of purchase price over fair value of net assets acquired(2) Number of acquired businesses 2012 3,643 2,895 9 2011 3,805 3,261 10 2010 1,275 1,091 9 (1) (2) Excluding changes in cost and equity investments but including $5 million in 2012 and $19 million in 2011, representing the fair value of replacement vested stock options issued to Thomas & Betts and Baldor employees, respectively, at the corresponding acquisition dates. Recorded as goodwill (see Note 11). In the table above, the “Acquisitions” and “Aggregate excess of purchase price over fair value of net assets acquired” amounts for 2012 relate primarily to the acquisition of Thomas & Betts Corporation (Thomas & Betts). For 2011, these amounts relate mainly to the acquisitions of Baldor Electric Corporation (Baldor) and EAM Software Holdings Pty Ltd (Mincom), while for 2010, these amounts relate primarily to the acquisition of the Ventyx group (Ventyx). Acquisitions of controlling interests have been accounted for under the acquisition method and have been included in the Company’s Consolidated Financial Statements since the date of acquisition. While the Company uses its best estimates and assumptions as part of the purchase price allocation process to value assets acquired and liabilities assumed at the acquisition date, the purchase price allocation for acquisitions is preliminary for up to 12 months after the acquisition date and is subject to refinement as more detailed analyses are completed and additional information about the fair values of the assets and liabilities becomes available. On May 16, 2012, the Company acquired all outstanding shares of Thomas & Betts for $72 per share in cash. The resulting cash outflows for the Company amounted to $3,700 million, representing $3,282 million for the purchase of the shares (net of cash acquired of $521 million), $94 million related to cash settlement of Thomas & Betts options held at acquisition date and $324 million for the repayment of debt assumed upon acquisition. Thomas & Betts designs, manu- factures and markets components used to manage the connection, distribution, transmission and reliability of electrical power in industrial, construction and utility applications. The acquisition of Thomas & Betts supports the Company’s strategy of expanding its Low Voltage Products operating segment into new geographies, sectors and products, and consequently the goodwill acquired represents the future benefits associated with the expansion of market access and product scope. ABB Annual Report 2012 | Financial review 91 Note 3 Acquisitions and increases in controlling interests, continued The aggregate preliminary allocation of the purchase consideration for business acquisitions in 2012 is as follows: ($ in millions) Customer relationships Technology Trade names Order backlog Intangible assets Fixed assets Debt acquired Deferred tax liabilities Inventories Other assets and liabilities, net(1) Goodwill(2) Total consideration (net of cash acquired)(3) Weighted-average useful life Thomas & Betts 18 years 5 years 10 years 7.5 months 15 years Allocated amounts Thomas & Betts Other 1,169 179 155 12 1,515 458 (619) (1,080) 300 84 2,723 3,381 18 43 6 1 68 25 – (24) 38 (17) 172 262 Total 1,187 222 161 13 1,583 483 (619) (1,104) 338 67 2,895 3,643 (1) (2) (3) Gross receivables from the Thomas & Betts acquisition totaled $387 million; the fair value of which was $344 million after rebates and allowance for estimated uncollectable receivables. The Company does not expect the majority of goodwill recognized to be deductible for income tax purposes. Cash acquired in the Thomas & Betts acquisition totaled $521 million. Additional consideration for the Thomas & Betts acquisition included $94 million related to the cash settlement of stock options held by Thomas & Betts employees at the acquisition date and $5 million representing the fair value of replacement vested stock options issued to Thomas & Betts employees at the acquisition date. The fair value of these stock options was estimated using a Black-Scholes model. The preliminary estimated fair values of the assets acquired and liabilities assumed for business combinations in 2012 are based on preliminary calculations and valuations, and facts and circumstances that existed at the respective acquisition dates. The Company’s estimates and assumptions are subject to change during the measurement periods of those acquisitions. The area where preliminary estimates are not yet finalized primarily relates to certain deferred tax liabilities. The Company’s Consolidated Income Statement for 2012 includes total revenues of $1,541 million and a net loss (including acquisition-related charges) of $10 million in respect of Thomas & Betts since the date of acquisition. The unaudited pro forma financial information in the table below summarizes the combined pro forma results of the Company and Thomas & Betts for 2012 and 2011, as if Thomas & Betts had been acquired on January 1, 2011. ($ in millions) Total revenues Income from continuing operations, net of tax 2012 40,251 2,923 2011 40,288 3,381 The unaudited pro forma results above include certain adjustments related to the Thomas & Betts acquisition. The table below summarizes the adjustments necessary to present the pro forma financial information of the Company and Thomas & Betts combined, as if Thomas & Betts had been acquired on January 1, 2011. ($ in millions) Impact on cost of sales from additional amortization of intangible assets (excluding order backlog capitalized upon acquisition) Impact on cost of sales from amortization of order backlog capitalized upon acquisition Impact on cost of sales from fair valuing acquired inventory Impact on cost of sales from additional depreciation of fixed assets Interest expense on Thomas & Betts debt Impact on selling, general and administrative expenses from Thomas & Betts stock-option plans Impact on selling, general and administrative expenses from acquisition-related costs Impact on interest and other finance expense from bridging facility costs Other Income taxes Total pro forma adjustments Adjustments 2012 2011 (26) 12 31 (12) 5 16 56 13 (5) (7) 83 (69) (12) (31) (33) 21 – (20) – (15) 44 (115) The pro forma results are for information purposes only and do not include any anticipated cost synergies or other effects of the planned integration of Thomas & Betts. Accordingly, such pro forma amounts are not necessarily indica- tive of the results that would have occurred had the acquisition been completed on the date indicated, nor are they indicative of the future operating results of the combined company. 92 Financial review | ABB Annual Report 2012 Note 3 Acquisitions and increases in controlling interests, continued On January 26, 2011, the Company acquired 83.25 percent of the outstanding shares of Baldor for $63.50 per share in cash. On January 27, 2011, the Company exercised its top-up option contained in the merger agreement, bringing its shareholding in Baldor to 91.6 percent, allowing the Company to complete a short-form merger under Missouri, United States, law. On the same date, the Company completed the purchase of the remaining 8.4 percent of outstand- ing shares. The resulting cash outflows for the Company amounted to $4,276 million, representing $2,966 million for the purchase of the shares (net of cash acquired), $70 million related to cash settlement of Baldor options held at acqui- sition date and $1,240 million for the repayment of debt assumed upon acquisition. Baldor markets, designs and manu- factures industrial electric motors, mechanical power transmission products, drives and generators. The final allocation of the purchase consideration for the Baldor acquisition in 2011 is as follows: ($ in millions) Customer relationships Technology Trade name Order backlog Other intangible assets Intangible assets Fixed assets Debt acquired Deferred tax liabilities Inventories Other assets and liabilities, net(1) Goodwill(2) Total consideration (net of cash acquired)(3) Weighted-average useful life 19 years 7 years 10 years 2 months 5 years 16 years Allocated amounts 996 259 121 15 15 1,406 382 (1,241) (693) 422 51 2,728 3,055 (1) (2) (3) Gross receivables from the acquisition totaled $266 million; the fair value of which was $263 million after allowance for estimated uncollectable receivables. The goodwill recognized is not deductible for income tax purposes. Cash acquired in the acquisition totaled $48 million. Additional consideration included $70 million related to the cash settlement of stock options held by Baldor employees at the acquisition date and $19 million representing the fair value of replacement vested stock options issued to Baldor employees at the acquisition date. The fair value of these stock options was estimated using a Black-Scholes model. The Company’s Consolidated Income Statement for 2011 includes total revenues of $1,950 million and net income (including acquisition-related charges) of $155 million in respect of Baldor since the date of acquisition. The unaudited pro forma financial information in the table below summarizes the combined pro forma results of the Company and Baldor for 2011 and 2010, as if Baldor had been acquired on January 1, 2010. ($ in millions) Total revenues Income from continuing operations, net of tax 2011 38,100 3,391 2010 33,310 2,726 The unaudited pro forma results above include certain adjustments related to the Baldor acquisition. The table below summarizes the adjustments necessary to present the pro forma financial information of the combined entity as if Baldor had been acquired on January 1, 2010. ($ in millions) Impact on cost of sales from additional amortization of intangible assets (excluding order backlog capitalized upon acquisition) Impact on cost of sales from amortization of order backlog capitalized upon acquisition Impact on cost of sales from fair valuing acquired inventory Interest expense on Baldor’s debt Baldor stock-option plans Impact on selling, general and administrative expenses from acquisition-related costs Other Income taxes Total pro forma adjustments Adjustments 2011 2010 (7) 15 57 11 66 64 – (65) 141 (91) (15) (57) 106 – (24) (23) 26 (78) The pro forma results are for information purposes only and do not include any anticipated cost synergies or other effects of the integration of Baldor. Accordingly, such pro forma amounts are not necessarily indicative of the results that would have occurred had the acquisition been completed on the date indicated, nor are they indicative of the future operating results of the combined company. ABB Annual Report 2012 | Financial review 93 Note 3 Acquisitions and increases in controlling interests, continued The aggregate allocation of the purchase consideration for other business acquisitions in 2011, excluding Baldor, was as follows: ($ in millions) Customer relationships Technology Trade names Order backlog Other intangible assets Intangible assets Fixed assets Debt acquired Deferred tax liabilities Inventories Other assets and liabilities, net Goodwill Total consideration (net of cash acquired) (1) The allocated amounts primarily relate to the acquisitions of Mincom, PGC Powergen Consulting SA (Trasfor) and AB Lorentzen & Wettre. Allocated amounts(1) 220 156 32 36 3 447 40 (202) (99) 35 (4) 533 750 On June 1, 2010, the Company acquired all of the shares of Ventyx Inc., Ventyx Software Inc. and Ventyx Dutch Holding B.V., representing substantially all of the revenues, assets and liabilities of the Ventyx group. Ventyx provides software solutions to global energy, utility, communications and other asset-intensive businesses and was integrated into the Power Systems operating segment. The aggregate purchase price of business acquisitions in 2010, settled in cash, has been allocated as follows: ($ in millions) Intangible assets(1) Deferred tax liabilities Other assets and liabilities, net(2) Goodwill(3) Total(4) (1) (2) (3) (4) Includes mainly capitalized software for sale and customer relationships. Including debt assumed upon acquisition. Goodwill recognized is not deductible for income tax purposes. Primarily relates to the acquisition of Ventyx. Weighted-average useful life 8 years Allocated amounts 356 (147) (25) 1,091 1,275 Increase in controlling interests in India In 2010, the Company increased its ownership interest in ABB Limited, India (its publicly listed subsidiary in India) from approximately 52 percent to 75 percent. Cash paid in 2010, including transaction costs, amounted to $956 million. The offer of 900 rupees per share resulted in a charge to “Capital stock and additional paid-in capital” of $838 million, including expenses related to the transaction. Note 4 Cash and equivalents and marketable securities Current Assets Cash and equivalents and marketable securities and short-term investments consisted of the following: December 31, 2012 ($ in millions) Cost basis gains losses Fair value equivalents investments Gross Gross Marketable securities unrealized unrealized Cash and and short-term Cash Time deposits Other short-term investments Debt securities available-for-sale: U.S. government obligations Other government obligations Corporate Equity securities available-for-sale Total 2,784 3,993 15 152 3 236 1,271 8,454 2,784 3,993 15 159 3 245 1,282 8,481 2,784 3,963 – – – 128 – 6,875 8 – 9 12 29 (1) – – (1) (2) – 30 15 159 3 117 1,282 1,606 94 Financial review | ABB Annual Report 2012 Note 4 Cash and equivalents and marketable securities, continued December 31, 2011 ($ in millions) Cost basis gains losses Fair value equivalents investments Gross Gross Marketable securities unrealized unrealized Cash and and short-term Cash Time deposits Debt securities available-for-sale: U.S. government obligations Other government obligations Corporate Equity securities available-for-sale Total Non-current assets 1,655 2,986 753 3 298 50 5,745 1,655 2,986 761 3 305 57 5,767 1,655 2,984 – – 180 – 4,819 8 – 8 10 26 – – (1) (3) (4) – 2 761 3 125 57 948 The Company also holds shares in a publicly-traded company which are classified as available-for-sale equity securities and recorded in “Other non-current assets”. At December 31, 2012 and 2011, other-than-temporary impairments were recognized on these securities but were not significant. In addition, certain held-to-maturity marketable securities (pledged in respect of a certain non-current deposit liability) are recorded in “Other non-current assets”. At December 31, 2012, the amortized cost, gross unrecognized gain and fair value (based on quoted market prices) of these securities were $97 million, $27 million and $124 million, respectively. At December 31, 2011, the amortized cost, gross unrecognized gain and fair value (based on quoted market prices) of these securities were $92 million, $28 million and $120 million, respectively. Gains, losses and contractual maturities Gross realized gains (reclassified from accumulated other comprehensive loss to income) on available-for-sale securities were $3 million, $8 million and $16 million in 2012, 2011 and 2010, respectively. Gross realized losses (reclassified from accumulated other comprehensive loss to income) on available-for-sale securities were not significant in 2012, 2011 and 2010. Such gains and losses were included in “Interest and other finance expense”. In 2012 and 2011, other-than-temporary impairments recognized on available-for-sale equity securities were not signifi- cant. There was no other-than-temporary impairment in 2010. At December 31, 2012, 2011 and 2010, gross unrealized losses on available-for-sale securities that have been in a continuous unrealized loss position were not significant and the Company does not intend and does not expect to be required to sell these securities before the recovery of their amortized cost. There were no sales of held-to-maturity securities in 2012, 2011 and 2010. Contractual maturities of debt securities consisted of the following: December 31, 2012 ($ in millions) Less than one year One to five years Six to ten years Total Available-for-sale Held-to-maturity Cost basis Fair value Cost basis Fair value 128 200 63 391 128 210 69 407 – 41 56 97 – 48 76 124 At December 31, 2012 and 2011, the Company pledged $96 million and $90 million, respectively, of available-for-sale marketable securities as collateral for issued letters of credit and other security arrangements. ABB Annual Report 2012 | Financial review 95 Note 5 Financial instruments Currency risk Commodity risk Interest rate risk Equity risk The Company is exposed to certain currency, commodity, interest rate and equity risks arising from its global operating, financing and investing activities. The Company uses derivative instruments to reduce and manage the economic impact of these exposures. Due to the global nature of the Company’s operations, many of its subsidiaries are exposed to currency risk in their operating activities from entering into transactions in currencies other than their functional currency. To manage such currency risks, the Company’s policies require the subsidiaries to hedge their foreign currency exposures from binding sales and purchase contracts denominated in foreign currencies. For forecasted foreign currency denominated sales of standard products and the related foreign currency denominated purchases, the Company’s policy is to hedge up to a maximum of 100 percent of the forecasted foreign currency denominated exposure, depending on the length of the forecasted exposures. Forecasted exposures greater than 12 months are not hedged. Forward foreign exchange contracts are the main instrument used to protect the Company against the volatility of future cash flows (caused by changes in exchange rates) of contracted and forecasted sales and purchases denominated in foreign currencies. In addition, within its treasury operations, the Company primarily uses foreign exchange swaps and forward foreign exchange contracts to manage the currency and timing mismatches arising in its liquidity management activities. Various commodity products are used in the Company’s manufacturing activities. Consequently it is exposed to volatil- ity in future cash flows arising from changes in commodity prices. To manage the price risk of commodities other than electricity, the Company’s policies require that the subsidiaries hedge the commodity price risk exposures from binding contracts, as well as at least 50 percent (up to a maximum of 100 percent) of the forecasted commodity exposure over the next 12 months or longer (up to a maximum of 18 months). In certain locations where the price of electricity is hedged, up to a maximum of 90 percent of the forecasted electricity needs, depending on the length of the forecasted exposures, is hedged. Swap and futures contracts are used to manage the associated price risks of commodities. The Company has issued bonds at fixed rates. Interest rate swaps are used to manage the interest rate risk associated with certain debt. In addition, from time to time, the Company uses instruments such as interest rate swaps, interest rate futures, bond futures or forward rate agreements to manage interest rate risk arising from the Company’s balance sheet structure but does not designate such instruments as hedges. The Company is exposed to fluctuations in the fair value of its warrant appreciation rights (WARs) issued under its MIP. A WAR gives its holder the right to receive cash equal to the market price of an equivalent listed warrant on the date of exercise. To eliminate such risk, the Company has purchased cash-settled call options which entitle the Company to receive amounts equivalent to its obligations under the outstanding WARs. In general, while the Company’s primary objective in its use of derivatives is to minimize exposures arising from its business, certain derivatives are designated and qualify for hedge accounting treatment while others either are not designated or do not qualify for hedge accounting. Volume of derivative activity Foreign exchange and interest rate derivatives The gross notional amounts of outstanding foreign exchange and interest rate derivatives (whether designated as hedges or not) were as follows: Type of derivative December 31, ($ in millions) Foreign exchange contracts Embedded foreign exchange derivatives Interest rate contracts Total notional amounts 2012 19,724 3,572 3,983 2011 2010 16,503 16,971 3,439 5,535 2,891 2,357 Derivative commodity contracts The following table shows the notional amounts of outstanding commodity derivatives (whether designated as hedges or not), on a net basis, to reflect the Company’s requirements in the various commodities: Type of derivative December 31, Copper swaps Aluminum swaps Nickel swaps Lead swaps Zinc swaps Silver swaps Electricity futures Crude oil swaps Unit Total notional amounts metric tonnes metric tonnes metric tonnes metric tonnes metric tonnes ounces 2012 45,222 5,495 21 2011 2010 38,414 20,977 5,068 3,050 18 36 13,025 13,325 9,525 225 125 1,415,322 1,981,646 – – megawatt hours 334,445 326,960 363,340 barrels 135,471 113,397 121,979 96 Financial review | ABB Annual Report 2012 Note 5 Financial instruments, continued Equity derivatives At December 31, 2012, 2011 and 2010, the Company held 67 million, 61 million and 58 million cash-settled call options on ABB Ltd shares with a total fair value of $26 million, $21 million and $45 million, respectively. Cash flow hedges As noted above, the Company mainly uses forward foreign exchange contracts to manage the foreign exchange risk of its operations, commodity swaps to manage its commodity risks and cash-settled call options to hedge its WAR liabilities. Where such instruments are designated and qualify as cash flow hedges, the effective portion of the changes in their fair value is recorded in “Accumulated other comprehensive loss” and subsequently reclassified into earnings in the same line item and in the same period as the underlying hedged transaction affects earnings. Any ineffectiveness in the hedge relationship, or hedge component excluded from the assessment of effectiveness, is recognized in earnings during the current period. At December 31, 2012, 2011 and 2010, “Accumulated other comprehensive loss” included net unrealized gains of $37 million, $12 million and $92 million, respectively, net of tax, on derivatives designated as cash flow hedges. Of the amount at December 31, 2012, net gains of $31 million are expected to be reclassified to earnings in 2013. At Decem- ber 31, 2012, the longest maturity of a derivative classified as a cash flow hedge was 78 months. In 2012, 2011 and 2010, the amounts of gains or losses, net of tax, reclassified into earnings due to the discontinuance of cash flow hedge accounting and recognized in earnings due to ineffectiveness in cash flow hedge relationships were not significant. The pre-tax effects of derivative instruments, designated and qualifying as cash flow hedges, on “Accumulated other comprehensive loss” and the Consolidated Income Statements were as follows: Type of derivative designated as a cash flow hedge Foreign exchange contracts Commodity contracts Cash-settled call options Total Type of derivative designated as a cash flow hedge Foreign exchange contracts Commodity contracts Cash-settled call options Total Gains (losses) recognized in OCI(1) 2012 Gains (losses) recognized in income on derivatives Gains (losses) reclassified from OCI(1) (ineffective portion and amount (effective portion) into income (effective portion) excluded from effectiveness testing) ($ in millions) Location ($ in millions) Location ($ in millions) 74 Total revenues Total cost of sales 4 Total cost of sales (4) SG&A expenses(2) 74 69 Total revenues (12) Total cost of sales (4) Total cost of sales (11) SG&A expenses(2) 42 – – – – – Gains (losses) recognized in OCI(1) 2011 Gains (losses) recognized in income on derivatives Gains (losses) reclassified from OCI(1) (ineffective portion and amount (effective portion) into income (effective portion) excluded from effectiveness testing) ($ in millions) Location ($ in millions) Location ($ in millions) 9 Total revenues Total cost of sales (13) Total cost of sales (17) SG&A expenses(2) (21) 113 Total revenues (9) Total cost of sales 2 Total cost of sales (18) SG&A expenses(2) 88 – – – – – Gains (losses) recognized in OCI(1) 2010 Gains (losses) recognized in income Type of derivative designated as a cash flow hedge on derivatives Gains (losses) reclassified from OCI(1) (ineffective portion and amount (effective portion) into income (effective portion) excluded from effectiveness testing) ($ in millions) Location ($ in millions) Location ($ in millions) Foreign exchange contracts 115 Total revenues Commodity contracts Cash-settled call options Total Total cost of sales 10 Total cost of sales (2) SG&A expenses(2) 123 (1) (2) OCI represents “Accumulated other comprehensive loss”. SG&A expenses represent “Selling, general and administrative expenses”. 36 (4) Total revenues Total cost of sales 8 Total cost of sales (11) SG&A expenses(2) 29 2 – 1 – 3 Derivative gains of $28 million, $61 million and $19 million, net of tax, were reclassified from “Accumulated other comprehensive loss” to earnings during 2012, 2011 and 2010, respectively. ABB Annual Report 2012 | Financial review 97 Note 5 Financial instruments, continued Fair value hedges To reduce its interest rate exposure arising primarily from its debt issuance activities, the Company uses interest rate swaps. Where such instruments are designated as fair value hedges, the changes in fair value of these instruments, as well as the changes in fair value of the risk component of the underlying debt being hedged, are recorded as offsetting gains and losses in “Interest and other finance expense”. Hedge ineffectiveness of instruments designated as fair value hedges in 2012, 2011 and 2010, was not significant. The effect of derivative instruments, designated and qualifying as fair value hedges, on the Consolidated Income Statements was as follows: Gains (losses) recognized in income on derivatives Gains (losses) recognized in income Type of derivative designated designated as fair value hedges on hedged item as a fair value hedge Location ($ in millions) Location Interest rate contracts Interest and other finance expense 6 Interest and other finance expense ($ in millions) (6) 2012 Gains (losses) recognized in income on derivatives Gains (losses) recognized in income Type of derivative designated designated as fair value hedges on hedged item as a fair value hedge Location ($ in millions) Location Interest rate contracts Interest and other finance expense (24) Interest and other finance expense ($ in millions) 24 2011 Gains (losses) recognized in income on derivatives Gains (losses) recognized in income Type of derivative designated designated as fair value hedges on hedged item as a fair value hedge Location ($ in millions) Location Interest rate contracts Interest and other finance expense (12) Interest and other finance expense ($ in millions) 12 2010 Derivatives not designated in hedge relationships Derivative instruments that are not designated as hedges or do not qualify as either cash flow or fair value hedges are economic hedges used for risk management purposes. Gains and losses from changes in the fair values of such derivatives are recognized in the same line in the income statement as the economically hedged transaction. Furthermore, under certain circumstances, the Company is required to split and account separately for foreign currency derivatives that are embedded within certain binding sales or purchase contracts denominated in a currency other than the functional currency of the subsidiary and the counterparty. The gains (losses) recognized in the Consolidated Income Statements on derivatives not designated in hedging relation- ships are included in the table below: Type of derivative not designated as a hedge Gains (losses) recognized in income ($ in millions) Foreign exchange contracts Embedded foreign exchange contracts Commodity contracts Interest rate contracts Cash-settled call options Total Location Total revenues Total cost of sales SG&A expenses(1) Interest and other finance expense Total revenues Total cost of sales Total cost of sales Interest and other finance expense Interest and other finance expense Interest and other finance expense (1) SG&A expenses represent “Selling, general and administrative expenses”. 