President's message

Dear stakeholder

2008 was not exactly the year of progress that you and I had envisaged for Philips 12 months ago. Our company’s transformation over the last few years has definitely produced a balanced, stronger and more resilient set of businesses active in the field of health and well-being, and these continued to improve their position in the market in 2008. But the acceleration of the economic downturn in the course of the year, particularly in the fourth quarter, took an increasing toll on several of our businesses that are sensitive to early cycle effects, especially those with direct or indirect consumer market exposure, requiring us to take decisive action.

Nevertheless there has been progress on several fronts. With the successful integration of the two largest acquisitions in Philips’ history – Respironics and Genlyte – more than 50% of our revenue is generated from businesses with global leadership positions; up from less than 40% in 2007. And a steady 31% of our sales continues to come from emerging markets. All that supported by a quality brand that gained 8% in value in 2008 alone and a workforce reaching high-performance benchmark engagement levels.

Performance

The increased strength and resilience of our business portfolio was particularly evident in Healthcare, which, in a very challenging operating environment, achieved excellent results – higher comparable sales and an improvement in underlying EBITA – and is on the way to becoming our largest sector.

The strong downturn in the latter part of 2008 affected the Group’s top line, particularly at Consumer Lifestyle and in our OEM businesses in Lighting, partly offset by continued healthy growth at Healthcare, leading to a moderate overall sales decline of 2.7%.

EBITA was down on 2007, largely due to a decline in sales-driven earnings at Consumer Lifestyle and Lighting, as well as an asbestos-related settlement charge. We also extended and accelerated the restructuring and change programs across our Healthcare, Consumer Lifestyle and Lighting sectors, further impacting EBITA. These programs are on track to deliver cost savings of approximately EUR 400 million on an annual basis, with effect from the second half of 2009.

We also moved quickly to extend our cash management initiatives, including rigorous management of working capital. This enabled us to end the year with a robust balance sheet supported by strong operating cash flows of almost EUR 1.5 billion.

Furthermore, we continued with the responsible sell-down of our non-core financial holdings by divesting our final holding in TSMC, as well as further reducing our stake in LG Display. The economic malaise affected the market value of our remaining financial stakes, causing us to write down EUR 1.4 billion on the value of our current financial holdings.

The road ahead

We remain fully committed to our primary financial objective of doubling EBITA per share, and will continue to drive forward our plans in this respect. However, the rapid and severe deterioration in the business environment means we no longer expect to be able to realize this goal in 2010.

For the mature markets in Western Europe and the US – and most emerging markets – we foresee very difficult conditions throughout 2009. Nonetheless, I firmly believe that the overall strength of our business portfolio, coupled with our strong balance sheet and tight focus on cost and cash management, will enable us to weather the current turmoil and make the most of the economic upturn when it comes.

Return to shareholders

We completed EUR 3.3 billion of the current EUR 5 billion share repurchase program announced in December 2007. However, in view of the risks and opportunities presented by the economic downturn and the turbulence on the financial markets, we decided that the most responsible course of action was to stop the share repurchase program until further notice and to maintain our financial flexibility.

In common with many in our peer group, our share price followed the downward trend of the market in 2008. Disappointing as this is, I remain confident that when better economic times return our share price will respond to reflect the intrinsic quality of our health and well-being portfolio.

At our General Meeting of Shareholders in March 2008 we increased the dividend for the fourth year in a row. We are proposing to the upcoming General Meeting of Shareholders to make a distribution of EUR 0.70 per common share – equal to last year’s dividend – resulting in an increased yield (as of December 31, 2008) of 5.1% for shareholders.

How did we do against our Management Agenda 2008?

Let me update you on how we performed on the objectives we set ourselves last year.

Integrate and leverage recent acquisitions, delivering anticipated return on investment

The two main integration processes concerned Respironics in our Healthcare sector and Genlyte in Lighting. Both contributed positively to sales and earnings, in line with expectation.

