President's message

Dear stakeholder How did we do against our ... Building the leading company in ...

Management Agenda 2010 Final thoughts

Dear stakeholder

Looking back at what was a testing year for Philips, I am very pleased with the progress we made in 2009. In the most challenging economic environment in decades, we acted swiftly and decisively to adjust our cost structure and working capital to market conditions – while continuing to invest in our future. We did this to make sure we emerge from the recession as a stronger company, well positioned to capitalize on future economic growth. The effects of our actions became increasingly visible in our earnings, our cash flow performance and our stronger position with customers, especially in the second half of the year.

Philips today is a simpler, more agile company. Compared to previous downturns, our new Health and Well-being portfolio proved its intrinsic quality and increased resilience through sustained profitability.

For the full year, comparable sales were down 11% on 2008. While Healthcare revenues were almost on par with 2008, Consumer Lifestyle saw the biggest drop in sales, due to a very weak consumer market and active portfolio pruning. Lighting rebounded strongly in the course of the year, though it continued to feel the impact of the ongoing decline in commercial construction. Emerging markets accounted for a steady 30% of revenues, with strong growth at Healthcare offsetting declines at Consumer Lifestyle.

EBITA as a percentage of sales rose from 2.8% to 4.5%. Our performance in the second half of the year reflected our proactive cost management and strong fundamentals, delivering an adjusted profitability of 9.9% for that period and a record 12.3% for a fourth quarter.

We tackled the recession without sacrificing our longer-term strategic ambitions. We continued to invest in marketing and innovation and to reallocate resources to emerging markets and high-margin, sustainable growth initiatives, while maintaining a strong balance sheet supported by robust operating cash flows. Examples include our acquisition of coffee-machine maker Saeco and the expansion of our Philips-branded stores for Consumer Lighting in China and India.

As a responsible corporate citizen committed to helping build a sustainable society, we continued to drive the implementation of our EcoVision programs. Green Products generated 31% of total sales, up from 23% in 2008, and our investment in Green Innovations is ahead of target to reach a cumulative EUR 1 billion by 2012.

As a sign of confidence in our future, we are proposing to the upcoming General Meeting of Shareholders to maintain this year’s dividend at EUR 0.70 per common share, in cash or stock – resulting in a yield (as of December 31, 2009) of 3.4% for shareholders.

1)	Subject to approval by the 2010 Annual General Meeting of Shareholders

How did we do against our Management Agenda 2009

Drive performance

Relentlessly manage cash

On the back of improved operating performance and strongly reduced working capital, we improved free cash flow to 3.7% of sales, more than offsetting the EUR 485 million cash-out for the final settlement of asbestos claims.

Proactively align cost structure with market conditions and increase productivity

We took swift action to adjust our cost structure to lower revenues. We substantially reduced our fixed costs through decisive but responsible actions to optimize our industrial footprint and organizational structure, and we tightly managed our discretionary expenses.

In 2009, in spite of 11% lower revenues, overall productivity improved by 5.6%, driven by the positive effect of our ongoing efficiency programs in all sectors. The restructuring and change programs across our sectors have put us in a stronger position, and we will continue to drive productivity improvement going forward.

Manage risks and opportunities in a balanced way to strengthen our market positions

In the face of the ongoing uncertainty, we focused on cash flow and profitability when making decisions regarding mix and pricing. Nevertheless we broadly managed to maintain our shares in the market, with gains for Healthcare and Lighting in emerging markets.

At Healthcare, we strengthened our position in image-guided intervention with the acquisition of Traxtal. At Consumer Lifestyle, we extended our leadership in the market for coffee appliances into the high-growth high-margin espresso machine segment with the acquisition of Italian manufacturer Saeco. And at Lighting, we further reinforced our position across the solid-state lighting value chain, for instance through the acquisition of lighting controls companies Dynalite and Teletrol.

Accelerate change

Organize around customers and markets, thereby improving Net Promoter Score

In today’s highly competitive business environment, customer intimacy and flexibility are essential, and we are continually adapting our organization to the changing needs of the marketplace – in both mature and emerging economies. In 2009 this translated to a 9% improvement in our Net Promoter Score to 60% (co-)leadership, up from 51% last year.

Increase Employee Engagement to high-performance level and implement ‘Leading to Win’

Compared to 2008, our Employee Engagement Index fell one point to 68, two points short of our high-performance target of 70. Though disappointed by this slight decline, it is encouraging to see that our engagement levels remain high despite such difficult times, and have indeed improved in several of our businesses. In fact, the participation rate increased to 91%.

The Employee Engagement survey is a key element of ‘Leading to Win’, the new way our people are evaluated and rewarded at year-end, which we drove deeper into the organization in 2009. Employees are no longer assessed solely on what they achieve (results), but also on how they achieve it (behavior). ‘Leading to Win’ is designed to develop a strong customer and performance-oriented culture that encourages employees to strive for results, not just in their own area, but for Philips as a whole.