2012 318 (193) (3) 68 (148) 28 10 1 (1) – 80 2011 (93) (25) – 265 (31) 11 (59) 1 – (1) 68 2010 436 (263) – 563 (279) 17 38 – – (1) 511 98 Financial review | ABB Annual Report 2012 Note 5 Financial instruments, continued The fair values of derivatives included in the Consolidated Balance Sheets were as follows: December 31, 2012 ($ in millions) assets” assets” current liabilities” liabilities” Derivative assets Derivative liabilities Current in Non-current in Current in Non-current in “Other current “Other non-current “Provisions and other “Other non-current Derivatives designated as hedging instruments: Foreign exchange contracts Commodity contracts Interest rate contracts Cash-settled call options Total Derivatives not designated as hedging instruments: Foreign exchange contracts Commodity contracts Interest rate contracts Cash-settled call options Embedded foreign exchange derivatives Total Total fair value 34 1 15 9 59 204 7 – – 26 237 296 20 – 31 16 67 62 1 – 1 13 77 144 14 1 – – 15 84 11 – – 86 181 196 6 – 2 – 8 20 1 – – 40 61 69 December 31, 2011 ($ in millions) assets” assets” current liabilities” liabilities” Derivative assets Derivative liabilities Current in Non-current in Current in Non-current in “Other current “Other non-current “Provisions and other “Other non-current Derivatives designated as hedging instruments: Foreign exchange contracts Commodity contracts Interest rate contracts Cash-settled call options Total Derivatives not designated as hedging instruments: Foreign exchange contracts Commodity contracts Interest rate contracts Cash-settled call options Embedded foreign exchange derivatives Total Total fair value 37 1 – 13 51 142 9 – 1 51 203 254 6 – 40 6 52 38 1 – 1 13 53 105 26 6 – – 32 289 33 – – 77 399 431 10 – – – 10 28 3 1 – 19 51 61 Although the Company is party to close-out netting agreements with most derivative counterparties, the fair values in the tables above and in the Consolidated Balance Sheets at December 31, 2012 and 2011, have been presented on a gross basis. ABB Annual Report 2012 | Financial review 99 Note 6 Fair values Recurring fair value measures December 31, 2012 ($ in millions) Assets The following tables show the fair value of financial assets and liabilities measured at fair value on a recurring basis: Level 1 Level 2 Level 3 Total fair value Available-for-sale securities in “Cash and equivalents” Debt securities – Corporate Available-for-sale securities in “Marketable securities and short-term investments” Equity securities Debt securities – U.S. government obligations Debt securities – Other government obligations Debt securities – Corporate Available-for-sale securities in “Other non-current assets” Equity securities Derivative assets – current in “Other current assets” Derivative assets – non-current in “Other non-current assets” Total Liabilities Derivative liabilities – current in “Provisions and other current liabilities” Derivative liabilities – non-current in “Other non-current liabilities” Total December 31, 2011 ($ in millions) Assets Available-for-sale securities in “Cash and equivalents” Debt securities – Corporate Available-for-sale securities in “Marketable securities and short-term investments” Equity securities Debt securities – U.S. government obligations Debt securities – Other government obligations Debt securities – Corporate Available-for-sale securities in “Other non-current assets” Equity securities Derivative assets – current in “Other current assets” Derivative assets – non-current in “Other non-current assets” Total Liabilities Derivative liabilities – current in “Provisions and other current liabilities” Derivative liabilities – non-current in “Other non-current liabilities” Total – 3 159 – – 2 – – 128 1,279 – 3 117 – 296 144 164 1,967 4 – 4 192 69 261 – – – – – – – – – – – – 128 1,282 159 3 117 2 296 144 2,131 196 69 265 Level 1 Level 2 Level 3 Total fair value – 3 761 – – 5 2 – 771 4 – 4 180 54 – 3 125 – 252 105 719 427 61 488 – – – – – – – – – – – – 180 57 761 3 125 5 254 105 1,490 431 61 492 The Company uses the following methods and assumptions in estimating fair values of financial assets and liabilities measured at fair value on a recurring basis: – Available-for-sale securities in “Cash and equivalents”, “Marketable securities and short-term investments” and “Other non-current assets”: If quoted market prices in active markets for identical assets are available, these are con- sidered Level 1 inputs; however, when markets are not active, these inputs are considered Level 2. If such quoted market prices are not available, fair value is determined using market prices for similar assets or present value tech- niques, applying an appropriate risk-free interest rate adjusted for non-performance risk. The inputs used in present value techniques are observable and fall into the Level 2 category. – Derivatives: The fair values of derivative instruments are determined using quoted prices of identical instruments from an active market, if available (Level 1). If quoted prices are not available, price quotes for similar instruments, appropriately adjusted, or present value techniques, based on available market data, or option pricing models are used. Cash-settled call options hedging the Company’s WAR liability are valued based on bid prices of the equivalent listed warrant. The fair values obtained using price quotes for similar instruments or valuation techniques represent a Level 2 input unless significant unobservable inputs are used. 100 Financial review | ABB Annual Report 2012 Note 6 Fair values, continued Non-recurring fair value measures During 2012, impairment charges of $87 million were recorded as an adjustment to the fair value of certain equity-method investments. The non-recurring fair value measures were determined using a discounted cash flow model adjusted for industry and market conditions using Level 3 inputs and the resulting fair value of those assets remeasured during 2012 and still held at December 31, 2012, was not significant. Other non-recurring fair value measurements in 2012 were not significant. There were no significant non-recurring fair value measurements during 2011. Disclosure about financial instruments carried on a cost basis Cash and equivalents (excluding available-for-sale debt securities with original maturities up to 3 months): The carrying amounts of “Cash and equivalents” approximate the fair values, of which, at December 31, 2012, $2,784 million and $3,963 million, were determined using Level 1 and Level 2 inputs, respectively. Marketable securities and short-term investments: In addition to the “Available-for-sale securities” disclosed in the “Recurring fair value measures” section above, “Market- able securities and short-term investments” at December 31, 2012, included time deposits of $30 million, the fair value of which was determined using Level 2 inputs and other short-term investments of $15 million, the fair value of which was determined using Level 1 inputs. The carrying amount of these investments approximates the fair value. Receivables, net: The carrying amounts of “Receivables, net” approximate their fair values and include short-term loans granted. At December 31, 2012, the fair values of short-term loans, with carrying amounts of $7 million, were determined using Level 2 inputs. Other non-current assets: Includes financing receivables (including loans granted) carried at amortized cost, less an allowance for credit losses, if required. Fair values are determined using a discounted cash flow methodology based upon loan rates of similar instru- ments and reflecting appropriate adjustments for non-performance risk. The carrying values and estimated fair values of long-term loans granted and outstanding at December 31, 2012, were $58 million and $59 million, respectively, and at December 31, 2011, were $52 million and $54 million, respectively. The fair values of long-term loans granted at December 31, 2012, were determined using Level 2 inputs. Includes held-to-maturity securities (see Note 4) whose carrying values and estimated fair values at December 31, 2012, were $97 million and $124 million, respectively, and at December 31, 2011, were $92 million and $120 million, respec- tively. The fair values of these securities at December 31, 2012, were determined using Level 2 inputs. Includes restricted cash and cash deposits (pledged in respect of a certain non-current deposit liability) totaling $271 million at December 31, 2012. Their carrying amounts approximate their fair values, which were determined using Level 1 inputs. Accounts payable, trade: The carrying amounts of “Accounts payable, trade” approximate their fair values. Short-term debt and current maturities of long-term debt, excluding finance lease liabilities: Includes commercial paper, bank borrowings and overdrafts as well as bonds maturing in the next 12 months. The carrying amounts of short-term debt and current maturities of long-term debt, excluding finance lease liabilities, approximate their fair values, of which, at December 31, 2012, $1,328 million and $1,184 million were determined using Level 1 and Level 2 inputs, respectively. Long-term debt excluding finance lease liabilities: Fair values of bond issues are determined using quoted market prices. The fair values of other debt are determined using a discounted cash flow methodology based upon borrowing rates of similar debt instruments and reflecting appropriate adjustments for non-performance risk. The carrying value and estimated fair value of long-term debt, excluding finance lease liabilities, at December 31, 2012, were $7,449 million and $7,909 million, respectively, and at December 31, 2011, were $3,151 million and $3,218 million, respectively. Of the fair value amount of $7,909 million at December 31, 2012, $7,870 million was determined using Level 1 inputs, with the remaining amount determined using Level 2 inputs. “Receivables, net” consisted of the following: 2012 8,233 801 (271) 8,763 3,955 (1,143) 2,812 11,575 2011 7,750 764 (227) 8,287 3,503 (1,017) 2,486 10,773 ABB Annual Report 2012 | Financial review 101 Note 7 Receivables, net December 31, ($ in millions) Trade receivables Other receivables Allowance Unbilled receivables, net: Costs and estimated profits in excess of billings Advance payments consumed Total Note 7 Receivables, net, continued ($ in millions) Balance at January 1, Additions Deductions Exchange rate differences Balance at December 31, “Trade receivables” in the table above includes contractual retention amounts billed to customers of $390 million and $381 million at December 31, 2012 and 2011, respectively. Management expects that the substantial majority of related contracts will be completed and the substantial majority of the billed amounts retained by the customer will be collected. Of the retention amounts outstanding at December 31, 2012, 72 percent and 19 percent are expected to be collected in 2013 and 2014, respectively. “Other receivables” in the table above consists of value added tax, claims, rental deposits and other non-trade receivables. “Costs and estimated profits in excess of billings” in the table above represents revenues earned and recognized for contracts under the percentage-of-completion or completed contract method of accounting. Management expects that the majority of the amounts will be collected within one year of the respective balance sheet date. The reconciliation of changes in the allowance for doubtful accounts is as follows: 2012 227 155 (113) 2 271 2011 215 157 (131) (14) 227 2010 312 119 (216) – 215 At December 31, 2012 and 2011, the gross amounts of, and doubtful debt allowance for, trade receivables (excluding those with a contractual maturity of one year or less) and other receivables (excluding tax and other receivables which are not considered to be of a financing nature) were as follows: ($ in millions) Recorded gross amount: Individually evaluated for impairment Collectively evaluated for impairment Total Doubtful debt allowance: From individual impairment evaluation From collective impairment evaluation Total Recorded net amount December 31, 2012 December 31, 2011 Trade receivables (excluding those with Trade receivables (excluding those with a contractual maturity Other a contractual maturity Other of one year or less) receivables Total of one year or less) receivables Total 335 326 661 (42) (11) (53) 608 128 87 215 (5) – (5) 210 463 413 876 (47) (11) (58) 818 252 282 534 (41) (9) (50) 484 108 129 237 (5) – (5) 232 360 411 771 (46) (9) (55) 716 Changes in the doubtful debt allowance for trade receivables (excluding those with a contractual maturity of one year or less) were as follows: ($ in millions) Balance at January 1, Reversal of allowance Additions to allowance Amounts written off Exchange rate differences Balance at December 31, 2012 50 (7) 16 (1) (5) 53 2011 37 (13) 36 (3) (7) 50 Changes in the doubtful debt allowance for “Other receivables” in 2012 and 2011, were not significant. The Company has a group-wide policy on the management of credit risk. The policy includes a credit assessment methodology to assess the creditworthiness of customers and assign to those customers a risk category on a scale from “A” (lowest likelihood of loss) to “E” (highest likelihood of loss), as shown in the following table: Risk category Equivalent Standard & Poor’s rating A B C D E AAA to AA– A+ to BBB– BB+ to BB– B+ to CCC– CC+ to D 102 Financial review | ABB Annual Report 2012 Note 7 Receivables, net, continued Third-party agencies’ ratings are considered, if available. For customers where agency ratings are not available, the customer’s most recent financial statements, payment history and other relevant information are considered in the assignment to a risk category. Customers are assessed at least annually or more frequently when information on signifi- cant changes in the customers’ financial position becomes known. In addition to the assignment to a risk category, a credit limit per customer is set. The following table shows the credit risk profile, on a gross basis, of trade receivables (excluding those with a contractual maturity of one year or less) and other receivables (excluding tax and other receivables which are not considered to be of a financing nature) based on the internal credit risk categories which are used as a credit quality indicator: Risk category December 31, 2012 December 31, 2011 Trade receivables (excluding Trade receivables (excluding those with a contractual Other those with a contractual Other ($ in millions) maturity of one year or less) receivables Total maturity of one year or less) receivables Total A B C D E Total gross amount 279 238 90 48 6 661 156 27 30 1 1 215 435 265 120 49 7 876 251 134 122 22 5 534 196 18 20 1 2 237 447 152 142 23 7 771 The following table shows an aging analysis, on a gross basis, of trade receivables (excluding those with a contractual maturity of one year or less) and other receivables (excluding tax and other receivables which are not considered to be of a financing nature): Past due > 90 days and > 90 days Not due at not accruing and accruing December 31, December 31, 2012 ($ in millions) 0–30 days 30–60 days 60–90 days interest interest 2012(1) Total Trade receivables (excluding those with a contractual maturity of one year or less) Other receivables Total gross amount 83 3 86 3 3 6 4 2 6 Past due 38 10 48 14 1 15 519 196 715 661 215 876 > 90 days and > 90 days Not due at not accruing and accruing December 31, December 31, 2011 ($ in millions) 0–30 days 30–60 days 60–90 days interest interest 2011(1) Total Trade receivables (excluding those with a contractual maturity of one year or less) Other receivables Total gross amount 73 4 77 6 1 7 5 1 6 49 15 64 6 3 9 395 213 608 534 237 771 (1) Trade receivables (excluding those with a contractual maturity of one year or less) principally represent contractual retention amounts that will become due subsequent to the completion of the respective long-term contract. “Inventories, net” consisted of the following: Note 8 Inventories, net December 31, ($ in millions) Raw materials Work in process Finished goods Advances to suppliers Advance payments consumed Total 2012 2,427 2,075 1,741 246 6,489 (307) 6,182 2011 2,345 1,796 1,628 253 6,022 (285) 5,737 “Work in process” in the table above contains inventoried costs relating to long-term contracts of $363 million and $267 million at December 31, 2012 and 2011, respectively. “Advance payments consumed” in the table above relates to contractual advances received from customers on work in process. ABB Annual Report 2012 | Financial review 103 Note 9 Other non-current assets December 31, ($ in millions) Pledged financial assets Investments “Other non-current assets” consisted of the following: Derivatives (including embedded derivatives) (see Note 5) Restricted cash Loans granted (see Note 6) Other Total 2012 2011 288 57 144 80 58 149 776 286 143 105 103 52 115 804 The Company entered into tax-advantaged leasing transactions with U.S. investors prior to 1999. Cash deposits and held-to-maturity marketable securities (representing prepaid rents relating to these transactions) are reflected as “Pledged financial assets” in the table above, with an offsetting non-current deposit liability, which is included in “Other non-current liabilities” (see Note 13). Net gains on these transactions are being recognized over the lease terms, which expire by 2021. “Investments” represents mainly non equity-accounted investments in companies. Such shares and other equity invest- ments are carried at cost or, where the investee is listed on a stock exchange, at fair value. “Restricted cash” at December 31, 2012 and 2011, included cash set aside in a restricted bank account in connection with a capital reduction in two of the Company’s subsidiaries in order to meet certain future obligations existing on the date of the capital reduction. As such obligations are met, the amount of the restricted cash is correspondingly reduced. The remaining balances at December 31, 2012 and 2011, contained individually insignificant amounts of restricted cash. “Loans granted” in the table above primarily represents financing arrangements provided to customers (relating to products manufactured by the Company) and are reported in the balance sheet at outstanding principal amount less any write-offs or allowance for uncollectible loans. The Company determines the loan losses based on historical experience and ongoing credit evaluation of the borrower’s financial position. At December 31, 2012 and 2011, the doubtful debt allowance on loans granted was not significant. The change in such allowance during 2012 and 2011 was also not significant. Note 10 Property, plant and equipment, net “Property, plant and equipment, net” consisted of the following: December 31, ($ in millions) Land and buildings Machinery and equipment Construction in progress Accumulated depreciation Total December 31, ($ in millions) Land and buildings Machinery and equipment Accumulated depreciation Total Assets under capital leases included in “Property, plant and equipment, net” were as follows: 2012 4,316 7,603 627 12,546 (6,599) 5,947 2011 3,648 6,847 548 11,043 (6,121) 4,922 2012 2011 88 95 183 (103) 80 80 75 155 (83) 72 In 2012, 2011 and 2010, depreciation expense, including depreciation of assets under capital leases, was $733 million, $660 million and $545 million, respectively. 104 Financial review | ABB Annual Report 2012 Note 11 Goodwill and other intangible assets Changes in “Goodwill” were as follows: ($ in millions) Cost at January 1, 2011 Accumulated impairment charges Balance at January 1, 2011 Goodwill acquired during the year(1) Exchange rate differences Other Balance at December 31, 2011 Goodwill acquired during the year(1) Exchange rate differences Balance at December 31, 2012 Discrete Low Power Power Automation Voltage Process Corporate Products Systems and Motion Products Automation and Other 614 – 614 109 (11) – 712 17 5 734 1,411 – 1,411 321 (24) (3) 547 – 547 2,765 (19) – 1,705 3,293 44 13 112 15 1,762 3,420 399 – 399 16 (8) – 407 2,723 17 3,147 1,090 – 1,090 50 (10) – 1,130 (1) 11 1,140 42 (18) 24 – (2) – 22 – 1 23 Total 4,103 (18) 4,085 3,261 (74) (3) 7,269 2,895 62 10,226 (1) Amounts include adjustments arising during the 12-month measurement period subsequent to the acquisition date. December 31, ($ in millions) Capitalized software for internal use Capitalized software for sale Intangibles other than software: Customer-related Technology-related Marketing-related Other Total ($ in millions) Capitalized software for internal use Intangibles other than software: Customer-related Technology-related Marketing-related Other Total In 2012, goodwill acquired primarily included $2,723 million in respect of Thomas & Betts (allocated to the Low Voltage Products operating segment) with the remainder representing goodwill in respect of Newave Energy Holding SA (allocated to the Discrete Automation and Motion operating segment), as well as a number of smaller acquisitions and purchase accounting adjustments. In 2011, goodwill acquired primarily included $2,728 million in respect of Baldor (allocated to the Discrete Automation and Motion operating segment) with the remainder representing goodwill in respect of Mincom (allocated to the Power Systems operating segment), Trasfor (allocated to the Power Products operating segment) and AB Lorentzen & Wettre (allocated to the Process Automation operating segment), as well as a number of smaller acquisitions and purchase accounting adjustments. Intangible assets other than goodwill consisted of the following: 2012 2011 Gross carrying Accumulated Net carrying Gross carrying Accumulated Net carrying amount amortization amount amount amortization amount 688 401 2,733 768 378 73 (533) (346) (319) (240) (59) (43) 155 55 2,414 528 319 30 640 393 1,499 564 213 70 (483) (295) (163) (123) (32) (30) 157 98 1,336 441 181 40 5,041 (1,540) 3,501 3,379 (1,126) 2,253 Additions to intangible assets other than goodwill consisted of the following: 2012 71 2011 74 1,204 1,272 222 161 – 415 153 3 1,658 1,917 ABB Annual Report 2012 | Financial review 105 Note 11 Goodwill and other intangible assets, continued Included in the additions of $1,658 million and $1,917 million in 2012 and 2011, respectively, were the following intangible assets other than goodwill related to business combinations: ($ in millions) Capitalized software for internal use Intangibles other than software: Customer-related (1) Technology-related Marketing-related Other Total (1) Includes order backlog related to business combinations. 2012 2011 Amount Weighted-average Amount Weighted-average acquired useful life acquired – 1,200 222 161 – 1,583 – 15 18 years 5 years 10 years – 1,267 415 153 3 15 years 1,853 useful life 5 years 18 years 6 years 10 years 4 years 14 years ($ in millions) Capitalized software for internal use Capitalized software for sale Intangibles other than software Total ($ in millions) 2013 2014 2015 2016 2017 Thereafter Total Note 12 Debt Short-term debt and current maturities of long-term debt December 31, ($ in millions) Amortization expense of intangible assets other than goodwill consisted of the following: 2012 2011 2010 79 38 332 449 87 48 200 335 75 32 50 157 In 2012, 2011 and 2010, impairment charges on intangible assets other than goodwill were not significant. At December 31, 2012, future amortization expense of intangible assets other than goodwill is estimated to be: 446 399 348 323 248 1,737 3,501 The Company’s total debt at December 31, 2012 and 2011, amounted to $10,071 million and $3,996 million, respectively. The Company’s “Short-term debt and current maturities of long-term debt” consisted of the following: Short-term debt (weighted-average interest rate of 1.7% and 3.4%, respectively) Current maturities of long-term debt (weighted-average nominal interest rate of 4.8% and 4.6%, respectively) Total 2012 1,531 1,006 2,537 2011 689 76 765 Short-term debt primarily represented issued commercial paper and short-term loans from various banks. At December 31, 2012 and 2011, the Company had in place three commercial paper programs: a $1 billion Euro-commer- cial paper program for the issuance of commercial paper in a variety of currencies; a 5 billion Swedish krona commercial paper program for the issuance of Swedish krona and euro-denominated commercial paper and, since the third quarter of 2012, a $2 billion commercial paper program for the private placement of U.S. dollar denominated commercial paper in the United States that replaced the previous $1 billion program (terminated in the third quarter of 2012). At Decem- ber 31, 2012 and 2011, $1,019 million and $435 million, were outstanding under the $2 billion and $1 billion programs, respectively, in the United States. 