The acquisition of leading North American luminaire manufacturer Genlyte not only gives us the leading position in the US market for professional lighting applications, but also makes us the only player with a truly global platform for its lighting applications and solutions.

The acquisition of Respironics – a leading US-based global provider of innovative respiratory and sleep therapy solutions for hospital and home use – is part of our strategy to create a global leadership position in the fast-growing home healthcare solutions market. In December, we further solidified this position with the acquisition of the aerosol therapy business of Medel SpA in Italy. The hospital activities of Respironics are now part of our integrated offering of Clinical Care Solutions, and we are well on our way with the creation of an integrated approach to sleep care involving our Lifestyle sector.

Take decisive steps to structurally deal with unsatisfactory EBITA margins in Connected Displays (Television)

In North America we entered into a five-year minimum brand licensing agreement with Funai Electric Company of Japan, under which Funai will assume responsibility for all Philips-branded consumer television activities in the United States and Canada. Toward the end of the year this agreement was extended, adding audio-video categories in the US and TV and audio-video categories in Mexico.

We drove further portfolio reductions around the world, for instance in Australia, New Zealand and South Africa, and announced our withdrawal from plasma-based TVs. We also signed a letter of intent regarding our PC Monitors business, creating a brand licensing agreement with TPV Technology for the global distribution and marketing of IT Display products.

Given the current economic turmoil, we will continue to evaluate whether more action is required in 2009. Going forward, we have a solid TV business – with leadership positions in selected geographic markets – that is driven by innovation and margin rather than volume.

Improve productivity as a driver for margin expansion

Our progress on this point was limited as our efficiency programs were mitigated by lower earnings in our operational sectors due to the economic downturn. The restructuring and change programs across our sectors will put us in a stronger position, but productivity remains a key focus point for management.

Step up resource investment in developing markets to accelerate growth in excess of 2x GDP

In 2008, we further increased our talent, marketing and R&D investments towards the emerging markets. In addition, we made a number of acquisitions in Brazil, China and India, designed to strengthen our position in healthcare in emerging markets.

Excluding Television, which we manage for margin instead of volume, our sales growth in emerging markets amounted to 6%, approximately in line with the latest 2x world GDP growth estimates. I am particularly pleased with the way our Healthcare and Lighting businesses weathered the economic downturn, with comparable sales growth of 12% and 8% respectively in the emerging markets for the year.

Increase innovation focus in support of Philips’ growth ambition

In 2008, sales of innovative products – i.e. products introduced within the last year (for B2C products) or three years (for B2B products) – amounted to 58% of total sales, again up 2 percentage points and more than double the 2003 level, but still not giving us the amount of new business we are looking for.

In difficult economic times like these, innovation is more crucial than ever to provide a competitive edge. In 2009 we will therefore – notwithstanding our focus on cash management – sustain our spending levels on R&D and marketing, while intensifying our efforts to increase the speed and productivity of innovation.

Sustainability continues to be a key driver of innovation. Sales of Green Products rose to 23% of overall sales, up from 20% in 2007, representing an important, growing part of our revenue stream. Our investment in Green Innovations amounted to over EUR 280 million in 2008, on track for a cumulative amount of EUR 1 billion to be invested by 2012.

Continue to drive a culture of superior customer experience

Ensuring a superior customer experience is absolutely crucial to the realization of our ambitions. The Net Promoter Score (NPS) is our single key metric of customer experience. NPS measures the answer to one simple question: “How likely is it that you would recommend this company/product to a friend or colleague?” Compared to 2007, we achieved NPS leadership in an additional 4% of our businesses on a comparable basis. During 2008, we also expanded the NPS measurement to now cover all our strategic areas, and at present 47% of our key businesses have industry-leading scores. Especially notable is our strong performance in the emerging markets such as Brazil, Russia, India and China. We are still committed to reach our 2010 NPS target and to this end we will drive customer experience improvement and execute strategic moves to continue to secure leading NPS positions.