Accelerate sector transformation programs

In view of macro-economic developments, we accelerated planned initiatives to increase organizational effectiveness, lower our fixed and discretionary cost base and simplify our structure. Within Healthcare we focused on de-layering our management structure to increase our speed of execution and lower operating costs. We effected further changes in Consumer Lifestyle in our drive for strong market-focused execution. And within Lighting we organized our sales force along channels and applications while continuing to reduce our fixed cost base through various restructuring projects.

Implement strategy

Further build the brand in the Health and Well-being space

We continue to invest heavily in our key differentiators – our brand and our end-user-driven innovation and design. In 2009 we again improved our position in the annual Interbrand ranking of the top-100 global brands, rising to 42^nd place. This clearly demonstrates we are translating our brand promise of “sense and simplicity” into a positive customer experience designed around their needs.

1)	According to Interbrand

Continue to re-allocate resources to growth opportunities and emerging markets, including selective mergers and acquisitions

Despite the recession, we sustained our investment in growth in 2009. One of our key endeavors was to step up our resource investment in emerging markets so that we are even better placed to meet the needs of local people – and to develop solutions for these countries that can also transfer to more mature markets throughout the rest of the world.

We acquired a number of strategically aligned high-growth businesses in 2009. As outlined above, these included coffee machine maker Saeco, healthcare company Traxtal in the growth area of image-guided intervention and therapy, and Dynalite and Teletron, two specialists in lighting controls – technology that is key to the unfolding LED lighting revolution.

Increase revenue derived from leadership positions

In spite of worldwide market downturns, some 60% of our revenue was generated by businesses with global leadership positions in 2009.

Building the leading company in Health and Well-being

Based on fundamental customer and end-user insights, we integrate technology and design into people-centric solutions that deliver on our promise of “sense and simplicity”. We believe the current economic crisis is likely to have the effect of accelerating the fundamental trends underpinning our strategy, thereby intensifying demand for healthcare (especially outside the hospital), a healthy lifestyle and solutions with a better ecological footprint, such as energy-efficient high-quality lighting.

With strong leadership positions in both clinical and home healthcare, as well as a growing presence in emerging markets, we will continue to simplify healthcare by focusing on the people in the care cycle – patients and care providers – in order to improve patient outcomes while easing the financial pressure on the healthcare system.

Building upon market-leading positions based on differentiation and profitability rather than scale, we will also continue to focus on innovative lifestyle solutions that enhance consumers’ sense of personal well-being. Where appropriate, we will enter new value spaces.

And, supported by the growing demand for energy-saving solutions and the trend toward solid-state lighting, we will continue to drive the transition from lighting products to application-based solutions.

We have responded to the economic downturn by stepping up our efforts to become a more customer-focused, agile and simpler company. I remain confident we will come out of this difficult economic period as a leader in the field of health and well-being. We have the strategy, financial resources and human capital that are required for success. Clearly, aspiring to improve people’s health and well-being automatically implies that sustainability will remain integral to everything we do.

Management Agenda 2010

Our Management Agenda 2010 is our compass for the next year of our journey to bring “sense and simplicity” to health and well-being markets.

In the column Drive performance we stress the importance of returning to growth and increasing market share. At the same time, we must continue to manage cost and cash aggressively, as that is essential to enable healthy growth.

Under Accelerate change we have made the empowerment of our people in local markets and customer-facing staff a key priority, so that we can help our customers more quickly and effectively and thus gain a competitive edge. Increasing the number of Philips promoters and driving engagement levels remain crucial objectives.

As well as referring to key strategic initiatives in our sectors, the final column, Implement strategy, reaffirms our vital ambition to strengthen our position in emerging markets and the importance of leveraging sustainability as an integral part of our strategy and an additional driver of growth.

Final thoughts

In the current climate we cannot reliably predict future developments. Visibility beyond the short term remains low. However, we are very confident about our prospects when the economy does recover.

We have a portfolio of strong businesses that provide innovative, simplicity-led solutions to many of the issues associated with important global trends – the demand for affordable healthcare, the desire for personal well-being and the need for greater energy efficiency.

We have a solid balance sheet and a good cash position, an increasingly strong brand and leading market positions, especially in emerging markets, as well as a committed, highly motivated workforce.

We will continue to stay focused on cost and cash flow and to act decisively to capture growth opportunities. I believe 2010 will be a year of solid progress towards our EBITA profitability target of 10% or better. During the past 12 months we have rigorously managed cash and cost while retaining the capability to ramp up production to meet demand when sales do rebound. Across our sectors we have substantially lowered our fixed costs and our break-even point. At the same time, we continue to invest in emerging markets and acquisitions while maintaining our spending on innovation and marketing.

We have weathered the storm and prepared the ground for a future of profitable growth. Going forward, I am convinced that relentless focus on our customers’ needs, along with rigorous execution of our strategy, will enable us to realize our ambition of becoming the leading company in Health and Well-being.

In conclusion, I would like to thank our customers and suppliers for their loyalty and support in these tough economic times. Once again, our employees – including those from our 2009 acquisitions – have responded to adversity with resilience and creative endeavor. Their efforts are greatly appreciated.

Finally, on behalf of the entire Board of Management, I would like to thank our shareholders for their continuing support. They can rest assured that we remain fully committed to increasing the value of their investment.

Gerard Kleisterlee, President