106 Financial review | ABB Annual Report 2012 Note 12 Debt, continued In addition, the Company has a $2 billion multicurrency revolving credit facility, maturing in 2015. The facility is for general corporate purposes, including as a back-stop for the above-mentioned commercial paper programs. Interest costs on drawings under the facility are LIBOR, STIBOR or EURIBOR (depending on the currency of the drawings) plus a margin of between 0.425 percent and 0.625 percent (depending on the Company’s credit rating), while commitment fees (payable on the unused portion of the facility) amount to 35 percent of the margin, which, given the Company’s credit ratings at December 31, 2012, represents commitment fees of 0.166 percent per annum. Utilization fees, payable on drawings, amount to 0.15 percent per annum on drawings over one-third but less than or equal to two-thirds of the facility, or 0.3 percent per annum on drawings over two-thirds of the facility. No utilization fees are payable on drawings representing one-third or less of the total facility. No amount was drawn at December 31, 2012 and 2011. The facility contains cross-default clauses whereby an event of default would occur if the Company were to default on indebtedness as defined in the facility, at or above a specified threshold. Long-term debt The Company utilizes derivative instruments to modify the interest characteristics of its long-term debt. In particular, the Company uses interest rate swaps to effectively convert certain fixed-rate long-term debt into floating rate obligations. The carrying value of debt, designated as being hedged by fair value hedges, is adjusted for changes in the fair value of the risk component of the debt being hedged. The following table summarizes the Company’s long-term debt considering the effect of interest rate swaps. Conse- quently, a fixed-rate debt subject to a fixed-to-floating interest rate swap is included as a floating rate debt in the table below: December 31, ($ in millions, except % data) Balance Nominal rate Effective rate Balance Nominal rate Effective rate 2012 2011 Floating rate Fixed rate Current portion of long-term debt Total 2,353 6,187 8,540 (1,006) 7,534 3.4% 3.1% 4.8% 1.6% 3.1% 1.3% 1,875 1,432 3,307 (76) 3,231 3.3% 3.7% 4.6% At December 31, 2012, maturities of long-term debt were as follows: ($ in millions) Due in 2013 Due in 2014 Due in 2015 Due in 2016 Due in 2017 Thereafter Total December 31, (in millions) Bonds: 4.625% EUR Instruments, due 2013 2.5% USD Notes, due 2016 1.25% CHF Bonds, due 2016 1.625% USD Notes, due 2017 4.25% AUD Notes, due 2017 1.50% CHF Bonds, due 2018 2.625% EUR Instruments, due 2019 4.0% USD Notes, due 2021 2.25% CHF Bonds, due 2021 5.625% USD Notes, due 2021 2.875% USD Notes, due 2022 4.375% USD Notes, due 2042 Total outstanding bonds Details of the Company’s outstanding bonds were as follows: 2012 2011 Nominal Carrying Nominal outstanding value(1) outstanding Carrying value(1) EUR USD CHF USD AUD CHF EUR USD CHF USD USD USD 700 600 500 500 400 350 1,250 650 350 250 1,250 750 $ $ $ $ $ $ $ $ $ $ $ $ $ 931 597 557 497 413 383 1,648 641 402 291 1,224 727 8,311 EUR USD CHF 700 600 500 USD CHF 650 350 $ $ $ $ $ 910 596 535 – – – – 640 378 – – – $ 3,059 (1) USD carrying value is net of bond discounts and includes adjustments for fair value hedge accounting, where appropriate. ABB Annual Report 2012 | Financial review 107 1.6% 3.7% 4.6% 1,006 17 35 1,184 917 5,381 8,540 Note 12 Debt, continued The 4.625% EUR Instruments, due 2013, pay interest annually in arrears at a fixed annual rate of 4.625 percent. The Company has the option to redeem the bonds early at any time from June 6, 2010, in accordance with the terms of the bonds. In the event of a change of control, a bondholder can require the Company to repurchase or redeem the bonds, in accordance with the terms of the bonds. The Company entered into interest rate swaps to hedge its interest obliga- tions on these bonds. After considering the impact of such swaps, these bonds effectively became a floating rate euro obligation and consequently have been shown as floating rate debt in the table of long-term debt above. The 2.5% USD Notes, due 2016, and the 4.0% USD Notes, due 2021, pay interest semi-annually in arrears, at fixed annual rates of 2.5 percent and 4.0 percent, respectively. The Company may redeem these notes prior to maturity, in whole or in part, at the greater of i) 100 percent of the principal amount of the notes to be redeemed and ii) the sum of the pres- ent values of remaining scheduled payments of principal and interest (excluding interest accrued to the redemption date) discounted to the redemption date at a rate defined in the note terms, plus interest accrued at the redemption date. The 1.25% CHF Bonds, due 2016, and the 2.25% Bonds, due 2021, pay interest annually in arrears, at fixed annual rates of 1.25 percent and 2.25 percent, respectively. The Company has the option to redeem the bonds prior to maturity, in whole, at par plus accrued interest, if 85 percent of the aggregate principal amount of the bonds has been redeemed or purchased and cancelled. The Company entered into interest rate swaps to hedge its interest obligations on these bonds. After considering the impact of such swaps, these bonds effectively became floating rate Swiss franc obligations and consequently have been shown as floating rate debt in the table of long-term debt above. The 1.50% CHF Bonds, due 2018, were issued in January 2012, and the Company recorded net proceeds of CHF 346 million (equivalent to approximately $370 million on date of issuance). The bonds have an aggregate principal of CHF 350 million and pay interest annually in arrears at a fixed annual rate of 1.5 percent. The Company has the option to redeem the bonds prior to maturity, in whole, at par plus accrued interest, if 85 percent of the aggregate principal amount of the bonds has been redeemed or purchased and cancelled. The 2.625% EUR Instruments, due 2019, were issued in March 2012, and the Company recorded proceeds (net of fees) of EUR 1,245 million (equivalent to approximately $1,648 million on date of issuance). The instruments have an aggregate principal of EUR 1,250 million and pay interest annually in arrears at a fixed rate of 2.625 percent per annum. In May 2012, the Company issued the following notes (i) $500 million of 1.625% USD Notes, due 2017, paying interest semi-annually in arrears at a fixed annual rate of 1.625 percent, (ii) $1,250 million of 2.875% USD Notes, due 2022, paying interest semi-annually in arrears at a fixed annual rate of 2.875 percent, and (iii) $750 million of 4.375% USD Notes, due 2042, paying interest semi-annually in arrears at a fixed annual rate of 4.375 percent. The Company may redeem these notes prior to maturity, in whole or in part, at the greater of i) 100 percent of the principal amount of the notes to be redeemed and ii) the sum of the present values of remaining scheduled payments of principal and interest (excluding interest accrued to the redemption date) discounted to the redemption date at a rate defined in the note terms, plus interest accrued at the redemption date. The aggregate net proceeds of these bond issues, after underwriting discount and other fees, amounted to $2,431 million. These notes, registered with the U.S. Securities and Exchange Commis- sion, were issued by ABB Finance (USA) Inc., a 100 percent owned finance subsidiary, and were fully and uncondition- ally guaranteed by ABB Ltd. There are no significant restrictions on the ability of the parent company to obtain funds from its subsidiaries by dividend or loan. In reliance on Rule 3-10 of Regulation S-X, the separate financial statements of ABB Finance (USA) Inc. are not provided. The 5.625% USD Notes, due 2021, were assumed in May 2012, upon the acquisition of Thomas & Betts and pay interest semi-annually in arrears at a fixed annual rate of 5.625 percent. These notes, with an aggregate principal of $250 million, were recorded at their fair value on the date the Company acquired Thomas & Betts and are being amortized to par over the period to maturity. The Company has the option to redeem the notes prior to maturity at the greater of i) 100 per- cent of the principal amount of the notes to be redeemed, and ii) the sum of the present values of remaining scheduled payments of principal and interest (excluding interest accrued to the redemption date) discounted to the redemption date at a rate defined in the note terms, plus interest accrued at the redemption date. The 4.25% AUD Notes, due 2017, were issued in November 2012. Net issuance proceeds (after underwriting fees) totaled AUD 398 million (equivalent to approximately $412 million on date of issuance). The notes, with an aggregate principal of AUD 400 million, pay fixed interest of 4.25 percent semi-annually in arrears. The Company entered into interest rate swaps to hedge its interest obligations on these bonds. After considering the impact of such swaps, these bonds effectively became floating rate Australian dollar obligations and consequently have been shown as floating rate debt in the table of long-term debt above. The Company’s bonds contain cross-default clauses which would allow the bondholders to demand repayment if the Company were to default on any borrowing at or above a specified threshold. Furthermore, all such bonds constitute unsecured obligations of the Company and rank pari passu with other debt obligations. In addition to the bonds described above, included in long-term debt at December 31, 2012 and 2011, are capital lease obligations, bank borrowings of subsidiaries and other long-term debt, none of which is individually significant. 108 Financial review | ABB Annual Report 2012 Note 13 Provisions and other current liabilities and other non-current liabilities December 31, ($ in millions) Contract-related provisions Taxes payable “Provisions and other current liabilities” consisted of the following: Restructuring and other related provisions Provisions for contractual penalties and compliance and litigation matters Provision for insurance related reserves Current derivative liabilities (see Note 5) Pension and other employee benefits (see Note 17) Income tax related liabilities Environmental provisions (see Note 15) Other Total “Other non-current liabilities” consisted of the following: December 31, ($ in millions) Income tax related liabilities Non-current deposit liabilities (see Note 9) Environmental provisions (see Note 15) Non-current derivative liabilities (see Note 5) Deferred income The Company’s lease obligations primarily relate to real estate and office equipment. Rent expense was $610 million, $601 million and $510 million in 2012, 2011 and 2010, respectively. Sublease income received by the Company on leased assets was $25 million, $41 million and $44 million in 2012, 2011 and 2010, respectively. At December 31, 2012, future net minimum lease payments for operating leases, having initial or remaining non- cancelable lease terms in excess of one year, consisted of the following: At December 31, 2012, the future net minimum lease payments for capital leases and the present value of the net minimum lease payments consisted of the following: Thereafter Total minimum lease payments Less amount representing estimated executory costs included in total minimum lease payments Net minimum lease payments Less amount representing interest Present value of minimum lease payments ABB Annual Report 2012 | Financial review 109 2012 2011 684 369 227 223 215 196 164 41 22 226 588 377 242 225 208 431 76 153 22 297 2,367 2,619 2012 732 283 69 69 48 365 1,566 2011 647 286 70 61 56 376 1,496 527 435 364 297 221 295 2,139 (62) 2,077 31 28 24 15 8 82 188 (2) 186 (83) 103 Other Total Note 14 Leases ($ in millions) 2013 2014 2015 2016 2017 Thereafter Sublease income Total ($ in millions) 2013 2014 2015 2016 2017 Note 14 Leases, continued Minimum lease payments have not been reduced by minimum sublease rentals due in the future under non-cancelable subleases. Such minimum sublease rentals were not significant. The present value of minimum lease payments is presented in “Short-term debt and current maturities of long-term debt” or “Long-term debt” in the Consolidated Bal- ance Sheets. Note 15 Commitments and contingencies Contingencies – Environmental The Company is engaged in environmental clean-up activities at certain sites arising under various United States and other environmental protection laws and under certain agreements with third parties. In some cases, these environmen- tal remediation actions are subject to legal proceedings, investigations or claims, and it is uncertain to what extent the Company is actually obligated to perform. Provisions for these unresolved matters have been set up if it is probable that the Company has incurred a liability and the amount of loss can be reasonably estimated. If a provision has been recog- nized for any of these matters, the Company records an asset when it is probable that it will recover a portion of the costs expected to be incurred to settle them. Management is of the opinion, based upon information presently available, that the resolution of any such obligation and non-collection of recoverable costs would not have a further material adverse effect on the Company’s consolidated financial statements. Contingencies related to former Nuclear Technology business The Company retained liabilities for certain specific environmental remediation costs at two sites in the United States that were operated by its former subsidiary, ABB CE-Nuclear Power Inc., which the Company sold to British Nuclear Fuels PLC (BNFL) in 2000. Pursuant to the sale agreement with BNFL, the Company has retained the environmental liabilities associated with its Combustion Engineering Inc. subsidiary’s Windsor, Connecticut, facility and agreed to reimburse BNFL for a share of the costs that BNFL incurs for environmental liabilities associated with its former Hematite, Missouri, facility. The primary environmental liabilities associated with these sites relate to the costs of remediating radiological and chemical contamination. Such costs are not incurred until a facility is taken out of use and generally are then incurred over a number of years. Based on information available, the Company believes that radiological remediation at the Windsor site will be concluded in 2013. In February 2011, the Company and Westinghouse Electric Company LLC (BNFL’s former subsidiary) agreed to settle and release the Company from its continuing environmental obligations under the sale agreement in respect of the Hematite site. The settlement amount was paid by the Company in February 2011. During 2007, the Company reached an agreement with U.S. government agencies to transfer oversight of the remedia- tion of the portion of the Windsor site under the U.S. Government’s Formerly Utilized Sites Remedial Action Program from the U.S. Army Corps of Engineers to the Nuclear Regulatory Commission which has oversight responsibility for the remaining radiological areas of that site and the Company’s radiological license for the site. Contingencies related to other present and former facilities primarily in North America The Company is involved in the remediation of environmental contamination at present or former facilities, primarily in the United States. The clean up of these sites involves primarily soil and groundwater contamination. A significant portion of the provisions in respect of these contingencies reflects the provisions of acquired companies. A substantial portion of one of the acquired entities remediation liability is indemnified by a prior owner. Accordingly, an asset equal to that portion of the remediation liability is included in “Other non-current assets”. The impact of the above Nuclear Technology and other environmental obligations on “Income from continuing opera- tions, net of tax” was not significant in 2012, 2011 and 2010. The impact on “Income from discontinued operations, net of tax” was not significant in 2012 and 2011, and was an income of $29 million in 2010. The effect of the above Nuclear Technology and other environmental obligations on the Company’s Consolidated State- ments of Cash Flows was not significant for the year ended December 31, 2012, and amounted to $149 million and $26 million for the years ended December 31, 2011 and 2010, respectively, primarily related to the Nuclear Technology business. The Company’s estimated cash expenditures for 2013 are $18 million and are covered by provisions included in “Provisions and other current liabilities”. The total effect of the above Nuclear Technology and other environmental obligations on the Company’s Consolidated Balance Sheets was as follows: December 31, ($ in millions) Provision balance relating to: Nuclear Technology business Various businesses Environmental provisions included in: Provisions and other current liabilities Other non-current liabilities 2012 2011 9 82 91 22 69 91 24 68 92 22 70 92 Provisions for the above estimated losses have not been discounted as the timing of payments cannot be reasonably estimated. 110 Financial review | ABB Annual Report 2012 Note 15 Commitments and contingencies, continued Contingencies – Regulatory, Compliance and Legal Antitrust In January 2007, the European Commission granted the Company full immunity from fines under its leniency program for the Company’s involvement in anti-competitive practices in the Gas Insulated Switchgear (GIS) business. The Com- pany’s GIS business remains under investigation for alleged anti-competitive practices in certain other jurisdictions, including Brazil. An informed judgment about the outcome of these investigations or the amount of potential loss or range of loss for the Company, if any, relating to these investigations cannot be made at this stage. In October 2009, the European Commission fined the Company euro 33.75 million (equivalent to $49 million on date of payment) for its involvement in anti-competitive practices in the power transformers business. In September 2012, the German Antitrust Authority (Bundeskartellamt) fined one of the Company’s German subsidiaries euro 8.7 million (equivalent to approximately $11 million on date of payment) for its involvement in anti-competitive practices in the German power transformers business. The Company did not appeal either decision and it paid both fines in full. The Company’s cables business is under investigation for alleged anti-competitive practices in a number of jurisdic- tions, including the European Union and Brazil. The Company has received the European Commission’s Statement of Objections concerning its investigation into the cables business and in June 2012 participated in the related Oral Hearing before the European Commission. The Company has also received an initial summary of the Brazilian Antitrust Authority’s (CADE) allegations regarding its investigation into the cables business. An informed judgment about the outcome of these investigations or the amount of potential loss or range of loss for the Company, if any, relating to these investigations cannot be made at this stage, except with respect to the Brazilian investigation, where the Company expects an unfavorable outcome. In May 2012, the Brazilian Antitrust Authority opened an investigation into certain power businesses of the Company, including its FACTS and power transformers business. An informed judgment about the outcome of this investigation or the amount of potential loss or range of loss for the Company, if any, relating to this investigation cannot be made at this stage. With respect to the foregoing matters which are still ongoing, Management is cooperating fully with the antitrust authorities. Suspect payments In April 2005, the Company voluntarily disclosed to the United States Department of Justice (DoJ) and the United States Securities and Exchange Commission (SEC) certain suspect payments in its network management unit in the United States. Subsequently, the Company made additional voluntary disclosures to the DoJ and the SEC regarding suspect payments made by other Company subsidiaries in a number of countries in the Middle East, Asia, South America and Europe (including to an employee of an Italian power generation company) as well as by its former Lummus business. These payments were discovered by the Company as a result of the Company’s internal audit program and compliance reviews. In September 2010, the Company reached settlements with the DoJ and the SEC regarding their investigations into these matters and into suspect payments involving certain of the Company’s subsidiaries in the United Nations Oil-for- Food Program. In connection with these settlements, the Company agreed to make payments to the DoJ and SEC totaling $58 million, which were settled in the fourth quarter of 2010. One subsidiary of the Company pled guilty to one count of conspiracy to violate the anti-bribery provisions of the U.S. Foreign Corrupt Practices Act and one count of violating those provisions. The Company entered into a deferred prosecution agreement and settled civil charges brought by the SEC. These settlements resolved the foregoing investigations. In lieu of an external compliance monitor, the DoJ and SEC have agreed to allow the Company to report on its continuing compliance efforts and the results of the review of its internal processes through September 2013. General In addition, the Company is aware of proceedings, or the threat of proceedings, against it and others in respect of private claims by customers and other third parties with regard to certain actual or alleged anti-competitive practices. Also, the Company is subject to other various legal proceedings, investigations, and claims that have not yet been resolved. With respect to the above-mentioned regulatory matters and commercial litigation contingencies, the Com- pany will bear the costs of the continuing investigations and any related legal proceedings. Liabilities recognized At December 31, 2012 and 2011, the Company had aggregate liabilities of $211 million and $208 million, respectively, included in “Provisions and other current liabilities” and in “Other non-current liabilities”, for the above regulatory, com- pliance and legal contingencies. As it is not possible to make an informed judgment on the outcome of certain matters and as it is not possible, based on information currently available to management, to estimate the maximum potential liability on other matters, there could be material adverse outcomes beyond the amounts accrued. General The following table provides quantitative data regarding the Company’s third-party guarantees. The maximum potential payments represent a “worst-case scenario”, and do not reflect management’s expected results. The carrying amount of liabilities recorded in the Consolidated Balance Sheets reflects the Company’s best estimate of future payments, which it may incur as part of fulfilling its guarantee obligations. ABB Annual Report 2012 | Financial review 111 Guarantees Note 15 Commitments and contingencies, continued December 31, ($ in millions) Performance guarantees Financial guarantees Indemnification guarantees Total Maximum potential payments 2012 149 83 190 422 2011 148 85 194 427 In respect of the above guarantees, the carrying amounts of liabilities at December 31, 2012 and 2011, were not sig nificant. Performance guarantees Performance guarantees represent obligations where the Company guarantees the performance of a third party’s product or service according to the terms of a contract. Such guarantees may include guarantees that a project will be com- pleted within a specified time. If the third party does not fulfill the obligation, the Company will compensate the guaran- teed party in cash or in kind. Performance guarantees include surety bonds, advance payment guarantees and standby letters of credit. The significant performance guarantees are described below. The Company retained obligations for guarantees related to the Power Generation business contributed in mid-1999 to the former ABB Alstom Power NV joint venture (Alstom Power NV). The guarantees primarily consist of performance guarantees and other miscellaneous guarantees under certain contracts such as indemnification for personal injuries and property damages, taxes and compliance with labor laws, environmental laws and patents. The guarantees are related to projects which are expected to be completed by 2013 but in some cases have no definite expiration date. In May 2000, the Company sold its interest in Alstom Power NV to Alstom SA (Alstom). As a result, Alstom and its sub sidiaries have primary responsibility for performing the obligations that are the subject of the guarantees. Further, Alstom, the parent company and Alstom Power NV, have undertaken jointly and severally to fully indemnify and hold harmless the Company against any claims arising under such guarantees. Management’s best estimate of the total maximum potential amount payable of quantifiable guarantees issued by the Company on behalf of its former Power Generation business was $78 million and $87 million at December 31, 2012 and 2011, respectively, and is subject to foreign exchange fluctuations. The Company has not experienced any losses related to guarantees issued on behalf of the former Power Generation business. The Company is engaged in executing a number of projects as a member of consortia that include third parties. In certain of these cases, the Company guarantees not only its own performance but also the work of third parties. The original maturity dates of these guarantees range from one to six years. At December 31, 2012 and 2011, the maxi- mum potential amount payable under these guarantees as a result of third-party non-performance was $57 million and $45 million, respectively. Financial guarantees Financial guarantees represent irrevocable assurances that the Company will make payment to a beneficiary in the event that a third party fails to fulfill its financial obligations and the beneficiary under the guarantee incurs a loss due to that failure. At December 31, 2012 and 2011, the Company had a maximum potential amount payable of $83 million and $85 million, respectively, under financial guarantees outstanding. Of each of those amounts, $19 million at both December 31, 2012 and 2011, was in respect of guarantees issued on behalf of companies in which the Company formerly had or has an equity interest. The guarantees outstanding have various maturity dates up to 2020. Indemnification guarantees The Company has indemnified certain purchasers of divested businesses for potential claims arising from the operations of the divested businesses. To the extent the maximum potential loss related to such indemnifications could not be calculated, no amounts have been included under maximum potential payments in the table above. Indemnifications for which maximum potential losses could not be calculated include indemnifications for legal claims. The significant indem- nification guarantees for which maximum potential losses could be calculated are described below. The Company issued to the purchasers of Lummus Global guarantees related to assets and liabilities divested in 2007. The maximum potential amount payable relating to this business, pursuant to the sales agreement, at each of Decem- ber 31, 2012 and 2011, was $50 million. The Company issued to the purchasers of its interest in Jorf Lasfar Energy Company S.C.A. guarantees related to assets and liabilities divested in 2007. The maximum potential amount payable at December 31, 2012 and 2011, of $140 million and $141 million, respectively, relating to this business, is subject to foreign exchange fluctuations. 