We also realized 8% growth of our total brand value in the annual ranking of the top-100 global brands compiled by Interbrand – the fifth increase in a row. In 2004, when we launched our “sense and simplicity” brand campaign, Philips’ total brand value was USD 4.4 billion. This has steadily increased to a total value of USD 8.3 billion in 2008. Such consistent improvement clearly illustrates that our “sense and simplicity” brand promise, founded on deep, validated insights into customer and end-user needs, continues to resonate with customers.

Bring employee engagement to high-performance benchmark

I am very pleased to report that we have made significant advances in Employee Engagement – our measure of the progress of our people initiatives.

The results of our 2008 survey exceeded expectations. Our overall Philips score leaped from 64% to 69% favorable – two points above our target for the year, and closing in on the high-performance benchmark. Our People Leadership Index, which measures the effectiveness of our leaders in engaging people, also rose by five points to a score of 69%.

'because health and well-being matters to people'

People’s needs remain the starting point for everything we do. By tracking trends in society and obtaining deep insights into the issues confronting people in their daily lives, we are able to identify opportunities and develop innovative solutions that are easy to access and relevant to people’s needs and aspirations.

Philips must continue to stand for “sense and simplicity”. That is what our customers should experience, each and every day, in dealing with us. Now more than ever, we need to redouble efforts to fully understand our customers and markets, so that we can identify and compete boldly – and successfully – for new opportunities as they arise.

We aim to further grow Philips as the leading brand in the health and well-being market space. Health and well-being is a theme that is becoming increasingly relevant for society around the world, and it will be a major driver of growth when the financial and economic turbulence has subsided. It is also the glue that bonds our businesses within Healthcare, Consumer Lifestyle and Lighting.

Our Healthcare sector is a great example of how we are building growth-orientated businesses with strong leadership positions in both clinical and home healthcare, as well as a growing presence in emerging markets.

In Consumer Lifestyle, we are focusing the business on innovative lifestyle solutions for personal well-being. We will continue to build upon existing market-leading positions based on differentiation and profitability, rather than scale. In addition, we will enter new, higher-margin value spaces with a particular focus on platforms such as healthy living, personal care and home life.

In Lighting, we have established leading positions in fast-growing areas such as LEDs and energy-efficient lighting with a segment-based marketing approach. Our task now is to strengthen our global leadership by driving the transition to application-based solutions to fuel future growth. Our strong IP position across the solid-state lighting value chain – and the licensing opportunities it brings – will further reinforce this leadership.

We will also continue to embed sustainability throughout our operations. Moving to this integrated financial, social and environmental annual report clearly illustrates this unified approach.

Staying the course

We are convinced that the strategic choices we have made are the right ones. Our goals are ambitious and they have become more challenging with the deterioration in the macro-economic climate. However, these difficult times call at most for a change of tactic, not a change of strategy.

Therefore, our Management Agenda 2009 is all about staying the course through this downturn. Its three themes – Drive performance, Accelerate change and Implement strategy– reflect the current reality, where the prime focus will be on managing cash flow and cost, while continuing to capture opportunities to strengthen our position in the market. Pursuing these goals – with a heightened sense of urgency – will ensure the long-term health, growth and profitability of our company. We have the strategy, portfolio, financial strength and talent to succeed.

Management agenda

Final thoughts

I would like to thank our employees, including our many new employees from our acquisitions, for their hard work over the past 12 months. Time and again, they have demonstrated the resilience and drive to rise to a challenge. And I know I can count on their continued dedication and effort in the face of this latest hurdle.

I would also like to thank our other stakeholders, and in particular our customers, for the loyalty and confidence they have shown toward us in 2008.

Finally, on behalf of my colleagues on the Board of Management, let me thank our shareholders for their continued support in these difficult times. We remain wholly committed to increasing the value of the company.

Gerard Kleisterlee, President