112 Financial review | ABB Annual Report 2012 Note 15 Commitments and contingencies, continued Product and order related contingencies The Company calculates its provision for product warranties based on historical claims experience and specific review of certain contracts. The reconciliation of “Provisions for warranties”, including guarantees of product performance, was as follows: ($ in millions) Balance at January 1, Warranties assumed through acquisitions Claims paid in cash or in kind Net increase in provision for changes in estimates, warranties issued and warranties expired The Company conducts business with certain companies where members of the Company’s board of directors or executive committee act as directors or senior executives. The Company’s board of directors has determined that the Company’s business relationships with those companies do not constitute material business relationships. This determination was made in accordance with the Company’s related party transaction policy which was prepared based on the Swiss Code of Best Practice and the independence criteria set forth in the corporate governance rules of the New York Stock Exchange. “Provision for taxes” consisted of the following: Exchange rate differences Balance at December 31, Related party transactions Note 16 Taxes ($ in millions) Current taxes Deferred taxes Tax expense from continuing operations Tax benefit from discontinued operations 2012 1,324 4 (219) 149 33 2011 1,393 10 (177) 124 (26) 1,291 1,324 2012 967 63 1,030 – 2011 1,278 (34) 1,244 (1) 2010 867 151 1,018 (3) Tax expense from continuing operations is reconciled below from the Company’s weighted-average global tax rate, rather than from the Swiss domestic statutory tax rate, as the parent company of the ABB Group, ABB Ltd, is domiciled in Switzerland and income generated in jurisdictions outside of Switzerland (hereafter “foreign jurisdictions”) which has already been subject to corporate income tax in those foreign jurisdictions is, to a large extent, tax exempt in Switzer- land. There is no requirement in Switzerland for a parent company of a group to file a tax return of the consolidated group determining domestic and foreign pre-tax income, and as the Company’s consolidated income from continuing opera- tions is predominantly earned outside of Switzerland, corporate income tax in foreign jurisdictions largely determines the global tax rate of the Company. The reconciliation of “Tax expense from continuing operations” at the weighted-average tax rate to the effective tax rate is as follows: ($ in millions, except % data) Income from continuing operations before taxes Weighted-average tax rate Income taxes at weighted-average tax rate Items taxed at rates other than the weighted-average tax rate Changes in valuation allowance, net Effects of changes in tax laws and enacted tax rates Other, net Tax expense from continuing operations Effective tax rate for the year 2012 3,838 23.6% 906 60 44 (27) 47 2011 4,550 24.9% 1,134 103 (22) (17) 46 2010 3,740 25.3% 945 (21) 60 6 28 1,030 26.8% 1,244 27.3% 1,018 27.2% In 2012 and 2011, the “Items taxed at rates other than the weighted-average tax rate” predominantly related to tax credits arising in foreign jurisdictions for which the technical merits did not allow a benefit to be taken. In 2012, 2011 and 2010, “Changes in the valuation allowance, net” included reductions in valuation allowances recorded in certain jurisdictions where the Company determined that it was more likely than not that such deferred tax assets (recognized for net operating losses and temporary differences in those jurisdictions) would be realized, as well as increases in the valuation allowance in certain other jurisdictions. In 2012, the “Changes in valuation allowance, net” included an expense of $36 million related to certain of the Company’s operations in Central Europe. In 2011, the “Changes in valuation allowance, net” included a benefit of $47 million, related to certain of the Company’s operations in Northern Europe, and in 2010, the “Changes in valuation allowance, net” included an expense of $44 million related to certain of the Company’s operations in Central Europe. ABB Annual Report 2012 | Financial review 113 Note 16 Taxes, continued In 2012, 2011 and 2010, “Other, net” of $47 million, $46 million and $28 million, respectively, in the table above, included expenses of $94 million, $60 million and $45 million, respectively, in relation to items that were deducted for financial accounting purposes, but were not tax deductible, such as interest expense, state and local taxes on productive activi- ties, disallowed meals and entertainment expenses and other similar items. Deferred income tax assets and liabilities consisted of the following: December 31, ($ in millions) Deferred tax assets: Unused tax losses and credits Pension and other accrued liabilities Inventories Property, plant and equipment Other Total gross deferred tax asset Valuation allowance Total gross deferred tax asset, net of valuation allowance Deferred tax liabilities: Property, plant and equipment, and intangible assets Pension and other accrued liabilities Inventories Other current assets Unremitted earnings Other Total gross deferred tax liability Net deferred tax asset (liability) Included in: “Deferred taxes” – current assets “Deferred taxes” – non-current assets “Deferred taxes” – current liabilities “Deferred taxes” – non-current liabilities Net deferred tax asset (liability) 2012 2011 1,009 1,395 287 125 104 2,920 (550) 2,370 963 1,064 276 192 134 2,629 (375) 2,254 (1,366) (1,037) (252) (118) (169) (766) (26) (164) (152) (220) (213) (60) (2,697) (1,846) (327) 408 869 334 (270) (1,260) (327) 932 318 (305) (537) 408 The decrease in “Net deferred tax asset (liability)” at December 31, 2012, related primarily to approximately $870 million of net deferred tax liabilities acquired in business combinations, including estimated taxes of $475 million provided for unremitted earnings of the acquired companies. Certain entities have deferred tax assets related to net operating loss carry-forwards and other items. As recognition of these assets did not meet the more likely than not criterion, valuation allowances were established, amounting to $550 million and $375 million, at December 31, 2012 and 2011, respectively. “Unused tax losses and credits” at Decem- ber 31, 2012 and 2011, in the table above, included $155 million and $166 million, respectively, for which the Company has established a full valuation allowance as, due to limitations imposed by the relevant tax law, the Company determined that, more likely than not, such deferred tax assets would not be realized. At December 31, 2012, “Valuation allowance” included an increase of $102 million arising upon business combinations. At December 31, 2012 and 2011, deferred tax liabilities totaling $766 million and $213 million have been provided for in respect of withholding taxes, dividend distribution taxes or additional corporate income taxes (hereafter “withholding taxes”) on unremitted earnings, as well as for limited Swiss income taxes on any such repatriated earnings. Income which has been generated outside of Switzerland and has already been subject to corporate income tax in such foreign jurisdictions is, to a large extent, tax exempt in Switzerland. Therefore, generally no or only limited Swiss income tax has to be provided for on the repatriated earnings of foreign subsidiaries. Certain countries levy withholding taxes on dividend distributions. Such taxes cannot always be fully reclaimed by the shareholder, although they have to be declared and withheld by the subsidiary. In 2012 and 2011, certain taxes arose in certain foreign jurisdictions for which the technical merits do not allow utilization of benefits. At December 31, 2012 and 2011, approximately $400 million, of foreign subsidiary retained earnings subject to withholding taxes upon distribu- tion were considered as permanently reinvested, as these funds are used for financing current operations as well as business growth through working capital and capital expenditure in those countries, and consequently, no deferred tax liability was set up. At December 31, 2012, net operating loss carry-forwards of $2,749 million and tax credits of $190 million were available to reduce future taxes of certain subsidiaries. Of these amounts, $1,782 million of loss carry-forwards and $180 million of tax credits will expire in varying amounts through 2032. The largest amount of these carry-forwards related to the Company’s U.S. operations. 114 Financial review | ABB Annual Report 2012 Note 16 Taxes, continued Unrecognized tax benefits consisted of the following: ($ in millions) Classification as unrecognized tax items on January 1, 2010 Net change due to acquisitions and divestments Increase relating to prior year tax positions Decrease relating to prior year tax positions Increase relating to current year tax positions Decrease relating to current year tax positions Decrease due to settlements with tax authorities Decrease as a result of the applicable statute of limitations Exchange rate differences Balance at December 31, 2010, which would, if recognized, affect the effective tax rate Net change due to acquisitions and divestments Increase relating to prior year tax positions Decrease relating to prior year tax positions Increase relating to current year tax positions Decrease relating to current year tax positions Decrease due to settlements with tax authorities Decrease as a result of the applicable statute of limitations Exchange rate differences Balance at December 31, 2011, which would, if recognized, affect the effective tax rate Net change due to acquisitions and divestments Increase relating to prior year tax positions Decrease relating to prior year tax positions Increase relating to current year tax positions Decrease relating to current year tax positions Decrease due to settlements with tax authorities Decrease as a result of the applicable statute of limitations Exchange rate differences Balance at December 31, 2012, which would, if recognized, affect the effective tax rate Penalties and interest related Unrecognized to unrecognized tax benefits tax benefits 712 5 56 (32) 114 (15) (40) (72) (14) 714 9 52 (31) 128 (2) (78) (135) (4) 653 10 51 (73) 141 (3) (89) (29) 8 669 176 – 38 (6) 5 (4) (9) (21) (1) 178 2 61 (11) 2 – (27) (35) (1) 169 – 26 (56) 1 – (11) (7) 5 127 Total 888 5 94 (38) 119 (19) (49) (93) (15) 892 11 113 (42) 130 (2) (105) (170) (5) 822 10 77 (129) 142 (3) (100) (36) 13 796 In 2012, the “Decrease relating to prior year tax positions” included a total of $87 million relating to the release of provi- sions due to favorable resolution of a tax dispute in Northern Europe. In 2012, the “Increase relating to current year tax positions” included a total of $108 million in taxes related to the interpretation of tax law and double tax treaty agree- ments by competent tax authorities. In 2012, the “Decrease due to settlements with tax authorities” included a total of $47 million relating to the interpretation of tax law and double tax treaty agreements by competent tax authorities. In 2011, the “Increase relating to prior year tax positions”, in unrecognized tax benefits above, related primarily to a tax dispute in Asia. The “Increase relating to prior year tax positions”, in penalties and interest related to unrecognized tax benefits above, mainly reflected the interest accrual on prior years’ tax positions. Also in 2011, the “Increase relating to current year tax positions” included a total of $97 million in taxes related to the interpretation of tax law and double tax treaty agreements by competent tax authorities. In 2011, the “Decrease due to settlements with tax authorities” included $49 million in tax, penalty and interest relating to a tax dispute in Northern Europe, while the “Decrease as a result of the applicable statute of limitations” included both the effect of the statute of limitations in certain jurisdictions, as well as instances where tax audits had been concluded by taxing authorities and the corresponding tax years were conse- quently considered closed. In 2010, the “Increase relating to current year tax positions” in the table above included an expense of $88 million related to the interpretation of tax law and double tax treaty agreements by competent tax authorities. At December 31, 2012, the Company expected the resolution, within the next twelve months, of uncertain tax positions related to pending court cases amounting to $41 million for taxes, penalties and interest. Otherwise, the Company had not identified any other significant changes which were considered reasonably possible to occur within the next twelve months. ABB Annual Report 2012 | Financial review 115 Note 16 Taxes, continued Region Europe The Americas Asia Middle East & Africa Note 17 Note 17 Employee benefits Employee benefits At December 31, 2012, the earliest significant open tax years that remained subject to examination were the following: Year 2007 2008 2003 2004 The Company operates defined benefit and defined contribution pension plans and termination indemnity plans, in accordance with local regulations and practices. These plans cover a large portion of the Company’s employees and provide benefits to employees in the event of death, disability, retirement, or termination of employment. Certain of these plans are multi-employer plans. The Company also operates other postretirement benefit plans including post- retirement healthcare benefits, and other employee-related benefits for active employees including long-service award plans. The measurement date used for the Company’s employee benefit plans is December 31. The funding policies of the Company’s plans are consistent with the local government and tax requirements. The Company also has several pension plans that are not required to be funded pursuant to local government and tax requirements. The Company recognizes in its Consolidated Balance Sheets the funded status of its defined benefit pension plans, postretirement plans, and other employee-related benefits measured as the difference between the fair value of the plan assets and the benefit obligation. Obligations and funded status of the plans The change in benefit obligation, change in fair value of plan assets, and funded status recognized in the Consolidated Balance Sheets were as follows: ($ in millions) Benefit obligation at January 1, Service cost Interest cost Contributions by plan participants Benefit payments Benefit obligations of businesses acquired Actuarial loss Plan amendments and other Exchange rate differences Benefit obligation at December 31, Fair value of plan assets at January 1, Actual return on plan assets Contributions by employer Contributions by plan participants Benefit payments Plan assets of businesses acquired Plan amendments and other Exchange rate differences Fair value of plan assets at December 31, Funded status – underfunded Defined pension Other postretirement benefits benefits 2012 9,817 221 396 77 (559) 684 1,124 (12) 315 12,063 2011 9,337 242 402 76 (549) 20 472 5 (188) 9,817 8,867 9,010 839 347 77 155 305 76 (559) (549) 482 (44) 273 10,282 1,781 18 (6) (142) 8,867 950 2012 260 1 11 – (15) 17 2 4 1 2011 214 2 12 – (16) 39 9 – – 281 260 – – 15 – (15) – – – – – – 16 – (16) – – – – 281 260 The amounts recognized in “Accumulated other comprehensive loss” and “Noncontrolling interests” were: December 31, ($ in millions) Transition liability Net actuarial loss Prior service cost Amount recognized in OCI(1) and NCI(2) Taxes associated with amount recognized in OCI(1) and NCI(2) Amount recognized in OCI(1) and NCI(2), net of tax(3) Defined pension benefits Other postretirement benefits 2012 – 2011 – 2010 – (2,574) (1,826) (1,135) (32) (34) (43) (2,606) (1,860) (1,178) 631 415 (1,975) (1,445) 270 (908) 2012 2011 2010 – (69) 33 (36) – (36) – (71) 42 (29) – (29) (1) (65) 51 (15) – (15) (1) (2) (3) OCI represents “Accumulated other comprehensive loss”. NCI represents “Noncontrolling interests”. NCI, net of tax, amounted to $(7) million, $(2) million and $(5) million at December 31, 2012, 2011 and 2010, respectively. 116 Financial review | ABB Annual Report 2012 Note 17 Employee benefits, continued In addition, the following amounts were recognized in the Company’s Consolidated Balance Sheets: Defined pension Other postretirement benefits benefits December 31, ($ in millions) Overfunded plans Underfunded plans – current Underfunded plans – non-current Funded status December 31, ($ in millions) Non-current assets Overfunded pension plans Other employee-related benefits Prepaid pension and other employee benefits December 31, ($ in millions) Current liabilities Underfunded pension plans Underfunded other postretirement benefit plans Other employee-related benefits Pension and other employee benefits (Note 13) December 31, ($ in millions) Non-current liabilities Underfunded pension plans Underfunded other postretirement benefit plans Other employee-related benefits Pension and other employee benefits 2012 (49) 27 1,803 1,781 2011 (138) 25 1,063 950 2012 2011 – 20 261 281 – 18 242 260 2012 2011 (49) (22) (71) (138) (1) (139) 2012 2011 27 20 117 164 25 18 33 76 2012 2011 1,803 1,063 261 226 242 182 2,290 1,487 December 31, ($ in millions) PBO exceeds assets Assets exceed PBO Total December 31, ($ in millions) ABO exceeds assets Assets exceed ABO Total The funded status, calculated by the projected benefit obligation (PBO) and fair value of plan assets, for pension plans with a PBO in excess of fair value of plan assets (underfunded) or fair value of plan assets in excess of PBO (overfunded), respectively, was: 2012 2011 PBO Assets Difference 11,378 685 9,548 734 12,063 10,282 1,830 (49) 1,781 PBO 7,353 2,464 9,817 Assets Difference 6,265 2,602 8,867 1,088 (138) 950 The accumulated benefit obligation (ABO) for all defined benefit pension plans was $11,668 million and $9,512 million at December 31, 2012 and 2011, respectively. The funded status, calculated by the ABO and fair value of plan assets for pension plans with ABO in excess of fair value of plan assets (underfunded) or fair value of plan assets in excess of ABO (overfunded), respectively, was: 2012 ABO Assets Difference 10,700 968 9,237 1,045 11,668 10,282 1,463 (77) 1,386 2011 Assets Difference 4,839 4,028 8,867 908 (263) 645 ABO 5,747 3,765 9,512 All of the Company’s other postretirement benefit plans are unfunded. ABB Annual Report 2012 | Financial review 117 Note 17 Employee benefits, continued Components of net periodic benefit cost ($ in millions) Service cost Interest cost Expected return on plan assets Amortization of transition liability Amortization of prior service cost/(credit) Amortization of net actuarial loss Curtailments, settlements and special termination benefits Net periodic benefit cost consisted of the following: Defined pension benefits Other postretirement benefits 2012 221 396 (494) – 42 98 2 2011 242 402 (507) – 44 52 3 2010 210 389 (422) – 26 71 8 2012 2011 2010 1 11 – – (9) 4 – 7 2 12 – 1 (9) 3 – 9 2 12 – 1 (9) 5 – 11 Net periodic benefit cost 265 236 282 The net actuarial loss and prior service cost for defined pension benefits estimated to be amortized from “Accumulated other comprehensive loss” into net periodic benefit cost in 2013 is $126 million and $34 million, respectively. The net actuarial loss and prior service (credit) for other postretirement benefits estimated to be amortized from “Accumulated other comprehensive loss” into net periodic benefit cost in 2013 is $4 million and $(9) million, respectively. Assumptions The following weighted-average assumptions were used to determine benefit obligations: December 31, (in %) Discount rate Rate of compensation increase Pension increase assumption Defined pension Other postretirement benefits benefits 2012 3.22 1.71 1.04 2011 3.91 1.62 0.97 2012 3.35 – – 2011 4.07 – – The discount rate assumptions are based upon AA-rated corporate bonds. In those countries with sufficient liquidity in corporate bonds, the Company used the current market long-term corporate bond rates and matched the bond dura- tion with the average duration of the pension liabilities. In those countries where the liquidity of the AA-rated corporate bonds was deemed to be insufficient, the Company determined the discount rate by adding the credit spread derived from an AA corporate bond index in another relevant liquid market, as adjusted for interest rate differentials, to the domestic government bond curve or interest rate swap curve. The following weighted-average assumptions were used to determine the “Net periodic benefit cost”: (in %) Discount rate Expected long-term rate of return on plan assets Rate of compensation increase Defined pension benefits Other postretirement benefits 2012 3.91 5.38 1.62 2011 4.29 5.45 2.05 2010 4.66 5.44 2.13 2012 4.07 – – 2011 5.03 – – 2010 5.54 – – The “Expected long-term rate of return on plan assets” is derived for each benefit plan by considering the expected future long-term return assumption for each individual asset class. A single long-term return assumption is then derived for each plan based upon the plan’s current and target asset allocation. The Company maintains other postretirement benefit plans, which are generally contributory with participants’ contribu- tions adjusted annually. The assumptions used were: December 31, Health care cost trend rate assumed for next year Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) Year that the rate reaches the ultimate trend rate 2012 8.60% 5.00% 2028 2011 8.84% 5.00% 2028 118 Financial review | ABB Annual Report 2012 Note 17 Employee benefits, continued A one-percentage-point change in assumed health care cost trend rates would have the following effects at December 31, 2012: ($ in millions) Effect on total of service and interest cost Effect on postretirement benefit obligation 1-percentage-point increase decrease 1 22 (1) (19) Plan assets The Company has pension plans in various countries with the majority of the Company’s pension liabilities deriving from a limited number of these countries. The pension plans’ structures reflect local regulatory environments and market practices. The pension plans are typically funded by regular contributions from employees and the Company. These plans are typically administered by boards of trustees (which include Company representatives) whose primary responsibility is to ensure that the plans meet their liabilities through contributions and investment returns. The boards of trustees have the responsibility for key investment strategy decisions. The accumulated contributions are invested in a diversified range of assets that are managed by third-party asset man- agers, in accordance with local statutory regulations, pension plan rules and the respective plans’ investment guide- lines, as approved by the boards of trustees. Plan assets are generally segregated from those of the Company and invested with the aim of meeting the respective plans’ projected future pension liabilities. Plan assets are measured at fair value at the balance sheet date. The boards of trustees manage the assets of the pension plans in a risk-controlled manner and assess the risks embed- ded in the pension plans through asset/liability modeling. The projected future development of pension liabilities is assessed relative to various alternative asset allocations in order to determine a strategic asset allocation for each plan that provides a balance between risk and return. Asset/liability management studies typically take place every three years. However, the risks of the plans are monitored on an ongoing basis. The assets of the major plans are reviewed at least quarterly, while the plans’ liabilities are reviewed in detail at least annually. The board of trustees’ investment goal is to maximize the long-term returns of plan assets within specified risk parameters, while considering the future liabilities and liquidity needs of the individual plans. Risk parameters taken into account include: – the funding ratio of the plan, – the likelihood of extraordinary cash contributions being required, and – the risk embedded in each individual asset class, and the plan asset portfolio as a whole. The Company’s investment policy is to achieve a balance between risk and return on the plans’ investments through the diversification of asset classes, the use of various external asset managers and the use of differing investment styles. This has resulted in a diversified portfolio with a mix of actively and passively managed investments. The Company’s global pension asset allocation is the result of the asset allocations of the individual plans, which are set by the respective boards of trustees. The target asset allocation of the Company’s plans on a weighted-average basis is as follows: Asset Class Cash and equivalents Global equities Emerging markets equities Global fixed income Emerging markets fixed income Insurance contracts Private equity Hedge funds Real estate Commodities Target percentage 2 21 5 53 5 1 2 1 9 1 100 The actual asset allocations of the plans are in line with the target asset allocations. Global and emerging markets fixed income securities include corporate bonds of companies from diversified industries and government bonds mainly from mature market issuers. Global and emerging markets equity securities primarily include investments in large-cap and mid-cap listed companies. Global equity securities represent equities listed in mature markets (mainly in the United States, Europe and Japan). Real estate investments consist largely of domestic real estate in Switzerland held in the Swiss plans. The investments in Private equity, Hedge funds and Commodities reflect a variety of investment strategies. ABB Annual Report 2012 | Financial review 119 Note 17 Employee benefits, continued Based on the above global asset allocation, the expected long-term return on assets at December 31, 2012, is 4.79 per- cent. The Company and the local boards of trustees regularly review the investment performance of the asset classes and individual asset managers. Due to the diversified nature of the investments, the Company is of the opinion that no significant concentration of risks exists in its pension fund assets. The Company does not expect any plan assets to be returned to the employer during 2013. At December 31, 2012 and 2011, plan assets include ABB Ltd’s shares (as well as an insignificant amount of the Company’s debt instruments) with a total value of $16 million and $14 million, respectively. The fair values of the Company’s pension plan assets by asset class are presented below. For further information on the fair value hierarchy and an overview of the Company’s valuation techniques applied see the “Fair value measures” section of Note 2. December 31, 2012 ($ in millions) Level 1 Level 2 Level 3 Total fair value Asset Class Cash and equivalents Global equities Emerging markets equities Global fixed income Emerging markets fixed income Insurance contracts Private equity Hedge funds Real estate Commodities Total 170 2,112 443 1,984 – – – – 87 52 252 77 – 3,140 707 76 – – – – – – – – – – 164 153 830 35 422 2,189 443 5,124 707 76 164 153 917 87 4,848 4,252 1,182 10,282 December 31, 2011 ($ in millions) Level 1 Level 2 Level 3 Total fair value Asset Class Cash and equivalents Global equities Emerging markets equities Global fixed income Emerging markets fixed income Insurance contracts Private equity Hedge funds Real estate Commodities Total 56 1,717 311 1,921 – – – – 73 44 365 76 – 2,838 398 37 – – – – – – – – – – 177 113 741 – 421 1,793 311 4,759 398 37 177 113 814 44 4,122 3,714 1,031 8,867 The following table represents the movements of those asset categories whose fair values use significant unobservable inputs (Level 3): ($ in millions) Balance at January 1, 2011 Return on plan assets: Assets still held at December 31, 2011 Assets sold during the year Purchases (sales) Transfers into Level 3 Exchange rate differences Balance at December 31, 2011 Return on plan assets: Assets still held at December 31, 2012 Assets sold during the year Purchases (sales) Transfers into Level 3 Exchange rate differences Balance at December 31, 2012 120 Financial review | ABB Annual Report 2012 Private equity Hedge funds Real estate Commodities Total Level 3 156 (3) 22 (27) 29 – 177 4 13 (31) – 1 164 136 (4) (6) (14) – 1 113 9 (7) 35 – 3 153 696 12 7 32 2 (8) 741 15 – 40 9 25 830 – – – – – – – (1) – 35 – 1 35 988 5 23 (9) 31 (7) 1,031 27 6 79 9 30 1,182 Note 17 Employee benefits, continued Real estate properties are valued under the income approach using the discounted cash flow method, by which the market value of a property is determined as the total of all projected future earnings discounted to the valuation date. The discount rates are determined for each property individually according to the property’s location and specific use, and by considering initial yields of comparable market transactions. Private equity investments include investments in partnerships and related funds. Such investments consist of both publicly-traded and privately-held securities. Publicly-traded securities that are not quoted in active markets are valued using available quotes and adjusted for liquidity restrictions. Privately-held securities are valued taking into account various factors, such as the most recent financing involving unrelated new investors, earnings multiple analyses using comparable companies and discounted cash flow analyses. Hedge funds are normally not exchange-traded and the shares of the funds are not redeemed daily. Depending on the fund structure, the fair values are derived through modeling techniques based on the values of the underlying assets adjusted to reflect liquidity and transferability restrictions. Contributions Employer contributions were as follows: ($ in millions) Total contributions to defined benefit pension and other postretirement benefit plans Of which, discretionary contributions to defined benefit pension plans Defined pension benefits Other postretirement benefits 2012 347 83 2011 305 36 2012 15 – 2011 16 – In 2012, the discretionary contributions included non-cash contributions of $42 million of available-for-sale securities to the Company’s pension plans in the U.K. and the U.S. The Company expects to contribute approximately $286 million to its defined benefit pension plans in 2013, of which discretionary contributions are $44 million. All 2013 discretionary contributions are expected to be non-cash contribu- tions. The Company expects to contribute approximately $20 million to its other postretirement benefit plans in 2013. The Company also maintains a number of defined contribution plans. The expense for these plans was $220 million, $144 million and $97 million in 2012, 2011 and 2010, respectively. The Company also contributed $11 million, $5 million and $30 million to multi-employer plans in 2012, 2011 and 2010, respectively. Estimated future benefit payments The expected future cash flows to be paid by the Company’s plans in respect of pension and other postretirement benefit plans at December 31, 2012, are as follows: ($ in millions) 2013 2014 2015 2016 2017 Years 2018–2022 Note 18 Share-based payment arrangements Pension benefits Other postretirement benefits Benefit payments Medicare subsidies 663 664 653 653 639 3,122 21 21 21 21 21 105 (1) (1) (1) (1) (1) (8) Medicare subsidies represent payments estimated to be received from the United States government as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The United States government began making the subsidy payments for employers in 2006. The Company has three principal share-based payment plans, as more fully described in the respective sections below. Compensation cost for these principal plans and for other equity-settled awards is recorded in “Total cost of sales” and in “Selling, general and administrative expenses” and totaled $60 million, $67 million and $66 million in 2012, 2011 and 2010, respectively. Compensation cost for cash-settled awards is recorded in “Selling, general and administrative expenses” and is disclosed in the “WARs”, “LTIP” and “Other share-based payments” sections of this note. The total tax benefit recognized in 2012, 2011 and 2010, was not significant. At December 31, 2012, the Company had the ability to issue up to 94 million new shares out of contingent capital in connection with share-based payment arrangements. In addition, 19 million shares held by the Company in treasury stock at December 31, 2012, could be used to settle share-based payment arrangements. As the primary trading market for the shares of ABB Ltd is the SIX Swiss Exchange, on which the shares are traded in Swiss francs, certain data disclosed below related to the instruments granted under share-based payment arrange- ments are presented in Swiss francs. ABB Annual Report 2012 | Financial review 121 Note 18 Share-based payment arrangements, continued MIP Under the MIP, the Company offers options and cash-settled WARs (and prior to the 2010 launch offered also physically- settled warrants) to key employees for no consideration. The warrants and options granted under the MIP allow participants to purchase shares of ABB Ltd at predetermined prices. Participants may sell the warrants and options rather than exercise the right to purchase shares. Equivalent war- rants are listed by a third-party bank on the SIX Swiss Exchange, which facilitates pricing and transferability of warrants granted under this plan. The options entitle the holder to request that the third-party bank purchase such options at the market price of equivalent listed warrants related to that MIP launch. If the participant elects to sell the warrants or options, the instruments will thereafter be held by a third party and, consequently, the Company’s obligation to deliver shares will be toward this third party. Each WAR gives the participant the right to receive, in cash, the market price of an equivalent listed warrant on the date of exercise of the WAR. The WARs are non-transferable. Participants may exercise or sell warrants and options and exercise WARs after the vesting period, which is three years from the date of grant. Vesting restrictions can be waived in certain circumstances such as death or disability. All warrants, options and WARs expire six years from the date of grant. Warrants and options The fair value of each warrant and option is estimated on the date of grant using a lattice model that uses the weighted- average assumptions noted in the table below. Expected volatilities are based on implied volatilities from equivalent listed warrants on ABB Ltd shares. The expected term of the warrants and options granted has been assumed to be the contractual six-year life of each warrant and option, based on the fact that after the vesting period, a participant can elect to sell the warrant or option rather than exercise the right to purchase shares, thereby realizing the time value of the warrants and options. The risk-free rate is based on a six-year Swiss franc interest rate, reflecting the six-year contractual life of the warrants and options. In estimating forfeitures, the Company has used the data from previous comparable MIP launches. Expected volatility Dividend yield Expected term Risk-free interest rate 2012 27% 3.60% 6 years 0.30% 2011 26% 2.44% 6 years 1.59% 2010 30% 2.35% 6 years 1.20% Presented below is a summary of the activity related to warrants and options under the MIP: Weighted- Weighted-aver- Aggregate Number Number average exer- age remaining intrinsic value of instruments of shares cise price (in contractual (in millions of (in millions) (in millions)(1) Swiss francs)(2) term (in years) Swiss francs)(3) Outstanding at January 1, 2012 Granted Exercised(4) Forfeited Expired Outstanding at December 31, 2012 Vested and expected to vest at December 31, 2012 Exercisable at December 31, 2012 165.6 86.8 (4.1) (4.5) (1.3) 242.5 228.6 84.2 33.1 17.4 (0.8) (0.9) (0.3) 48.5 45.7 16.8 25.56 16.07 15.30 21.36 31.58 22.38 22.46 27.05 (1) (2) (3) (4) Information presented reflects the number of shares of ABB Ltd that can be received upon exercise, as warrants and options have a conversion ratio of 5:1. Information presented reflects the exercise price per share of ABB Ltd. Computed using the closing price, in Swiss francs, of ABB Ltd shares on the SIX Swiss Exchange and the exercise price per share of ABB Ltd. The cash received upon exercise amounted to approximately $14 million. The shares were delivered out of treasury stock. 3.7 3.6 1.6 45.8 42.8 0.8 At December 31, 2012, there was $64 million of total unrecognized compensation cost related to non-vested warrants and options granted under the MIP. That cost is expected to be recognized over a weighted-average period of 2.0 years. The weighted-average grant-date fair value (per instrument) of warrants and options granted during 2012, 2011 and 2010 was 0.59 Swiss francs, 0.83 Swiss francs and 0.81 Swiss francs, respectively. In 2011 and 2010, the aggregate intrinsic value (on the dates of exercise) of instruments exercised was 11 million Swiss francs and 9 million Swiss francs, respectively. The amount in 2012 was not significant. 122 Financial review | ABB Annual Report 2012 Note 18 Share-based payment arrangements, continued Exercise price (in Swiss francs)(1) 26.00 36.40 19.00 22.50 25.50 15.75 17.50 Presented below is a summary, by launch, related to instruments outstanding at December 31, 2012: Number of Number Weighted-average instruments of shares remaining contractual (in millions) (in millions)(2) term (in years) 25.9 27.1 22.8 37.0 44.3 69.7 15.7 242.5 5.2 5.4 4.6 7.4 8.9 13.9 3.1 48.5 0.4 1.4 2.4 3.4 4.4 5.4 5.4 3.7 Total number of instruments and shares (1) (2) Information presented reflects the exercise price per share of ABB Ltd. Information presented reflects the number of shares of ABB Ltd that can be received upon exercise. Outstanding at January 1, 2012 Granted Exercised Expired Outstanding at December 31, 2012 Exercisable at December 31, 2012 ESAP WARs As each WAR gives the holder the right to receive cash equal to the market price of the equivalent listed warrant on date of exercise, the Company records a liability based upon the fair value of outstanding WARs at each period end, accreted on a straight-line basis over the three-year vesting period. In “Selling, general and administrative expenses”, the Company recorded income of $8 million and aggregate expense of $8 million for 2011 and 2010, respectively, as a result of changes in both the fair value and vested portion of the outstanding WARs. The 2012 amount was not signifi- cant. To hedge its exposure to fluctuations in the fair value of outstanding WARs, the Company purchased cash-settled call options, which entitle the Company to receive amounts equivalent to its obligations under the outstanding WARs. The cash-settled call options are recorded as derivatives measured at fair value (see Note 5), with subsequent changes in fair value recorded through earnings to the extent that they offset the change in fair value of the liability for the WARs. In 2011 and 2010, the Company recorded aggregate expense of $24 million and $10 million, respectively, in “Selling, general and administrative expenses” related to the cash-settled call options. The 2012 amount was not significant. The aggregate fair value of outstanding WARs was $26 million and $17 million at December 31, 2012 and 2011, respectively. The fair value of WARs was determined based upon the trading price of equivalent warrants listed on the SIX Swiss Exchange. Presented below is a summary of the activity related to WARs: Number of WARs (in millions) 61.3 17.3 (11.5) (0.3) 66.8 30.4 The aggregate fair value at date of grant of WARs granted in 2012, 2011 and 2010, was $10 million, $10 million and $7 million, respectively. In 2012, 2011 and 2010, share-based liabilities of $7 million, $7 million and $25 million, respec- tively, were paid upon exercise of WARs by participants. The employee share acquisition plan (ESAP) is an employee stock option plan with a savings feature. Employees save over a twelve month period, by way of regular payroll deductions. At the end of the savings period, employees choose whether to exercise their stock options using their savings plus interest to buy ABB Ltd shares (American Depositary Shares (ADS) in the case of employees in the United States and Canada – each ADS representing one registered share of the Company) at the exercise price set at the grant date, or have their savings returned with interest. The savings are accumulated in bank accounts held by a third-party trustee on behalf of the participants and earn interest. Employees can withdraw from the ESAP at any time during the savings period and will be entitled to a refund of their accumulated savings. The fair value of each option is estimated on the date of grant using the same option valuation model as described under the MIP, using the assumptions noted in the table below. The expected term of the option granted has been determined to be the contractual one-year life of each option, at the end of which the options vest and the participants are required to decide whether to exercise their options or have their savings returned with interest. The risk-free rate is based on one-year Swiss franc interest rates, reflecting the one year contractual life of the options. In estimating for feitures, the Company has used the data from previous ESAP launches. ABB Annual Report 2012 | Financial review 123 Note 18 Share-based payment arrangements, continued Expected volatility Dividend yield Expected term Risk-free interest rate 2012 23% 3.45% 1 year 0% 2011 33% 3.13% 1 year 0% 2010 27% 2.49% 1 year 0.26% Presented below is a summary of activity under the ESAP: Weighted- Weighted- Aggregate Number of average exercise average remaining intrinsic value shares price (in contractual (in millions of (in millions)(1) Swiss francs)(2) term (in years) Swiss francs)(2)(3) Outstanding at January 1, 2012 Granted Forfeited Exercised(4) Not exercised (savings returned plus interest) Outstanding at December 31, 2012 Vested and expected to vest at December 31, 2012 Exercisable at December 31, 2012 4.9 4.4 (0.3) (2.3) (2.3) 4.4 4.2 – 15.98 17.08 15.99 15.98 15.98 17.08 17.08 – 0.8 0.8 – 7.4 7.1 – (1) (2) (3) (4) Includes shares represented by ADS. Information presented for ADS is based on equivalent Swiss franc denominated awards. Computed using the closing price, in Swiss francs, of ABB Ltd shares on the SIX Swiss Exchange and the exercise price of each option in Swiss francs. The cash received upon exercise was approximately $40 million and the corresponding tax benefit was not significant. The shares were delivered out of treasury stock. LTIP The exercise prices per ABB Ltd share and per ADS of 17.08 Swiss francs and $18.30, respectively, for the 2012 grant, 15.98 Swiss francs and $18.10, respectively, for the 2011 grant and 20.46 Swiss francs and $20.55, respectively, for the 2010 grant were determined using the closing price of the ABB Ltd share on SIX Swiss Exchange and ADS on the New York Stock Exchange on the respective grant dates. At December 31, 2012, there was $5 million of total unrecognized compensation cost related to non-vested options granted under the ESAP. That cost is expected to be recognized over the first ten months of 2013 in “Total cost of sales” and in “Selling, general and administrative expenses”. The weighted-average grant-date fair value (per option) of options granted during 2012, 2011 and 2010, was 1.29 Swiss francs, 1.89 Swiss francs and 1.96 Swiss francs, respectively. The total intrinsic value (on the dates of exercise) of options exercised in 2012, 2011 and 2010, was not significant. The Company has a long-term incentive plan (LTIP) for members of its Executive Committee and selected other execu- tives (Eligible Participants), as defined in the terms of the LTIP and determined by the Company’s Governance, Nomi- nation and Compensation Committee. The LTIP involves annual conditional grants of the Company’s stock to such Eligible Participants that are subject to certain conditions. The 2012, 2011 and 2010 launches under the LTIP are each com- posed of two components: (i) a performance component (earnings per share performance for the 2012 launch and share- price performance for the 2011 and 2010 launches) and (ii) a retention component. Under the performance component, the number of shares granted is dependent upon the base salary of the Eligible Participant. For the 2012 LTIP launch, the actual number of shares that will vest at a future date is dependent on (i) the Company’s weighted cumulative earnings per share performance over three financial years, beginning with the year of launch, and (ii) the fulfillment of the service condition as defined in the terms and conditions of the LTIP. The cumulative earnings per share performance is weighted as follows: 33 percent of the first year’s result, 67 percent of the second year’s result and 100 percent of the third year’s result. The actual number of shares that ultimately vest will vary depend- ing on the weighted cumulative earnings per share outcome, interpolated between a lower threshold (no shares vest) and an upper threshold (the number of shares vesting is capped at 200 percent of the conditional grant). For the 2011 and 2010 LTIP launches, the actual number of shares that will vest at a future date is dependent on (i) the performance of ABB Ltd shares during a defined three-year period (Evaluation Period) compared to those of a selected peer group of publicly-listed multinational companies and (ii) the fulfillment of the service condition as defined in the terms and conditions of the LTIP. The actual number of shares that ultimately vest cannot exceed 100 percent of the conditional grant. The performance of the Company compared to its peers over the Evaluation Period will be measured as the sum, in percentage terms, of the average percentage price development of the ABB Ltd share price over the Evaluation Period (from a reference price of 22.25 Swiss francs and 21.63 Swiss francs for the 2011 and 2010 launches, respec- tively) and an average annual dividend yield percentage (the Company’s Performance). In order for shares to vest, the Company’s Performance over the Evaluation Period must be equal to or better than half of the defined peers. The actual number of shares to be delivered by the Company, after the end of the Evaluation Period, will be dependent on the Company’s ranking in comparison with the defined peers. The full amount of the grant will vest if the Company’s Performance is positive and better than three-quarters of the defined peers. If the Company’s Performance is negative but other conditions are met, a reduced number of shares will vest. In addition, if the Company’s net income (adjusted for the financial impact of items that are, in the opinion of the Company’s Board, non-operating, non-recurring or unforeseen – such as divestments and acquisitions) is negative for the year preceding the year in which the Evaluation Period ends, no shares will vest, irrespective of the outcome of the Company’s Performance. 124 Financial review | ABB Annual Report 2012 Note 18 Share-based payment arrangements, continued Under the retention component of the 2012, 2011 and 2010 LTIP launches, each Eligible Participant was conditionally granted an individually defined maximum number of shares which fully vest at the end of the respective vesting periods (if the participant remains an Eligible Participant till the end of such period). For the 2012, 2011 and 2010 LTIP launches, under the performance component, an Eligible Participant receives, in cash, 100 percent of the value of the shares that have vested. Under the retention component, an Eligible Participant receives 70 percent of the shares that have vested in the form of shares and 30 percent of the value of the shares that have vested in cash, with the possibility to elect to receive the 30 percent portion also in shares rather than cash. Presented below is a summary of activity under the LTIP: Nonvested at January 1, 2012 Granted Vested Expired(3) Forfeited Nonvested at December 31, 2012 Number of shares Equity & Cash or choice of 100% Only Cash Weighted-average grant-date Equity Settlement Settlement Total fair value per share (in thousands)(1) (in thousands)(2) (in thousands) (Swiss francs) 1,854 868 (205) (885) (9) 1,623 497 516 – (20) – 993 2,351 1,384 (205) (905) (9) 2,616 13.25 15.21 20.75 7.33 21.57 15.72 (1) (2) (3) Shares that, subject to vesting, the Eligible Participant can elect to receive 100 percent in the form of shares. Shares that, subject to vesting, the Eligible Participant can only receive in cash. Expired as the criteria for the Company’s performance condition were not satisfied. Equity-settled awards are recorded in the “Capital stock and additional paid-in capital” component of stockholders’ equity, with compensation cost recorded in “Selling, general and administrative expenses” over the vesting period (which is from grant date to the end of the vesting period) based on the grant-date fair value of the shares. Cash-settled awards are recorded as a liability remeasured at fair value at each reporting date for the percentage vested, with changes in the liability recorded in “Selling, general and administrative expenses”. At December 31, 2012, there was $12 million of total unrecognized compensation cost related to equity-settled awards under the LTIP. That cost is expected to be recognized over a weighted-average period of 1.9 years. The compensation cost recorded in 2012, 2011 and 2010, for cash-settled awards was not significant. The aggregate fair value, at the dates of grant, of shares granted in 2012, 2011 and 2010, was approximately $22 million, $16 million and $7 million, respectively. The total grant-date fair value of shares that vested during 2010 was $10 million. The amounts for 2012 and 2011 were not significant. The weighted-average grant-date fair value (per share) of shares granted during 2012, 2011 and 2010, was 15.21 Swiss francs, 17.91 Swiss francs and 13.79 Swiss francs, respectively. For the earnings per share performance component of the 2012 LTIP launch, the aggregate fair value of the conditionally granted shares is based on the market price of the ABB Ltd share at each reporting date and the probable outcome of the earnings per share achievement that would result in the vesting of the highest number of shares, as computed using a Monte Carlo simulation model. The main inputs to this model are revenue growth rates and Operational EBITDA mar- gin (see Note 23 for a definition) targets. The aggregate fair value of the shares relating to the (cash-settled) share-price performance component under the 2011 and 2010 LTIP launches is based on the market price of the ABB Ltd share at each reporting date adjusted for the probability of vesting as computed using a Monte Carlo simulation model at each reporting date. The main inputs to the Monte Carlo simulation model for the December 31, 2012 and 2011, fair values for the Company and each peer com- pany were as follows: Cash-settled awards at December 31, Input ranges for: Option implied volatilities (%) Risk-free rates (%) Equity betas Equity risk premiums (%) 2012 From 2011 To From 16.2 1.0 0.85 5.0 48.4 3.1 1.24 7.0 16.6 1.0 0.86 5.0 To 49.8 3.7 1.26 7.0 For the retention component under the 2012, 2011 and 2010 LTIP launches, the fair value of granted shares for equity-settled awards is the market price of the ABB Ltd share on grant date and the fair value of granted shares for cash-settled awards is the market price of the ABB Ltd share at each reporting date. Other share-based payments The Company has other minor share-based payment arrangements with certain employees. The compensation cost recorded in “Selling, general and administrative expenses” in 2012, 2011 and 2010, for the cash-settled arrangements was not significant. ABB Annual Report 2012 | Financial review 125 Note 19 Stockholders’ equity At both December 31, 2012 and 2011, the Company had 2,819 million authorized shares, of which 2,315 million were registered and issued. At the Annual General Meeting of Shareholders (AGM) held in April 2012 and at the AGM held in April 2011, shareholders approved the payment of a dividend of 0.65 Swiss francs per share and 0.60 Swiss francs per share, respectively, both out of the capital contribution reserve in stockholders’ equity of the unconsolidated statutory financial statements of ABB Ltd, prepared in accordance with Swiss law. The dividends were paid in May 2012 (amounting to $1,626 million) and May 2011 (amounting to $1,569 million), respectively. In April 2010, at the AGM, shareholders approved the pay- ment of a dividend in the form of a nominal value reduction of 0.51 Swiss francs per share, reducing the nominal value of ABB Ltd’s shares from 1.54 Swiss francs per share to 1.03 Swiss francs per share. The distribution, paid in July 2010 and equivalent to $1,112 million, resulted in a reduction in “Capital stock and additional paid-in capital”. During 2010, the Company purchased on the open market an aggregate of 12.1 million of its own shares for use in con- nection with its employee incentive plans. These transactions resulted in an increase in treasury stock of $228 million. During 2012 and 2011 there were no purchases or sales of treasury stock on the open market. Upon and in connection with each launch of the Company’s MIP, the Company sold call options to a bank at fair value, giving the bank the right to acquire shares equivalent to the number of shares represented by the MIP warrant and WAR awards to participants. Under the terms of the agreement with the bank, the call options can only be exercised by the bank to the extent that MIP participants have either sold or exercised their warrants or exercised their WARs. In 2012, 2011 and 2010, the bank exercised certain of the call options it held. As a consequence, in 2012, the Company delivered 2.7 million shares out of treasury stock and in 2011 and 2010, the Company delivered 6.0 million and 2.1 mil- lion shares, respectively, from contingent capital. At December 31, 2012, such call options representing 8.5 million shares and with strike prices ranging from 15.75 to 36.40 Swiss francs were held by the bank. The call options expire in periods ranging from May 2013 to May 2018. However, only 1.8 million of these instruments, with strike prices ranging from 19.00 to 36.40 Swiss francs, could be exercised at December 31, 2012, under the terms of the agreement with the bank. In addition to the above, at December 31, 2012, the Company had further outstanding obligations to deliver: – up to 2.7 million shares, at a strike price of 26.00 Swiss francs, relating to the options granted under the 2007 launch of the MIP, vesting in May 2010 and expiring in May 2013, – up to 2.9 million shares, at a strike price of 36.40 Swiss francs, relating to the options granted under the 2008 launch of the MIP, vesting in May 2011 and expiring in May 2014, – up to 4.5 million shares, at a strike price of 19.00 Swiss francs, relating to the options granted under the 2009 launch of the MIP, vesting in May 2012 and expiring in May 2015, – up to 7.4 million shares, at a strike price of 22.50 Swiss francs, relating to the options granted under the 2010 launch of the MIP, vesting in May 2013 and expiring in May 2016, – up to 8.9 million shares, at a strike price of 25.50 Swiss francs, relating to the options granted under the 2011 launch of the MIP, vesting in May 2014 and expiring in May 2017, – up to 17.1 million shares, at a weighted-average strike price of 16.07 Swiss francs, relating to the options granted under the 2012 launches of the MIP, vesting in May 2015 and expiring in May 2018, – up to 4.4 million shares, at a strike price of $18.30 (to employees in the U.S. and Canada) and at a strike price of 17.08 Swiss francs (to employees in other countries) under the ESAP, vesting and expiring in November 2013, – up to 1.6 million shares free-of-charge to Eligible Participants under the 2012, 2011 and 2010 launches of the LTIP, vesting and expiring in May 2015, March 2014 and March 2013, respectively, and – approximately 2 million shares in connection with certain other share-based payment arrangements with employees. See Note 18 for a description of the above share-based payment arrangements. In November 2012 and 2010, the Company delivered 2.3 million and 3.2 million shares, respectively, from treasury stock, under the ESAP. In 2011, the number of shares delivered under the ESAP was not significant. Amounts available to be distributed as dividends to the stockholders of ABB Ltd are based on the requirements of Swiss law and ABB Ltd’s Articles of Incorporation, and are determined based on amounts presented in the unconsoli- dated financial statements of ABB Ltd, Zurich, prepared in accordance with Swiss law. At December 31, 2012, of the 12,357 million Swiss francs ($13,504 million) total stockholders’ equity reflected in such unconsolidated financial state- ments, 2,384 million Swiss francs ($2,605 million) represents share capital and 9,973 million Swiss francs ($10,899 mil- lion) represent reserves. Of these reserves, legal reserves for own shares of 395 million Swiss francs ($432 million) and ordinary legal reserves of 1,000 million Swiss francs ($1,093 million) are restricted. In February 2013, the Company announced that a proposal will be put to the 2013 AGM to distribute 0.68 Swiss francs per share to shareholders. 126 Financial review | ABB Annual Report 2012 Note 20 Earnings per share Basic earnings per share is calculated by dividing income by the weighted-average number of shares outstanding dur- ing the year. Diluted earnings per share is calculated by dividing income by the weighted-average number of shares outstanding during the year, assuming that all potentially dilutive securities were exercised, if dilutive. Potentially dilutive securities comprise outstanding written call options and outstanding options and shares granted subject to certain conditions under the Company’s share-based payment arrangements. In 2012, 2011 and 2010, outstanding securities representing a maximum of 56 million, 39 million and 26 million shares, respectively, were excluded from the calcula- tion of diluted earnings per share as their inclusion would have been anti-dilutive. Basic earnings per share ($ in millions, except per share data in $) Amounts attributable to ABB shareholders: Income from continuing operations, net of tax Income from discontinued operations, net of tax Net income 2012 2011 2010 2,700 4 2,704 3,159 9 3,168 2,551 10 2,561 Weighted-average number of shares outstanding (in millions) 2,293 2,288 2,287 Basic earnings per share attributable to ABB shareholders: Income from continuing operations, net of tax Income from discontinued operations, net of tax Net income Diluted earnings per share ($ in millions, except per share data in $) Amounts attributable to ABB shareholders: Income from continuing operations, net of tax Income from discontinued operations, net of tax Net income 1.18 – 1.18 1.38 – 1.38 1.12 – 1.12 2012 2011 2010 2,700 4 2,704 3,159 9 3,168 2,551 10 2,561 Weighted-average number of shares outstanding (in millions) 2,293 2,288 2,287 Effect of dilutive securities: Call options and shares Dilutive weighted-average number of shares outstanding Diluted earnings per share attributable to ABB shareholders: Income from continuing operations, net of tax Income from discontinued operations, net of tax Net income 2 3 4 2,295 2,291 2,291 1.18 – 1.18 1.38 – 1.38 1.11 0.01 1.12 ABB Annual Report 2012 | Financial review 127 Note 21 Other comprehensive income The following table includes amounts recorded within “Total other comprehensive income (loss)” including the related income tax effects. ($ in millions) Foreign currency translation adjustments tax 389 effect of tax tax effect of tax (6) 383 (280) 5 (275) tax 362 effect of tax 8 370 2012 2011 2010 Before Tax Net Before Tax Net Before Tax Net Available-for-sale securities: Net unrealized gains (losses) arising during the year Reclassification adjustments for net (gains) losses included in net income Unrealized gains (losses) on available-for-sale securities Pension and other postretirement plans: 5 1 6 (2) – (2) 3 1 4 (2) (1) (3) 3 1 2 1 5 2 16 (16) – Prior service (costs) credits arising during the year (42) 6 (36) (35) 12 (23) (70) Amortization of prior service costs (credits) included in net income Net prior service cost arising during the year 33 (9) (3) 3 30 (6) 35 – (13) (1) 22 (1) 17 (53) (3) 1 (2) 16 (5) 11 13 (15) (2) (54) 12 (42) Net actuarial gains (losses) arising during the year (846) 245 (601) (750) 157 (593) 156 (32) 124 Amortization of net actuarial (gains) losses included in net income Net actuarial gains (losses) arising during the year 102 (744) (32) 213 70 (531) 55 (695) (11) 146 44 (549) 76 232 (14) (46) 62 186 Amortization of transition liability included in net income – – – 1 – 1 1 – 1 Pension and other postretirement plans adjustments (753) 216 (537) (694) 145 (549) 180 (35) 145 Cash flow hedge derivatives: Net gains (losses) arising during the year 74 (21) 53 (21) 2 (19) 123 (32) 91 Reclassification adjustments for net (gains) losses included in net income (42) 14 (28) (88) 27 (61) (29) 10 (19) Unrealized gains (losses) of cash flow hedge derivatives 32 (7) 25 (109) 29 (80) 94 (22) 72 Total other comprehensive income (loss) (326) 201 (125) (1'082) 180 (902) 636 (51) 585 Note 22 Restructuring and related expenses Restructuring-related activities ($ in millions) Employee severance costs Estimated contract settlement, loss order and other costs Inventory and long-lived asset impairments Total In 2012 and 2011, the Company executed minor restructuring-related activities and incurred charges of $180 million and $164 million, respectively, which were mainly recorded in “Total cost of sales”. 2012 92 72 16 180 2011 83 53 28 164 At December 31, 2012 and 2011, the balance of restructuring and related liabilities is primarily included in “Provisions and other current liabilities”. Cost take-out program In December 2008, the Company announced a two-year cost take-out program that aimed to sustainably reduce the Company’s cost of sales and general and administrative expenses. As of December 31, 2010, the Company had substantially completed the cost take-out program. 128 Financial review | ABB Annual Report 2012 Note 22 Restructuring and related expenses, continued ($ in millions) Employee severance costs The Company recorded the following expenses under this program: Estimated contract settlement, loss order and other costs Inventory and long-lived asset impairments Total These expenses were recorded as follows: ($ in millions) Total cost of sales Selling, general and administrative expenses Other income (expense), net Total Cumulative costs incurred up to December 31, 2010 536 230 70 836 Cumulative costs incurred up to December 31, 2010 475 143 218 836 2010 95 98 20 213 2010 110 36 67 213 Expenses incurred under the program, per operating segment, were as follows: ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation Corporate and Other Total Cumulative costs incurred up to December 31, 2010 2010 122 139 256 114 183 22 836 44 48 35 36 44 6 213 The most significant individual exit plans within this program related to the reorganization of the Company’s Robotics business, the downsizing of the former Automation Products business in France and Germany, as well as the Power Systems business in Germany. Note 23 Operating segment and geographic data The Chief Operating Decision Maker (CODM) is the Company’s Executive Committee. The CODM allocates resources to and assesses the performance of each operating segment using the information outlined below. The Company’s oper- ating segments consist of Power Products, Power Systems, Discrete Automation and Motion, Low Voltage Products and Process Automation. The remaining operations of the Company are included in Corporate and Other. A description of the types of products and services provided by each reportable segment is as follows: – Power Products: manufactures and sells high- and medium-voltage switchgear and apparatus, circuit breakers for all current and voltage levels, power and distribution transformers and sensors for electric, gas and water utilities and for industrial and commercial customers. – Power Systems: designs, installs and upgrades high-efficiency transmission and distribution systems and power plant automation and electrification solutions, including monitoring and control products, software and services and incorporating components manufactured by both the Company and by third parties. – Discrete Automation and Motion: manufactures and sells motors, generators, variable speed drives, rectifiers, excita- tion systems, robotics, programmable logic controllers, and related services for a wide range of applications in factory automation, process industries, and utilities. – Low Voltage Products: manufactures products and systems that provide protection, control and measurement for electrical installations, as well as enclosures, switchboards, electronics and electromechanical devices for industrial machines, plants and related service. In addition the segment manufactures products for wiring and cable manage- ment, cable protection systems, power connection and safety. The segment also makes intelligent building control systems for home and building automation to improve comfort, energy efficiency and security. – Process Automation: develops and sells control and plant optimization systems, automation products and solutions, including instrumentation, as well as industry-specific application knowledge and services for the oil, gas and petro- chemicals, metals and minerals, marine and turbocharging, pulp and paper, chemical and pharmaceuticals, and power industries. – Corporate and Other: includes headquarters, central research and development, the Company’s real estate activities, Group treasury operations and other minor activities. The Company evaluates the performance of its segments based on operational earnings before interest, taxes, depreciation and amortization (Operational EBITDA) and Operational EBITDA margin (being Operational EBITDA as a percentage of Operational revenues). ABB Annual Report 2012 | Financial review 129 Note 23 Operating segment and geographic data, continued Operational EBITDA represents earnings before interest and taxes (EBIT) excluding depreciation and amortization, restructuring and restructuring-related expenses, adjusted for the following: (i) unrealized gains and losses on deriva- tives (foreign exchange, commodities, embedded derivatives), (ii) realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized, (iii) unrealized foreign exchange movements on receivables/ payables (and related assets/liabilities), (iv) acquisition-related expenses and (v) certain non-recurring items. Operational revenues are total revenues adjusted for the following: (i) unrealized gains and losses on derivatives, (ii) realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized, and (iii) unrealized foreign exchange movements on receivables (and related assets). The CODM primarily reviews the results of each segment on a basis that is before the elimination of profits made on inventory sales between segments. Segment results below are presented before these eliminations, with a total deduc- tion for intersegment profits to arrive at the Company’s consolidated Operational EBITDA. The following tables present segment revenues, depreciation and amortization, Operational EBITDA, Operational EBITDA margin, as well as reconciliations of Operational EBITDA to EBIT and Operational revenues to Total revenues, capital expenditure and total assets. Intersegment sales and transfers for 2012, 2011 and 2010, are accounted for as if the sales and transfers were to third parties, at current market prices. 2012 ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation Corporate and Other Intersegment elimination Consolidated 2011 ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation Corporate and Other Intersegment elimination Consolidated 2010 ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation Corporate and Other Intersegment elimination Consolidated Third-party Intersegment Total and Operational Operational EBITDA revenues revenues revenues amortization revenues EBITDA(1) margin (%) Depreciation Operational 8,987 7,575 8,480 6,276 7,946 72 – 39,336 1,730 10,717 277 925 362 210 1,505 (5,009) – 7,852 9,405 6,638 8,156 1,577 (5,009) 39,336 209 174 263 250 82 204 – 1,182 10,702 7,812 9,405 6,626 8,134 1,576 (5,009) 39,246 1,585 290 1,735 1,219 1,003 (279) 2 5,555 14.8% 3.7% 18.4% 18.4% 12.3% – – 14.2% Third-party Intersegment Total and Operational Operational EBITDA revenues revenues revenues amortization revenues EBITDA(1) margin (%) Depreciation Operational 9,028 7,833 8,047 4,953 8,078 51 – 37,990 1,841 10,869 268 759 351 222 1,508 (4,949) – 8,101 8,806 5,304 8,300 1,559 (4,949) 37,990 200 144 251 116 83 201 – 995 10,901 8,128 8,817 5,315 8,318 1,558 (4,949) 38,088 1,782 743 1,664 1,059 1,028 (282) 20 6,014 16.3% 9.1% 18.9% 19.9% 12.4% – – 15.8% Third-party Intersegment Total and Operational Operational EBITDA revenues revenues revenues amortization revenues EBITDA(1) margin (%) Depreciation Operational 8,486 6,590 4,978 4,263 7,209 63 – 31,589 1,713 10,199 196 639 291 223 1,468 (4,530) – 6,786 5,617 4,554 7,432 1,531 (4,530) 31,589 177 84 78 105 76 182 – 702 10,202 6,783 5,613 4,554 7,427 1,532 (4,530) 31,581 1,861 304 1,026 926 925 (230) 12 4,824 18.2% 4.5% 18.3% 20.3% 12.5% – – 15.3% (1) Operational EBITDA by segment is presented before the elimination of intersegment profits made on inventory sales. 130 Financial review | ABB Annual Report 2012 Note 23 Operating segment and geographic data, continued 2012 ($ in millions, except Power Power Automation Low Voltage Process Intersegment Operational EBITDA margin in %) Products Systems and Motion Products Automation elimination Consolidated Operational revenues 10,702 7,812 9,405 6,626 8,134 (3,433) 39,246 Discrete Corporate and Other and 30 68 (3) 17 18 Unrealized gains and losses on derivatives Realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized Unrealized foreign exchange movements on receivables (and related assets) Total revenues Operational EBITDA Depreciation and amortization Acquisition-related expenses (2) (23) (13) 10,717 1,585 (209) (5) 7,852 290 (174) (70) – 3 9,405 1,735 (263) – (5) 6,638 1,219 (250) (8) (106) and certain non-operational items (1) Unrealized gains and losses on derivatives (foreign exchange, commodities, embedded derivatives) Realized gains and losses on derivatives where the underlying hedged transaction has not yet 43 44 been realized (6) (21) 2 1 Unrealized foreign exchange movements on receivables/ payables (and related assets/ liabilities) Restructuring and restructuring- related expenses EBIT (19) (65) 1,328 (10) (52) 7 (2) 4 1,469 21 – (5) (23) 856 1 – – 4 – 8,156 (3,432) 1,003 (82) (277) (204) 131 (21) (20) 39,336 5,555 (1,182) (2) 27 (2) (4) (28) 912 (12) (199) (2) – (3) (16) (514) 135 (28) (43) (180) 4,058 Operational EBITDA margin (%) 14.8% 3.7% 18.4% 18.4% 12.3% – 14.2% ABB Annual Report 2012 | Financial review 131 Note 23 Operating segment and geographic data, continued 2011 ($ in millions, except Power Power Automation Low Voltage Process Intersegment Operational EBITDA margin in %) Products Systems and Motion Products Automation elimination Consolidated Operational revenues 10,901 8,128 8,817 5,315 8,318 (3,391) 38,088 Discrete Corporate and Other and Unrealized gains and losses on derivatives (49) (56) (29) (16) (39) Realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized Unrealized foreign exchange movements on receivables (and related assets) Total revenues Operational EBITDA Depreciation and amortization Acquisition-related expenses (17) (19) 1 34 10,869 1,782 (200) 48 8,101 743 (144) 17 8,806 1,664 (251) – 5 5,304 1,059 (116) and certain non-operational items – – (90) – Unrealized gains and losses on derivatives (foreign exchange, commodities, embedded derivatives) (58) (16) (29) (21) Realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized (14) (19) Unrealized foreign exchange movements on receivables/ payables (and related assets/ liabilities) Restructuring and restructuring- related expenses EBIT 36 (70) 1,476 38 (54) 548 (2) 12 (10) 1,294 – 2 (20) 904 2 19 8,300 1,028 (83) – 4 2 20 (8) 963 1 – – (3,390) (262) (201) (188) (33) 123 37,990 6,014 (995) (17) (107) (38) (158) 1 1 (2) (518) (32) 109 (164) 4,667 Operational EBITDA margin (%) 16.3% 9.1% 18.9% 19.9% 12.4% – 15.8% 132 Financial review | ABB Annual Report 2012 Note 23 Operating segment and geographic data, continued 2010 ($ in millions, except Power Power Automation Low Voltage Process Intersegment Operational EBITDA margin in %) Products Systems and Motion Products Automation elimination Consolidated Operational revenues 10,202 6,783 5,613 4,554 7,427 (2,998) 31,581 Discrete Corporate and Other and Unrealized gains and losses on derivatives Realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized Unrealized foreign exchange movements on receivables (and related assets) Total revenues Operational EBITDA Depreciation and amortization Unrealized gains and losses on derivatives (foreign exchange, commodities, embedded 20 30 6 9 (29) 10,199 1,861 (177) (36) 6,786 304 (84) derivatives) 10 (8) Realized gains and losses on derivatives where the underlying hedged transaction has not yet been realized Unrealized foreign exchange movements on receivables/ payables (and related assets/ liabilities) Restructuring and restructuring- related expenses EBIT 4 (15) (18) (44) 1,636 (35) (48) 114 16 (1) (11) 5,617 1,026 (78) 6 – (8) (35) 911 3 1 (4) 4,554 926 (105) 4 – (1) (36) 788 11 12 (18) 7,432 925 (76) (33) 3 (16) (44) 759 – 1 (2) (2,999) (218) (182) 18 (1) (1) (6) (390) 80 28 (100) 31,589 4,824 (702) (3) (9) (79) (213) 3,818 Operational EBITDA margin (%) 18.2% 4.5% 18.3% 20.3% 12.5% – 15.3% ($ in millions) Power Products Power Systems Discrete Automation and Motion Low Voltage Products Process Automation Corporate and Other Consolidated Capital expenditure(1) Total assets(1) 2012 2011 2010 259 194 197 208 91 344 192 136 202 149 72 270 1,293 1,021 200 119 98 100 76 247 840 2012 7,701 8,083 9,416 9,534 4,847 9,489 2011 7,355 7,469 9,195 3,333 4,777 7,519 49,070 39,648 2010 7,205 6,039 3,696 2,899 4,728 11,728 36,295 (1) Capital expenditure and Total assets are after intersegment eliminations and therefore refer to third-party activities only. ABB Annual Report 2012 | Financial review 133 Note 23 Operating segment and geographic data Geographic information ($ in millions) Europe The Americas Asia Middle East and Africa Revenues Long-lived assets at December 31, 2012 14,073 10,699 10,750 3,814 39,336 2011 2010 14,657 12,378 9,043 10,136 4,154 6,213 8,872 4,126 2012 3,543 1,347 883 174 2011 3,067 829 862 164 37,990 31,589 5,947 4,922 Revenues by geography reflect the location of the customer. Approximately 17 percent, 14 percent and 10 percent of the Company’s total revenues in 2012, 2011 and 2010, respectively, came from customers in the United States. Approxi- mately 12 percent, 13 percent and 14 percent of the Company’s total revenues in 2012, 2011 and 2010, respectively, were generated from customers in China. In 2012, 2011, and 2010, more than 98 percent of the Company’s total rev- enues were generated from customers outside Switzerland. Long-lived assets represent “Property, plant and equipment, net” and are shown by location of the assets. At Decem- ber 31, 2012, approximately 17 percent of the Company’s long-lived assets were located in each of Switzerland and the United States. At December 31, 2011, approximately 19 percent and 13 percent of the Company’s long-lived assets were located in Switzerland and Sweden, respectively. The Company does not segregate revenues derived from transactions with external customers for each type or group of products and services. Accordingly, it is not practicable for the Company to present revenues from external customers by product and service type. At December 31, 2012, approximately 49 percent of the Company’s employees are subject to collective bargaining agreements in various countries. Approximately half of these agreements will expire in 2013. Collective bargaining agree- ments are subject to various regulatory requirements and are renegotiated on a regular basis in the normal course of business. Note 24 Compensation The disclosures required by the Swiss Code of Obligations on compensation to the Board of Directors and Executive Committee are shown in Notes 10, 11 and 12 to the Financial Statements of ABB Ltd, Zurich. 134 Financial review | ABB Annual Report 2012 Report of management on internal control over financial reporting The Board of Directors and management of ABB Ltd and its consolidated subsidiaries (“ABB”) are responsible for establishing and maintaining adequate internal control over financial reporting. ABB’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of the published Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with ABB’s policies and procedures may deteriorate. Management conducted an assessment of the effectiveness of internal control over financial reporting based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has concluded that ABB’s internal control over financial reporting was effective as of December 31, 2012. Ernst & Young Ltd, an independent registered public accounting firm, has issued an opinion on the effectiveness of ABB’s internal control over financial reporting as of December 31, 2012, which is included on page 137 of this Annual Report. Joe Hogan Chief Executive Officer Eric Elzvik Chief Financial Officer Zurich, Switzerland March 14, 2013 135 Financial review | ABB Annual Report 2010 ABB Annual Report 2012 | Financial review 135 Report of the Statutory Auditor on the Consolidated Financial Statements To the General Meeting of ABB Ltd, Zurich As statutory auditor, we have audited the accompanying consolidated finan- cial statements of ABB Ltd, which are comprised of the consolidated balance sheets as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, cash flows, and changes in stockholders’ equity, and notes thereto, for each of the three years in the period ended December 31, 2012. Board of Directors’ Responsibility The Board of Directors is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles and the requirements of Swiss law. This respon- sibility includes designing, implementing and maintaining an internal control system relevant to the preparation and fair presentation of consolidated finan- cial statements that are free from material misstatement, whether due to fraud or error. The Board of Directors is further responsible for selecting and applying appropriate accounting policies and making accounting estimates that are reasonable in the circumstances. Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Swiss law, Swiss Auditing Standards and the standards of the Public Com- pany Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance whether the consolidated financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assess- ment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers the internal control system relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of the accounting poli- cies used and the reasonableness of accounting estimates made, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appro- priate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above, present fairly, in all material respects, the consolidated financial position of ABB Ltd as of Decem- ber 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in accordance with U.S generally accepted accounting principles and comply with Swiss law. Report on other legal requirements We confirm that we meet the legal requirements on licensing according to the Auditor Oversight Act (AOA) and independence (article 728 CO and article 11 AOA) and that there are no circumstances incompatible with our independence. In accordance with article 728a paragraph 1 item 3 CO and Swiss Auditing Standard 890, we confirm that an internal control system exists, which has been designed for the preparation of consolidated financial statements according to the instructions of the Board of Directors. We recommend that the consolidated financial statements submitted to you be approved. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), ABB Ltd’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Spon- soring Organizations of the Treadway Commission (COSO), and our report dated March 14, 2013 expressed an unqualified opinion on the effectiveness of ABB Ltd’s internal control over financial reporting. Ernst & Young Ltd Nigel Jones Licensed audit expert (Auditor in charge) Zurich, Switzerland March 14, 2013 John Cassidy U.S. Certified Public Accountant 136 Financial review | ABB Annual Report 2012 Report of the Group Auditor on internal control over financial reporting Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, ABB Ltd maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the COSO criteria. We also have audited, in accordance with Swiss law, Swiss Auditing Standards and the standards of the Public Company Accounting Oversight Board (United States), the 2012 consolidated financial statements of ABB Ltd and our report dated March 14, 2013, expressed an unqualified opinion thereon. Ernst & Young Ltd Nigel Jones Licensed audit expert (Auditor in charge) Zurich, Switzerland March 14, 2013 John Cassidy U.S. Certified Public Accountant To the Board of Directors and Stockholders of ABB Ltd, Zurich We have audited ABB Ltd’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). ABB Ltd’s Board of Directors and management are responsible for maintaining effective internal control over financial reporting, and management is responsible for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of management on internal control over financial report- ing. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accor- dance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the com- pany; (2) provide reasonable assurance that transactions are recorded as nec- essary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assur- ance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. ABB Annual Report 2012 | Financial review 137 Financial Statements of ABB Ltd, Zurich Income Statement Year ended December 31 (CHF in thousands) Dividend income Finance income Other income Finance expense Personnel expenses Other expenses Revaluation gain/loss on own shares Net income before taxes Income taxes Net income Balance Sheet December 31 (CHF in thousands) Cash and equivalents Cash deposit with ABB Group Treasury Operations Receivables Total current assets Long-term loans – Group Participation Own shares Other assets Total non-current assets Total assets Current liabilities Bonds Total liabilities Share capital Legal reserves Ordinary reserves Capital contribution reserve Reserve for own shares Free reserves Other reserves Retained earnings Net income Total stockholders’ equity Total liabilities and stockholders’ equity 138 Financial review | ABB Annual Report 2012 2012 2011 1,200,000 1,200,000 26,054 55,521 (70,701) (42,906) (32,962) 38,674 16,560 49,532 (9,555) (27,983) (58,463) (76,447) 1,173,680 1,093,644 (500) 363 1,173,180 1,094,007 2012 553 2011 1,505 3,347,513 2,444,487 21,415 13,975 3,369,481 2,459,967 900,000 8,973,229 352,387 11,449 1,500,000 8,973,229 430,192 9,329 10,237,065 10,912,750 13,606,546 13,372,717 50,351 1,199,040 1,249,391 41,157 848,664 889,821 2,384,186 2,384,186 1,000,000 3,968,875 395,274 138,122 3,297,518 1,173,180 1,000,000 5,268,717 511,752 20,723 2,203,511 1,094,007 12,357,155 12,482,896 13,606,546 13,372,717 Notes to Financial Statements Note 1 General Note 2 Receivables December 31 (CHF in thousands) Non-trade receivables Non-trade receivables – Group Accrued income – Group Total Note 3 Loans – Group December 31 (CHF in thousands) Long-term loans – Group Note 4 Participation December 31 Company name ABB Asea Brown Boveri Ltd Note 5 Current liabilities December 31 (CHF in thousands) Non-trade payables Non-trade payables – Group Accrued expenses Accrued expenses – Group Total ABB Ltd, Zurich (the Company) is the parent company of the ABB Group whose consolidated financial statements include 100 percent of the assets, liabilities, revenues, expenses, income and cash flows of ABB Ltd and group compa- nies in which the Company has a controlling interest, as if the Company and its group companies were a single com- pany. The consolidated financial statements are of overriding importance for the purpose of the economic and financial assessment of the Company. The unconsolidated financial statements of the Company are prepared in accordance with Swiss law and serve as complementary information to the consolidated financial statements. Certain prior-year amounts have been reclassified to conform to the current year’s presentation. 2012 144 17,412 3,859 21,415 2011 167 9,947 3,861 13,975 2012 2011 900,000 1,500,000 The Company maintains interest bearing credit agreements with ABB Asea Brown Boveri Ltd, Zurich, Switzerland. These loans are stated at the lower of cost or fair value. Purpose Holding Domicile CH-Zurich Share capital CHF 2,768,000,000 Ownership interest 2012 100% 2011 100% The participation is valued at the lower of cost or fair value, using valuation models accepted under Swiss law. 2012 3,284 465 44,990 1,612 50,351 2011 1,874 1,716 35,915 1,652 41,157 ABB Annual Report 2012 | Financial review 139 Note 6 Stockholders’ equity Share capital Legal reserves Capital Free reserves Total 2012 (CHF in thousands) reserves reserve own shares reserves earnings Net income Opening balance as of January 1 2,384,186 1,000,000 5,268,717 511,752 20,723 2,203,511 1,094,007 12,482,896 Ordinary contribution Reserve for Other Retained Allocation to retained earnings Allocation to other reserves Release to other reserves Release to other reserves Dividend payment Net income for the year (921) (1,298,921) 921 1,298,921 (116,478) 116,478 (1,298,921) 1,094,007 (1,094,007) – – – – (1,298,921) 1,173,180 1,173,180 Closing balance as of December 31 2,384,186 1,000,000 3,968,875 395,274 138,122 3,297,518 1,173,180 12,357,155 Share capital as of December 31, 2012 Issued shares Contingent shares Authorized shares Share capital as of December 31, 2011 Issued shares Contingent shares Authorized shares Number of Par value Total registered shares 2,314,743,264 304,038,800 200,000,000 (CHF) 1.03 1.03 1.03 (CHF in thousands) 2,384,186 313,160 206,000 Number of Par value Total registered shares 2,314,743,264 304,038,800 200,000,000 (CHF) 1.03 1.03 1.03 (CHF in thousands) 2,384,186 313,160 206,000 During 2012, a bank holding call options related to ABB Group’s management incentive plan (MIP), exercised a portion of the options. Such options had been issued by the group company that facilitates the MIP (related to MIP launches during 2006) at fair value and with a strike price of CHF 15.30. At issuance, the group company had entered into an intercompany option agreement with the same terms and conditions to enable it to meet its future obligations. As a result of the exercise by the bank, the Company issued 2,726,800 shares at CHF 15.30 out of own shares. The ABB Group has an employee share acquisition plan (ESAP). To enable the group company that facilitates the ESAP to deliver shares to employees who have exercised their stock options, the group company entered into an agreement with the Company to acquire the required number of shares at their then market value from the Company. Consequently in November 2012 and 2011, the Company issued, out of own shares, to the group company, 2,344,733 and 20,366 shares at CHF 17.23 and CHF 16.75, respectively. In 2012 and 2011, the Company transferred 466,622 and 964,943 own shares at an average price per share of CHF 21.03 in both cases to fulfill its obligations under other share-based arrangements. The average acquisition price of the own shares at both December 31, 2012 and 2011, was CHF 21.03. The movement in the number of own shares during the year was as follows: Opening balance as of January 1 Cancellation Purchases Transfers Closing balance as of December 31 2012 2011 24,332,144 25,317,453 – – – – (5,538,155) (985,309) 18,793,989 24,332,144 The own shares are stated at the lower of cost or fair value. As a consequence of the increase in the fair value, the own shares were revalued at December 31, 2012 to CHF 18.75 from CHF 17.68 per share, resulting in a write-up of CHF 38,674 thousand in 2012. As a result of the Swiss corporate tax reform II that became effective on January 1, 2011, qualifying contributions from the shareholders exceeding the nominal share capital can be distributed without deduction of Swiss withholding tax. According to the corresponding guidelines, such contributions have been recorded in a specific account (Capital contri- bution reserve) within the legal reserves in order to benefit from the favorable tax treatment. 140 Financial review | ABB Annual Report 2012 Note 7 Contingent liabilities The Company has issued a support letter to a surety institution for the issuance of surety bonds on behalf of group companies. The amount issued under this letter was CHF 274,515 thousand as of December 31, 2012 (CHF 282,345 thousand as of December 31, 2011). Furthermore, the Company has Keep-well agreements with certain group companies. A Keep-well agreement is a shareholder agreement between the Company and a group company. These agreements provide for maintenance of a minimum net worth in the group company and the maintenance of 100 percent direct or indirect ownership by the Company. The Keep-well agreements additionally provide that if at any time the group company has insufficient liquid assets to meet any payment obligation on its debt (as defined in the agreements) and has insufficient unused commitments under its credit facilities with its lenders, the Company will make available to the group company sufficient funds to enable it to fulfill such payment obligation as it falls due. A Keep-well agreement is not a guarantee by the Company for payment of the indebtedness, or any other obligation, of a group company. No party external to the ABB Group is a party to any of these Keep-well agreements. In addition, the Company has provided certain guarantees securing the performance of Group companies in connection with commercial paper programs, indentures or other debt instruments to enable them to fulfill the payment obligation under such instruments as they fall due. The amount guaranteed under these instruments was CHF 6,481,807 thousand as of December 31, 2012. Furthermore, the Company is the guarantor in the Group’s $2 billion multicurrency revolving credit facility, maturing in 2015 but no amounts were outstanding at December 31, 2012 and 2011. The Company through certain of its direct and indirect subsidiaries is involved in various regulatory and legal matters. The Company’s direct and indirect subsidiaries have made certain related accruals as further described in note 15 of the Consolidated Financial Statements of ABB Ltd. There could be material adverse outcomes beyond the accrued liabilities. The Company is part of a value added tax group and therefore is jointly liable to the Swiss Federal Tax Department for the value added tax liabilities of the other members. Note 8 Bonds December 31 (CHF in thousands) Bond 2011–2016 1.25% coupon Bond 2011–2021 2.25% coupon Bond 2012–2018 1.5% coupon Total 2012 498,937 350,000 350,103 2011 498,664 350,000 – 1,199,040 848,664 The 1.25% CHF Bonds, due 2016, the 2.25% Bonds, due 2021 and the 1.5% Bonds, due 2018, pay interest annually in arrears, at fixed annual rates of 1.25 percent, 2.25 percent and 1.5 percent, respectively. The Company recorded net proceeds of CHF 346 million in 2012. The bonds are stated at their nominal value less any discount or plus any on issuance. Bonds are accreted to par over the period to maturity. The Company has, through Group Treasury Operations, entered into interest rate swaps with banks to effectively convert the bonds maturing 2016 and 2021 into floating rate obligations. Note 9 Significant shareholders Investor AB, Sweden, held 182,030,142 and 179,030,142 ABB Ltd shares as of December 31, 2012 and 2011, respectively. These holdings represent 7.9 percent and 7.7 percent of ABB Ltd’s total share capital and voting rights as registered in the Commercial Register on December 31, 2012 and 2011, respectively. Pursuant to its disclosure notice, BlackRock, Inc., USA, disclosed that, as per July 25, 2011, it, together with its direct and indirect subsidiaries, held 69,702,100 ABB Ltd shares. These holdings correspond to 3.0 percent of ABB Ltd’s total share capital and voting rights as registered in the Commercial Register on December 31, 2012 and 2011, respectively. To the best of the Company’s knowledge, no other shareholder holds 3 percent or more of the total share capital and voting rights on December 31, 2012 and 2011, respectively. Note 10 Board of Directors compensation The compensation levels of members of the Board of directors were as follows: Function Chairman of the Board Member of the Board and Committee chairman Member of the Board Board term Board term 2012/2013 2011/2012 (CHF) (CHF) 1,200,000 1,200,000 400,000 300,000 400,000 300,000 ABB Annual Report 2012 | Financial review 141 Note 10 Board of Directors compensation, continued Board compensation is payable in semi-annual installments in arrears. The first payment is made in November, for the period of Board membership from election at the Annual General Meeting to October of that year. The second payment is made in May of the following year for the period of Board membership from November to the end of that Board term. Board members elect to receive either 50 percent or 100 percent of their compensation in ABB shares. The reference price for the shares to be delivered (and hence the calculation of the number of shares to be delivered) is the average closing price of the ABB share during a defined 30-day period which is different for each installment. The ABB shares are kept in a blocked account for three years after the date of original delivery and may only be disposed of earlier (with limited exception) if the respective person has left the Board of directors. The compensation amounts per individual Board member are listed in the table below: Paid in 2012 Paid in 2011 November May November May Board term 2012/2013 Board term 2011/2012 Board term 2011/2012 Board term 2010/2011 Settled in shares – number Settled in shares – Total com- number pensation Settled in shares – number Settled in shares – Total com- number pensation Settled of shares Settled of shares paid Settled of shares Settled of shares paid Name/Function in cash(1) received(2) in cash(1) received(2) 2012(3),(4),(5) in cash(1) received(2) in cash(1) received(2) 2011(4),(5) (CHF) (CHF) (CHF) (CHF) (CHF) (CHF) Hubertus von Grünberg Chairman of the Board – 23,298 – 22,685 1,200,000 – 25,917 – 19,303 1,200,000 Roger Agnelli (6) Member of the Board 75,000 2,873 75,000 2,807 300,000 75,000 3,196 75,000 2,388 300,000 Louis R. Hughes(6) Member of the Board and beginning with the 2011/2012 board term Chairman of the Finance, Audit and Compliance Committee 100,000 3,840 100,000 3,751 400,000 100,000 4,272 75,000 2,388 350,000 Hans Ulrich Märki Member of the Board and Chairman of the Governance, Nomina- tion and Compensation Committee Michel de Rosen(7) – 10,649 Member of the Board 75,000 2,873 Michael Treschow(7) – – 10,364 400,000 5,614 300,000 – – 11,746 – 8,757 400,000 6,392 75,000 2,388 300,000 Member of the Board 75,000 2,922 75,000 2,843 300,000 75,000 3,251 75,000 2,419 300,000 Bernd W. Voss(8) Member of the Board and Chairman of the Finance, Audit and Compliance Committee until the 2011/2012 board term Jacob Wallenberg(6) – – – – – – – 100,000 3,222 200,000 Member of the Board 75,000 2,873 75,000 2,807 300,000 75,000 3,196 75,000 2,388 300,000 Ying Yeh(7),(9) Member of the Board 75,000 2,905 75,000 2,807 300,000 75,000 3,197 – – 150,000 Total 475,000 52,233 400,000 53,678 3,500,000 400,000 61,167 475,000 43,253 3,500,000 (1) (2) (3) (4) (5) (6) (7) (8) (9) Represents gross amounts paid, prior to deductions for social security, withholding tax etc. Number of shares per Board member is calculated based on net amount due after deductions for social security, withholding tax etc. For the 2012–2013 Board term, all members elected to receive 50% of their gross compensation in the form of ABB shares, except for Hubertus von Grünberg and Hans Ulrich Märki who elected to receive 100%. For the 2011–2012 Board term, all members elected to receive 50% of their gross compensation in the form of ABB shares, except for Hubertus von Grünberg, Hans Ulrich Märki and Michel de Rosen who elected to receive 100%. In addition to the Board remuneration stated in the above table, the Company paid in 2012 and 2011 CHF 211,008 and CHF 213,122 respectively, in employee social security payments. Member of the Finance, Audit and Compliance Committee. Member of the Governance, Nomination and Compensation Committee. Bernd W. Voss did not stand for election to the Company’s board at the AGM in April 2011. Ying Yeh was elected to the Company’s board at the AGM in April 2011. 142 Financial review | ABB Annual Report 2012 Note 10 Board of Directors compensation, continued Board members do not receive pension benefits and are not eligible to participate in any of ABB’s employee incentive programs. No loans or guarantees were granted to Board members in 2012 and 2011. Except as disclosed herein, no payments were made to former Board members in 2012 and 2011. Note 11 Executive Committee compensation Other than as disclosed herein, no members of the Board received any additional fees and remuneration for services rendered to ABB. Also, in 2012 ABB did not pay any additional fees or remuneration to persons closely linked to a member of the Board for services rendered to ABB. A related party includes a spouse, children below the age of eighteen, legal or natural persons acting as a fiduciary and legal entities controlled by a member of the Board. The table below provides an overview of the total compensation of members of the Executive Committee in 2012, comprising cash compensation and an estimate of the value (at grant date) of shares conditionally awarded under the 2012 one-time Acquisition Integration Execution Plan (AIEP) that vest at the beginning of 2014 and the three-year Long-term Incentive plan (LTI Plan) that vest in 2015. Cash compensation includes the base salary, accrued short-term variable compensation for 2012, pension benefits, as well as other benefits comprising mainly social security and health insurance contributions. The compensation is shown gross (i.e. before deduction of employee’s social insurance and pension contributions). e l b a i r a v m r e t - t r o h S ) 1 ( n o i t a s n e p m o c y r a l a s e s a B Name (CHF) (CHF) Joe Hogan 2,010,011 3,316,500 Michel Demaré 1,200,007 1,320,000 Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan(4) Greg Scheu (joined on 805,002 865,673 791,993 950,004 770,006 816,669 718,837 641,963 885,500 962,500 880,000 1,045,000 847,000 913,000 803,000 697,279 r e d n u d e t n a r g s d r a w a d e s a b - e r a h s f o e u l a v d e t a m i t s E ) 3 ( 2 1 0 2 n i n a P l I T L e h t (CHF) r e d n u d e t n a r g s d r a w a d e s a b ) 3 ( 2 1 0 2 n i P E I A e m i t - e n o e h t - e r a h s f o e u l a v d e t a m i t s E (CHF) l a t o t b u S 2 1 0 2 (CHF) 2 1 0 2 l a t o T (CHF) 4,115,136 10,157,801 – 3,169,425 – – 10,157,801 3,169,425 851,003 3,000,497 896,656 3,897,153 1,363,655 3,592,456 974,623 4,567,079 899,193 2,983,531 891,085 3,874,616 1,067,784 3,522,380 1,058,174 4,580,554 865,483 2,891,617 857,673 3,749,290 1,099,345 3,275,918 924,511 4,200,429 820,512 820,512 2,934,264 2,878,865 813,119 3,747,383 835,403 3,714,268 s t i f e n e b n o i s n e P (CHF) 284,870 271,450 286,938 235,680 273,583 280,372 263,892 234,425 222,181 313,377 ) 2 ( s t i f e n e b r e h t O (CHF) 431,284 377,968 172,054 164,948 138,762 179,220 145,236 212,479 369,734 405,734 May 1, 2012) 450,002 495,000 161,816 42,727 713,574 1,863,119 751,851 2,614,970 Prith Banerjee (joined ABB on May 7, 2012) 456,523 500,914 137,742 401,148 740,017 2,236,344 389,860 2,626,204 Total Executive Committee members as of Dec. 31, 2012 10,476,690 12,665,693 2,966,326 3,041,294 13,356,214 42,506,217 8,392,955 50,899,172 Peter Leupp (retired from the EC on March 1, 2012)(5) 496,694 291,960 167,900 206,794 Total former Executive Committee members as of Dec. 31, 2012 496,694 291,960 167,900 206,794 – – 1,163,348 1,163,348 – – 1,163,348 1,163,348 Total 10,973,384 12,957,653 3,134,226 3,248,088 13,356,214 43,669,565 8,392,955 52,062,520 (1) (2) (3) (4) (5) The table above shows accruals related to the short-term variable compensation for the year 2012 for all Executive Committee members, except for Peter Leupp, who received in July 2012 a pro-rata short-term variable compensation payment covering the period of his service as an EC member. For all other Executive Committee members, the short-term variable com- pensation will be paid in 2013, after the publication of the financial results. In March 2012, the current and former Executive Committee members received the 2011 short-term variable compensation payments totaling CHF 12,102,149. Short-term variable compensation is linked to the objectives defined in the ABB Group’s scorecard. Upon full achievement of these objectives, the short-term variable compensation of the CEO corresponds to 150 percent of his base salary, while for all other Executive Committee members it represents 100 percent of their respective base salary. The Board has the discretion to approve a payout that is up to 50 percent higher (representing up to 225 percent of the base salary for the CEO and 150 percent of the base salary for other members of the Executive Committee), if the objectives are exceeded. For 2012, the Board exercised its discretion and awarded a 10 percent higher payout, reflecting the Company’s performance against the objectives. Other benefits comprise payments related to social security, health insurance, children’s education, transportation, tax advice and certain other items. The estimated value of the share-based awards is subject to performance and other parameters (e. g. earnings per share) and may therefore vary in value from the above numbers at the date of vesting, January 3, 2014 (AIEP) and May 31, 2015 (LTI Plan). The above amounts have been calculated using the market value of the ABB share on the day of grant and, in the case of the AIEP and the performance component of the LTI Plan, the Monte Carlo simulation model. Frank Duggan received 20 percent of his base salary in AED and 80 percent in EUR at a fixed AED/EUR exchange rate for the period January to December 2012. All AED payments were converted into Swiss francs at a rate of 0.2491288 per AED. The above compensation figures for Peter Leupp include contractual payments for the period March 1, 2012 to July 31, 2012, but exclude payments to him, after his retirement from the Executive Committee, in his capacity as director of ABB in China and of ABB Limited, India. ABB Annual Report 2012 | Financial review 143 Note 11 Executive Committee compensation, continued The table below provides an overview of the total compensation of members of the Executive Committee in 2011, comprising cash compensation and an estimate of the value of shares conditionally awarded under a three-year incentive plan that runs until 2014. Cash compensation includes the base salary, the accrued short-term variable compensation for 2011, pension benefits, as well as other benefits comprising mainly social security and health insurance contributions. The compensation is shown gross (i.e. before deduction of employee’s social insurance and pension contributions). e l b a i r a v m r e t - t r o h S ) 1 ( n o i t a s n e p m o c y r a l a s e s a B (CHF) (CHF) 1,991,676 3,376,800 1,200,006 1,344,000 799,168 812,502 748,258 945,002 770,005 701,230 741,676 660,835 597,598 901,600 917,280 842,128 1,064,000 862,400 551,861 840,000 742,560 595,962 s t i f e n e b n o i s n e P (CHF) 280,384 267,014 282,501 229,895 267,566 275,936 285,712 267,987 227,416 215,716 256,020 ) 2 ( s t i f e n e b r e h t O (CHF) 849,768 323,361 173,691 171,064 300,585 220,816 164,442 320,362 224,330 244,075 140,636 s d r a w a d e s a b - e r a h s f o e u l a v d e t a m i t s E ) 3 ( 1 1 0 2 n i d e t n a r g (CHF) 1 1 0 2 l a t o T (CHF) 2,871,650 9,370,278 1,189,349 4,323,730 687,243 868,307 745,419 811,031 2,844,203 2,999,048 2,903,956 3,316,785 – 2,082,559 541,126 769,347 680,105 623,213 2,382,566 2,802,769 2,543,291 2,213,429 Name Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Peter Leupp Veli-Matti Reinikkala(4) Brice Koch Tarak Mehta Frank Duggan (joined on March 1, 2011)(5) Total Executive Committee members as of December 31, 2011 9,967,956 12,038,591 2,856,147 3,133,130 9,786,790 37,782,614 Tom Sjökvist (retired from the EC on September 30, 2010)(6) Anders Jonsson (retired from the EC on July 31, 2010)(6) Total former Executive Committee members as of December 31, 2011 188,851 – 188,851 – – – 47,971 – 617,040 857,284 47,971 1,474,324 – – – 853,862 857,284 1,711,146 Total 10,156,807 12,038,591 2,904,118 4,607,454 9,786,790 39,493,760 (1) (2) (3) (4) (5) (6) To reflect widespread market practice, in 2011, the basis of presentation of the short-term variable compensation changed from a cash basis to an accruals basis. Payment is made in the following year, after publication of the financial results. On July 1, 2011, Veli-Matti Reinikkala relocated from the U.S. to Switzerland. According to the Group’s policy, he received in 2011 a pro-rata short-term variable compensation payout of CHF 244,581 for his service in the U.S. for the period January 1, 2011, to June 30, 2011. The final payout amount for Veli-Matti Reinikkala, which is based on the 2011 results, has been reduced by this pro-rata short-term variable compensation payment already received. In March 2011, the current and former Executive Committee members received the 2010 short-term variable compensation payments in the amount of CHF 11,951,967. This number does not include any short-term variable compensation amount for Frank Duggan, who joined the Executive Committee on March 1, 2011. Short-term variable compensation is linked to the targets defined in the ABB Group’s scorecard. Upon full achievement of these targets, the short-term variable compensation of the CEO corresponds to 150 percent of his base salary, while for all other Executive Committee members it represents 100 percent of their respective base salary. The Board has the discretion to approve a higher payout than 100 percent, if the targets are exceeded. For 2011, the Board exercised its discretion and awarded a 12 percent higher payout, reflecting the company’s performance against the targets. Other benefits comprise payments related to social security, health insurance, children’s education, transportation, tax advice and certain other items. The estimated value of the share-based awards is subject to performance and other parameters (e.g. the share price development) and may therefore vary in value from the above numbers at the date of vesting, March 15, 2014. The above amounts have been calculated using the market value of the ABB share on the day of grant adjusted, in the case of the perfor- mance component, according to the parameters considered in the Monte Carlo simulation model. Veli-Matti Reinikkala received 50 percent of his base salary in USD and 50 percent in EUR at a fixed USD/EUR exchange rate for the period January to June 2011. All USD payments were converted into Swiss francs at a rate of 0.94115 per USD. As of July 2011, Veli-Matti Reinikkala relocated to Switzerland and since then receives his compensation in Swiss francs. Frank Duggan received 20 percent of his base salary in AED and 80 percent in EUR at a fixed AED/EUR exchange rate for the period March to December 2011. All AED payments were converted into Swiss francs at a rate of 0.2562417 per AED. The above compensation figures related to Tom Sjökvist and Anders Jonsson represent contractual payments for the period January to December 2011. 144 Financial review | ABB Annual Report 2012 Note 11 Executive Committee compensation, continued LTI Plan awards granted to members of the Executive Committee during 2012 are summarized in the table below. The vesting date of the respective award is listed in the footnotes to the table. h c n u a l 2 1 0 2 e h t f o t n e n o p m o c s e r a h s f o r e b m u n e c n e r e f e R e c n a m r o f r e p e h t r e d n u ) 4 ( , ) 1 ( n a P l I T L f o s d r a w a f o e u l a v d e t a m i t s e l a t o T e c n a m r o f r e p e h t r e d n u d e t n a r g n a P l I T L e h t f o t n e n o p m o c ) 2 ( 2 1 0 2 n i (CHF) h c n u a l 2 1 0 2 e h t r e d n u d e t n a r g s e r a h s n o i t n e t e r f o r e b m u N ) 3 ( , ) 1 ( n a P l I T L f o - e r a h s f o e u l a v d e t a m i t s e l a t o T r e d n u d e t n a r g s d r a w a d e s a b e h t f o t n e n o p m o c n o i t n e t e r e h t ) 2 ( 2 1 0 2 n i n a P l I T L (CHF) h c n u a l 2 1 0 2 e h t r e d n u d e t n a r g s e r a h s f o r e b m u n l a t o T ) 3 ( , ) 1 ( n a P l I T L f o d e t n a r g s d r a w a d e s a b - e r a h s f o ) 2 ( 2 1 0 2 n i n a P l I T L e h t r e d n u e u l a v d e t a m i t s e l a t o T (CHF) 123,541 1,860,269 148,249 2,254,867 271,790 4,115,136 – 20,781 22,588 20,652 24,524 19,878 21,426 18,845 18,845 17,425 18,071 – 312,919 340,128 310,976 369,280 299,321 322,631 283,767 283,767 262,384 272,112 – 35,377 67,293 38,673 45,924 37,223 51,066 35,289 35,289 29,664 30,763 – 538,084 1,023,527 588,217 698,504 566,162 776,714 536,745 536,745 451,190 467,905 – 56,158 89,881 59,325 70,448 57,101 72,492 54,134 54,134 47,089 48,834 – 851,003 1,363,655 899,193 1,067,784 865,483 1,099,345 820,512 820,512 713,574 740,017 Name Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Greg Scheu (joined on May 1, 2012) Prith Banerjee (joined ABB on May 7, 2012) Total Executive Committee members as of December 31, 2012 326,576 4,917,554 554,810 8,438,660 881,386 13,356,214 (1) (2) (3) (4) Vesting date May 31, 2015. The shares of the performance component are valued using the market value of the ABB share on the grant date and the Monte Carlo simulation model. The estimated value applied to the shares of the retention component, represents the market value of the ABB share on the grant date of the award. The LTI Plan foresees to deliver 30 percent of the value of the vested retention shares in cash, but participants have the possibility to elect upon vesting to receive 100 percent of the vested award in shares. The vested performance component under the plan, if any, will be fully settled in cash. The plan foresees a maximum payout of 200% of the number of reference shares, based on the weighted cumulative EPS performance against predefined objectives. In addition to the above awards, 7 members of the Executive Committee participated in the ninth launch of ESAP which will allow them to save over a twelve-month period and, in November 2013, use their savings to acquire ABB shares under the ESAP. The maximum number of shares the Executive Committee members are entitled to acquire depends on their savings’ amount and currency. One of the Executive Committee members is entitled to acquire up to a maximum of 570 ABB shares and the other Executive Committee members who participated in ESAP are each entitled to acquire up to 580 ABB shares at an exercise price of CHF 17.08 per share. No parties related to any member of the Executive Committee received any fees or remunerations for services rendered to ABB, other than on an arm’s length basis. A related party includes a spouse, children below the age of eighteen, legal or natural persons acting as fiduciary and legal entities controlled by a member of the Executive Committee. No loans or guarantees were granted to members of the Executive Committee in 2012. ABB Annual Report 2012 | Financial review 145 Note 11 Executive Committee compensation, continued Share-based awards granted to members of the Executive Committee during 2011 are summarized in the table below. The vesting date of the respective award, granted under the LTI Plan, is listed in the footnotes to the table. y l l a n o i t i d n o c f o r e b m u n m u m x a M i e h t f o t n e n o p m o c e c n a m r o f r e p ) 4 ( , ) 1 ( n a P l I T L f o h c n u a l 1 1 0 2 e h t r e d n u s e r a h s d e t n a r g 60,526 26,967 15,196 15,460 14,194 17,933 – 11,965 14,158 12,516 13,780 e h t r e d n u d e t n a r g s d r a w a d e s a b e h t f o t n e n o p m o c e c n a m r o f r e p - e r a h s f o e u l a v d e t a m i t s e l a t o T ) 2 ( 1 1 0 2 n i n a P l I T L (CHF) 530,470 236,348 133,183 135,497 124,401 157,171 – 104,866 124,086 109,695 120,773 h c n u a l 1 1 0 2 e h t r e d n u d e t n a r g s e r a h s n o i t n e t e r f o r e b m u N ) 3 ( , ) 1 ( n a P l I T L f o 99,371 40,450 23,517 31,104 26,359 27,753 – 18,517 27,388 24,211 21,326 - e r a h s f o e u l a v d e t a m i t s e l a t o T r e d n u d e t n a r g s d r a w a d e s a b e h t f o t n e n o p m o c n o i t n e t e r e h t ) 2 ( 1 1 0 2 n i n a P l I T L (CHF) h c n u a l 1 1 0 2 e h t r e d n u d e t n a r g s e r a h s f o r e b m u n l a t o T ) 3 ( , ) 1 ( n a P l I T L f o d e t n a r g s d r a w a d e s a b - e r a h s f o e u l a v d e t a m i t s e l a t o T ) 2 ( 1 1 0 2 n i (CHF) 2,341,180 159,897 2,871,650 953,001 554,060 732,810 621,018 653,860 – 436,260 645,261 570,410 502,440 67,417 38,713 46,564 40,553 45,686 – 30,482 41,546 36,727 35,106 1,189,349 687,243 868,307 745,419 811,031 – 541,126 769,347 680,105 623,213 Name Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Peter Leupp Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Total Executive Committee members as of December 31, 2011 202,695 1,776,490 339,996 8,010,300 542,691 9,786,790 (1) (2) (3) (4) Vesting date March 15, 2014. The estimated value applied to the shares of the retention component, represents the market value of an ABB share on the grant date of the award. The estimated value applied to the shares of the performance component, represents the market value of an ABB share on the grant date, adjusted according to the parameters considered in the Monte Carlo simulation model. The LTI Plan foresees to deliver 30 percent of the value of the vested retention shares in cash, but participants have the possibility to elect upon vesting to receive 100 percent of the vested award in shares. The vested performance shares under the plan will be fully settled in cash. Share-based awards granted to members of the Executive Committee under the one-time AIEP during 2012 are summarized in the table below. The vesting date of the award is listed in the footnotes to the table. Number of conditionally Total estimated value of granted shares under the one-time share-based awards granted under 2012 launch of AIEP(1),(3) the one-time AIEP in 2012(2) Name Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan (CHF) – – 66,795 72,603 66,380 78,827 63,891 68,870 60,572 62,232 56,008 29,042 625,220 – – 896,656 974,623 891,085 1,058,174 857,673 924,511 813,119 835,403 751,851 389,860 8,392,955 Greg Scheu (joined on May 1, 2012) Prith Banerjee (joined ABB on May 7, 2012) Total Executive Committee members as of December 31, 2012 (1) (2) (3) Vesting date January 3, 2014. The shares are valued using the market value of the ABB share on the grant date and the Monte Carlo simulation model. The AIEP foresees to deliver 30 percent of the value of the vested shares in cash, but participants have the possibility to elect, prior to vesting, to receive 100 percent of the vested award in shares. The plan foresees a maximum payout of 768,286 shares, subject to the fulfillment of the plan objectives and the assessment by the CEO of the individual’s performance. 146 Financial review | ABB Annual Report 2012 Note 11 Executive Committee compensation, continued No parties related to any of the Executive Committee members received any fees or remunerations for services rendered to ABB, other than on an arm’s length basis. A related party includes a spouse, children below the age of eighteen, legal or natural persons acting as fiduciary and legal entities controlled by a member of the Executive Committee. No loans or guarantees were granted to members of the Executive Committee in 2012. Note 12 Share ownership of ABB by Board members and members of the Executive Committee Name Hubertus von Grünberg Roger Agnelli Louis R. Hughes Hans Ulrich Märki Michel de Rosen Michael Treschow Jacob Wallenberg(1) Ying Yeh Total At December 31, 2012 and 2011, the members of the Board of directors as of that date, held the following numbers of shares (or ADSs representing such shares): Total number of shares held(1) December 31, 2012 December 31, 2011 173,370 160,672 63,928 410,192 128,595 97,506 174,882 8,909 127,387 154,992 56,337 389,179 120,108 91,741 169,202 3,197 1,218,054 1,112,143 (1) Share amounts provided in this section do not include the shares beneficially owned by Investor AB, of which Mr. Wallenberg is chairman At December 31, 2012 and 2011, the members of the Executive Committee, as of that date, held the following numbers of shares (or ADSs representing such shares), the conditional rights to receive ABB shares under the LTI Plan, options (either vested or unvested as indicated) under the MIP and unvested shares in respect of other compensation arrangements: d l e h s e r a h s f o r e b m u n l a t o T 255,046 397,772 219,365 164,191 179,189 134,118 122,763 30,424 15,771 15,803 s n o i t p o d e t s e v f o r e b m u N ) 1 ( I P M e h t r e d n u d l e h – – – – – – – – 190,850 631,930 Name Joe Hogan Michel Demaré(4) Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Greg Scheu Unvested at December 31, 2012 s n o i t p o d e t s e v n u f o r e b m u N ) 1 ( I P M e h t r e d n u d l e h 0 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 2 ( n a P l I T L e h t 1 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 2 ( n a P l I T L e h t 2 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 2 ( n a P l I T L e h t s n o i t p o d e t s e v n u f o r e b m u N ) 1 ( I P M e h t r e d n u d l e h r e d n u e l b a r e v i l e d s e r a h S ) 3 ( P E I A 2 1 0 2 e m i t - e n o e h t s u n o b n o - n g i s f o t c e p s e r n i d e t n a r g s e r a h s f o r e b m u N (vesting (vesting (vesting (vesting (vesting (vesting (vesting 2013) 2014) – – – – – – – – – – – – – – – – – – – – 2013) 87,841 41,609 23,140 23,440 21,938 27,647 20,065 21,036 12,714 14,309 – – 2014) 99,371 40,450 23,517 31,104 26,359 27,753 18,517 27,388 24,211 21,326 – – 2015) 148,249 – 35,377 67,293 38,673 45,924 37,223 51,066 35,289 35,289 2014) – – 66,795 72,603 66,380 78,827 63,891 68,870 60,572 62,232 29,664 56,008 30,763 29,042 2013) 189,682 – – – – – – – – – – – (joined on May 1, 2012) 32 544,920 201,250 221,375 Prith Banerjee (joined ABB on May 7, 2012) – – – – Total Executive Committee members as of December 31, 2012 1,534,474 1,367,700 201,250 221,375 293,739 339,996 554,810 625,220 189,682 (1) (2) (3) (4) Options may be sold or exercised/converted into shares at the ratio of 5 options for 1 share. The LTI Plan foresees to deliver 30 percent of the value of the vested retention shares in cash, but participants have the possibility to elect to receive 100 percent of the vested award in shares. The AIEP foresees to deliver 30 percent of the value of the vested shares in cash, but participants have the possibility to elect to receive 100 percent of the vested award in shares. The actual number of shares to be delivered could be increased up to a total maximum amount of 768,286 shares. Total number of shares held includes 4,500 shares held jointly with spouse. ABB Annual Report 2012 | Financial review 147 Note 12 Share ownership of ABB by Board members and members of the Executive Committee, continued ) 1 ( d l e h s e r a h s f o r e b m u n l a t o T 223,546 373,935 206,902 152,889 167,186 120,485 125,113 106,522 30,424 11,868 15,130 Unvested at December 31, 2011 - i d n o c f o r e b m u n m u m x a M i f o h c n u a l 9 0 0 2 e h t r e d n u s e r a h s d e t n a r g y l l a n o i t ) 3 ( n a P l I T L e h t s e r a h s g n i h c t a m f o r e b m u N 9 0 0 2 e h t r e d n u e l b a r e v i l e d f o n o i t r o p t n e m t s e v n i - o c ) 3 ( n a P l I T L e h t 0 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 3 ( n a P l I T L e h t 1 1 0 2 e h t r e d n u e l b a r e v i l e d f o t n e n o p m o c n o i t n e t e r s e r a h s n o i t n e t e R ) 3 ( n a P l I T L e h t d e t s e v n u f o r e b m u N ) 2 ( I P M e h t r e d n u d l e h s n o i t p o n o - n g i s f o t c e p s e r n i d e t n a r g s e r a h s f o r e b m u N ) 3 ( s u n o b (vesting 2012) (vesting 2012) (vesting 2012) (vesting 2013) (vesting 2014) (vesting 2013) – – – – – – – – – – 212,500 268,362 127,119 67,974 64,443 64,443 81,215 67,974 63,320 42,408 37,467 – 45,000 34,054 16,919 16,147 16,262 18,590 13,917 16,174 – 5,576 – 87,841 41,609 23,140 23,440 21,938 27,647 23,140 20,065 21,036 12,714 14,309 99,371 40,450 23,517 31,104 26,359 27,753 – 18,517 27,388 24,211 21,326 189,682 – – – – – – – – – – d l e h s n o i t p o f o r e b m u N ) 2 ( I P M e h t r e d n u – – – – – – – – – 190,850 419,430 Name Joe Hogan Michel Demaré(4) Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Peter Leupp Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Total Executive Com- mittee members as of December 31, 2011 1,534,000 610,280 212,500 884,725 182,639 316,879 339,996 189,682 1) (2) (3) (4) Includes shares deposited as match for the co-investment portion of the 2009 LTI Plan. These shares may be sold/transferred but then the corresponding number of co-investment shares would be forfeited. Options may be sold or exercised/converted into shares at the ratio of 5 options for 1 share. The LTI Plan foresees to deliver 30 percent of the value of the vested retention shares in cash, but participants have the possibility to elect to receive 100 percent of the vested award in shares. Total number of shares held includes 4,500 shares held jointly with spouse. Furthermore, at December 31, 2012, the following members of the Executive Committee held conditionally granted ABB shares under the performance component of the LTIP 2010, 2011 and 2012, which at the time of vesting will be settled in cash. Maximum number of conditionally Maximum number of conditionally granted shares under the granted shares under the Reference number of shares performance component of the performance component of the under the performance component Name 2010 launch of LTI Plan 2011 launch of LTI Plan of the 2012 launch of LTI Plan (vesting 2013) (vesting 2014) 58,854 27,740 14,952 15,146 14,175 17,865 12,965 13,593 8,392 9,444 – – 60,526 26,967 15,196 15,460 14,194 17,933 11,965 14,158 12,516 13,780 – – (vesting 2015) 123,541 – 20,781 22,588 20,652 24,524 19,878 21,426 18,845 18,845 17,425 18,071 193,126 202,695 326,576 Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan Greg Scheu (joined on May 1, 2012) Prith Banerjee (joined ABB on May 7, 2012) Total Executive Committee members as of Dec. 31, 2012 148 Financial review | ABB Annual Report 2012 Note 12 Share ownership of ABB by Board members and members of the Executive Committee, continued As of December 31, 2011, the following members of the Executive Committee held conditionally granted ABB shares under the performance component of the LTI Plan 2010, 2011 and warrant appreciation rights (WARs): Maximum number of conditionally Maximum number of conditionally granted shares under the granted shares under the Name 2010 launch of LTI Plan 2011 launch of LTI Plan WARs held under the MIP performance component of the performance component of the Number of fully vested (vesting 2013) (vesting 2014) Joe Hogan Michel Demaré Gary Steel Ulrich Spiesshofer Diane de Saint Victor Bernhard Jucker Peter Leupp Veli-Matti Reinikkala Brice Koch Tarak Mehta Frank Duggan 58,854 27,740 14,952 15,146 14,175 17,865 14,952 12,965 13,593 8,392 9,444 60,526 26,967 15,196 15,460 14,194 17,933 – 11,965 14,158 12,516 13,780 Total Executive Committee members as of Dec. 31, 2011 208,078 202,695 – – – – – – 375,000 – – – 375,000 750,000 The members of the Board of directors and Executive Committee owned less than 1 percent of the Company’s total shares outstanding at December 31, 2012 and 2011. Other than as disclosed, at December 31, 2012, no party related to any member of the Board of directors or Executive Committee held any shares of ABB or options in ABB shares. Note 13 Risk assessment Once a year, the Company’s Board of directors performs a risk assessment in accordance with the group’s risk management process and discusses appropriate actions if necessary. ABB Annual Report 2012 | Financial review 149 Proposed appropriation of available earnings (CHF in thousands) Net income for the year Carried forward from previous year Earnings available to the Annual General Meeting Ordinary reserves Capital contribution reserve Balance to be carried forward 2012 1,173,180 3,297,518 4,470,698 2011 1,094,007 2,203,511 3,297,518 – – – – 4,470,698 3,297,518 The Board of directors proposes to carry forward the available earnings in the amount of CHF 4,470,698 thousand. On February 14, 2013, the Company announced that a proposal will be put to the April 2013 Annual General Meeting to convert capital contribution reserve to other reserves in the amount of CHF 0.68 per share and distribute a dividend for the 2012 fiscal year of CHF 0.68 per share. 150 Financial review | ABB Annual Report 2012 Report of the Statutory Auditor To the General Meeting of ABB Ltd, Zurich As statutory auditor, we have audited the accompanying financial statements of ABB Ltd, which comprise the balance sheet, income statement and notes for the year ended December 31, 2012. Board of Directors’ responsibility The Board of Directors is responsible for the preparation of the financial state- ments in accordance with the requirements of Swiss law and the company’s articles of incorporation. This responsibility includes designing, implementing and maintaining an internal control system relevant to the preparation of financial statements that are free from material misstatement, whether due to fraud or error. The Board of Directors is further responsible for selecting and applying appropriate accounting policies and making accounting estimates that are reasonable in the circumstances. Auditor’s responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Swiss law and Swiss Auditing Standards. Those standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers the internal control system relevant to the entity’s preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control system. An audit also includes evaluating the appropriateness of the accounting policies used and the reasonableness of accounting estimates made, as well as evaluating the overall presentation of the financial state- ments. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements for the year ended December 31, 2012 comply with Swiss law and the company’s articles of incorporation. Report on other legal requirements We confirm that we meet the legal requirements on licensing according to the Auditor Oversight Act (AOA) and independence (article 728 CO and article 11 AOA) and that there are no circumstances incompatible with our independence. In accordance with article 728a paragraph 1 item 3 CO and Swiss Auditing Standard 890, we confirm that an internal control system exists, which has been designed for the preparation of financial statements according to the instructions of the Board of Directors. We further confirm that the proposed appropriation of available earnings complies with Swiss law and the company’s articles of incorporation. We recommend that the financial statements submitted to you be approved. Ernst & Young Ltd Nigel Jones Licensed audit expert (Auditor in charge) Zurich, Switzerland March 14, 2013 Thomas Stenz Licensed audit expert ABB Annual Report 2012 | Financial review 151 Investor information ABB Ltd share price trend during 2012 Share price (data based on closing prices) During 2012, the price of ABB Ltd shares listed on the SIX Swiss Exchange increased 6 percent, while the Swiss Perfor- mance Index increased 18 percent. The price of ABB Ltd shares on NASDAQ OMX Stockholm increased 4 percent, compared to the OMX 30 Index, which increased 12 percent. The price of ABB Ltd American Depositary Shares traded on the New York Stock Exchange increased 10 percent compared to the Dow Jones Industrial Index, which increased by 7 percent. Source: Bloomberg High Low Year-end Average daily traded number of shares, in million SIX Swiss Exchange Stockholm Stock Exchange NASDAQ OMX New York (CHF) 20.12 14.83 18.75 6.38 (SEK) 146.70 109.00 134.10 1.67 (US$) 21.91 15.42 20.79 2.60 Source: Bloomberg Market capitalization Shareholder structure Major shareholders Dividend proposal On December 31, 2012, ABB Ltd’s market capitalization based on outstanding shares (total number of outstanding shares: 2,295,949,275) was approximately CHF 43 billion ($47.7billion, SEK 307.9 billion). As of December 31, 2012, the total number of shareholders directly registered with ABB Ltd was approximately 188,000. In addition, another 243,000 shareholders hold shares indirectly through nominees. In total, ABB has approximately 431,000 shareholders. As of December 31, 2012, Investor AB, Stockholm, Sweden, owned 182,030,142 shares of ABB Ltd, corresponding to 7.9 percent of ABB’s total share capital and voting rights as registered in the Commercial Register on December 31, 2012. As of July 25, 2011, BlackRock, Inc., New York, U.S., owned 69,702,100 shares of ABB Ltd, corresponding to 3.0 percent of ABB’s total share capital and voting rights as registered in the Commercial Register on December 31, 2012. To the best of ABB’s knowledge, no other shareholder held 3 percent or more of ABB’s total share capital and voting rights as of December 31, 2012. ABB’s Board of Directors has proposed a dividend for 2012 of CHF 0.68 per share, compared to CHF 0.65 per share in the prior year. Translated into U.S. dollars using year-end 2012 exchange rate, the dividend corresponds to approxi- mately 63 percent of ABB’s 2012 net income. The proposal is in line with the Company’s dividend policy to pay a steadily rising, sustainable annual dividend over time. As it did in 2012, the Board proposes that the dividend be paid from ABB Ltd’s capital contribution reserve, a form of payment that would be exempt from Swiss withholding tax. If approved by shareholders at the company’s Annual General Meeting on April 25, 2013, the ex-dividend date would be April 29, 2013, for shares traded on the SIX Swiss Exchange and NASDAQ OMX Stockholm and April 30, 2013, for American Depositary Shares traded on the New York Stock Exchange. The respective dividend payout dates would be May 3, 2013 in Switzerland, May 7, 2013 in Sweden, and May 10, 2013 in the United States. 152 Financial review | ABB Annual Report 2012 Key data Dividend per share (CHF) Par value per share (CHF) Votes per share Earnings per share (USD)(2) Total ABB stockholders’ equity per share (USD)(3) Cash flow from operations per share (USD)(2) Dividend pay out ratio (%)(4) Weighted-average number of shares outstanding (in millions) Dilutive weighted-average number of shares outstanding (in millions) 2012 0.68(1) 1.03 1 1.18 7.36 1.65 63% 2,293 2,295 2011 0.65 1.03 1 1.38 6.89 1.58 50% 2,288 2,291 2010 0.60 1.03 1 1.12 6.52 1.83 57% 2,287 2,291 (1) (2) (3) (4) Proposed by the Board of Directors and subject to approval by shareholders at the Annual General Meeting on April 25, 2013, in Zurich, Switzerland Calculation based on dilutive weighted-average number of shares outstanding Calculation based on the number of shares outstanding as of December 31 Dividend per share (converted to U.S. dollars at year-end exchange rates) divided by basic earnings per share ABB Ltd Annual General Meeting The 2013 Annual General Meeting of ABB Ltd will be held at 10:00 a.m. on Thursday, April 25, 2013, at the Messe Zurich hall in Zurich-Oerlikon, Switzerland. The Annual General Meeting will be held principally in German and will be simulta- neously translated into English and French. Shareholders entered in the share register, with the right to vote, by April 17, 2013, are entitled to participate in the Annual General Meeting. Admission cards Holders of registered shares of ABB Ltd will receive their admission cards on request using the reply form enclosed with the invitation. The reply form or a corresponding notification must reach the company no later than April 19, 2013. For technical reasons, notifications arriving after that date can no longer be taken into consideration. The full text of the invitation in accordance with Article 700 of the Swiss Code of Obligations will be published in the Schweizerisches Handelsamtsblatt of April 2, 2013. For shareholders in Sweden an Information Meeting will be held in Västerås, Sweden, on April 26, 2013, at 10:00 a.m. ABB shareholders’ calendar 2013 First quarter 2013 results ABB Ltd Annual General Meeting, Zurich ABB Ltd Information Meeting, Västerås Second quarter 2013 results Third quarter 2013 results April 24 April 25 April 26 July 25 October 24 ABB Annual Report 2012 | Financial review 153 Stock exchange listings ABB Ltd is listed on the SIX Swiss Exchange, NASDAQ OMX Stockholm and the New York Stock Exchange. The global ISIN code for the ABB share Ticker symbols for ABB Ltd Ticker symbols for ABB Ltd at Bloomberg Ticker symbols for ABB Ltd at Reuters Credit rating for ABB Ltd as of February 28, 2013 Standard & Poor’s Moody’s CH 001 222 171 6 SIX Swiss Exchange NASDAQ OMX Stockholm New York Stock Exchange (NYSE) SIX Swiss Exchange NASDAQ OMX Stockholm New York Stock Exchange (NYSE) SIX Swiss Exchange NASDAQ OMX Stockholm New York Stock Exchange (NYSE) ABBN ABB ABB ABBN VX ABB SS ABB US ABBN.VX ABB.ST ABB.N Long-term corporate credit rating Long-term senior unsecured debt Short-term corporate credit rating Outlook: Stable A A A–1 Long-term senior unsecured rating Short-term debt rating Outlook: Stable A2 Prime-1* *ABB Ltd’s financing subsidiaries have also a Prime-1 rating, with the exception of ABB Capital B.V. which has a Prime-2 rating. These credit ratings are subject to revision at any time. ABB does not have any other agreements with internationally recognized statistical rating organizations to provide long-term and short-term credit ratings. 2011–2015 Financial targets and definitions ABB has published financial targets for the period 2011 to 2015, which are available at www.abb.com/investorcenter. These comprise compound annual growth rates for revenues and earnings per share, as well as free cash flow as a percentage of net income, cash return on invested capital and operational EBITDA margin. At the divisional level, ABB provides organic revenue growth targets on a compound annual growth rate basis as well as profitability targets in the form of Operational EBITDA margins. In December 2012, ABB announced the repositioning of Power Systems division to focus on higher-margin products, systems, services and software activities, together with revised targets for the division. Operational EBITDA and operational EBITDA margin are defined in Note 23 to ABB’s Consolidated Financial Statements. Free cash flow is calculated as net cash provided by operating activities adjusted for i) changes in financing and other non-current receivables, net, (included in Other investing activities) ii) purchases of property, plant and equipment and intangible assets, and iii) proceeds from sales of property, plant and equipment (included in Other investing activities). Cash return on invested capital is calculated as the sum of i) net cash provided by operating activities and ii) interest paid; divided by the sum of i) fixed assets (before related accumulated amortization and depreciation), and ii) net working capital: less deferred tax liabilities recognized in certain acquisitions. Fixed assets is the sum of i) Property, plant and equipment, net, ii) Goodwill, iii) Other intangible assets, net, and iv) Investments in equity-accounted companies. Net working capital is the sum of i) Receivables, net, ii) Inventories, net, and iii) Prepaid expenses; less the sum of i) Accounts payable, trade, ii) Billings in excess of sales, iii) Employee and other payables, iv) Advances from customers, and v) Accrued expenses. 154 Financial review | ABB Annual Report 2012 Bondholder information Outstanding public bonds, as of February 28, 2013, are listed in the table below. Issuer ABB Ltd ABB Ltd ABB Ltd ABB Finance (Australia) Pty Limited ABB Finance (USA) Inc. ABB Finance (USA) Inc. ABB Finance (USA) Inc. ABB Finance B.V. ABB International Finance Ltd. Issued Principal Amount Coupon CHF 500 million CHF 350 million CHF 350 million AUD 400 million USD 500 million USD 1,250 million USD 750 million EUR 1,250 million EUR 700 million 1.25% 1.50% 2.25% 4.25% 1.625% 2.875% 4.375% 2.625% 4.625% Due 10/11/2016 11/23/2018 10/11/2021 11/22/2017 05/08/2017 05/08/2022 05/08/2042 03/26/2019 06/06/2013 ISIN CH0139264961 CH0146696528 CH0139265000 AU3CB0202216 US00037BAA08 US00037BAB80 US00037BAC63 XS0763122578 XS0252915813 144A: US00038AAA16 ABB Treasury Center (USA), Inc. USD 600 million 2.50% 06/15/2016 RegS: USU00292AA73 144A: US00038AAB98 ABB Treasury Center (USA), Inc. Thomas & Betts Corporation USD 650 million USD 250 million 4.00% 5.625% 06/15/2021 RegS: USU00292AB56 11/15/2021 US884315AG74 ABB Annual Report 2012 | Financial review 155 2012 price trend for ABB Ltd shares Price trend for ABB Ltd shares Swiss Performance Index rebased 1/12 2/12 3/12 4/12 5/12 6/12 7/12 8/12 9/12 10/12 11/12 12/12 Price trend for ABB Ltd shares OMX 30 Index rebased 1/12 2/12 3/12 4/12 5/12 6/12 7/12 8/12 9/12 10/12 11/12 12/12 Price trend for ABB Ltd shares Dow Jones Index rebased Zurich CHF 22 21 20 19 18 17 16 15 14 13 12 Stockholm SEK 160 153 146 139 132 125 118 111 104 097 090 New York USD 23 22 21 20 19 18 17 16 15 14 13 1/12 2/12 3/12 4/12 5/12 6/12 7/12 8/12 9/12 10/12 11/12 12/12 Source: Bloomberg 156 Financial review | ABB Annual Report 2012 For an additional copy of this report, please use the contact information on the back cover or download copies from our website at www.abb.com. An interactive version of the report is also available on our website. Parts of the ABB Annual Report 2012 have been translated into German and/or Swedish. Please note that the English- language version of the ABB Annual Report is the binding version. Caution concerning forward-looking statements The ABB Annual Report 2012 includes “forward- looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We have based these forward-looking statements largely on current expectations, estimates and projections about the factors that may affect our future perfor- mance, including global economic conditions as well as the economic conditions of the regions and the industries that are major markets for ABB. The words “believe,” “may,” “will,” “estimate,” “continue,” “target,” “anticipate,” “intend,” “expect” and similar words and the express or implied discussion of strategy, plans or intentions are intended to identify forward-looking statements. These forward-looking statements are subject to risks, uncertainties and assumptions, including among other things, the following: (i) business risks related to the global volatile economic environment; (ii) costs associated with compliance activities; (iii) difficulties encoun- tered in operating in emerging markets; (iv) risks inherent in large, long-term projects served by parts of our business; (v) the timely development of new products, technologies, and services that are useful for our customers; (vi) our ability to anticipate and react to technological change and evolving industry standards in the markets in which we op- erate; (vii) changes in interest rates and fluctuations in currency exchange rates; (viii) changes in raw materials prices or limitations of supplies of raw materials; (ix) the weakening or unavailability of our intellectual property rights; (x) industry consolida- tion resulting in more powerful competitors and fewer customers; (xi) effects of competition and changes in economic and market conditions in the product markets and geographic areas in which we operate; (xii) effects of, and changes in, laws, regulations, governmental policies, taxation, or accounting standards and practices and (xiii) other factors described in documents that we may furnish from time to time with the US Securities and Ex- change Commission, including our Annual Reports on Form 20-F. Although we believe that the expec- tations reflected in any such forward-looking statements are based on reasonable assumptions, we can give no assurance that they will be achieved. We undertake no obligation to update publicly or revise any forward-looking statements because of new information, future events or otherwise. In light of these risks and uncertainties, the forward- looking information, events and circumstances might not occur. Our actual results and performance could differ substantially from those anticipated in our forward-looking statements. ABB Ltd Corporate Communications P.O. Box 8131 CH-8050 Zurich Switzerland Tel: +41 (0)43 317 71 11 Fax: +41 (0)43 317 79 58 www.abb.com © C o p y r i g h t 2 0 1 3 A B B . A l l r i g h t s r e s e r v e d .