Details of treasury risks

Liquidity risk Currency risk Interest rate risk Equity price risk

Commodity price risk Credit risk Country risk Other insurable risks

Philips is, as mentioned before, exposed to several types of financial risk. This section further analyzes financial risks. Philips does not purchase or hold derivative financial instruments for speculative purposes. Information regarding financial instruments is included in note (32) Fair value of financial assets and liabilities and note (33) Other financial instruments.

This section ‘Details of treasury risks’ up to and including ‘Other insurable risks’ forms an integral part of the Group financial statements.

Liquidity risk

Liquidity risk is the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.

The rating of the Company’s debt by major rating services may improve or deteriorate. As a result, Philips’ future borrowing capacity may be influenced and its financing costs may fluctuate. Philips has various sources to mitigate the liquidity risk for the group. As of December 31, 2009, Philips had EUR 4,386 million in cash and cash equivalents, a USD 2.5 billion Commercial Paper Program, and a USD 2.5 billion committed revolving facility that could serve as back-up for short-term financing requirements that would normally be satisfied through the Commercial Paper Program. Additionally EUR 357 million of investments in its available-for-sale financial assets and listed equity-accounted investees (fair value at December 31, 2009) were available. Furthermore, Philips had a committed undrawn bilateral loan of EUR 200 million. As of December 31, 2009 Philips did not have any loans outstanding under any of these facilities.

On Febuary 18 , 2010 Philips signed a new 5-year EUR 1.8 billion revolving credit facility to replace the existing USD 2.5 billion facility.

Currency risk

Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. Currency fluctuations may impact Philips’ financial results. Philips is exposed to currency risk in the following areas:

• Transaction exposures, related to forecasted sales and purchases and on-balance-sheet receivables/payables resulting from such transactions
• Translation exposure of net income in foreign entities
• Translation exposure of foreign-currency intercompany and external debt and deposits
• Translation exposure of foreign-currency-denominated equity invested in consolidated companies
• Translation exposure to equity interests in non-functional-currency equity-accounted investees and available-for-sale financial assets.

It is Philips’ policy that significant transaction exposures are hedged by the businesses. Accordingly, all businesses are required to identify and measure their exposures resulting from material transactions denominated in currencies other than their own functional currency. Philips’ policy generally requires committed foreign currency exposures to be fully hedged using forwards. Anticipated transactions may be hedged using forwards or options or a combination thereof. The amount hedged as a proportion of the total exposure identified varies per business and is a function of the ability to project cash flows, the time horizon for the cash flows and the way in which the businesses can adapt to changed levels of foreign-currency exchange rates. As a result, hedging activities may not eliminate all currency risks for these transaction exposures. Generally, the maximum tenor of these hedges is 18 months.

The following table outlines the estimated nominal value in millions of euros for transaction exposure and related hedges for Philips’ most significant currency exposures as of December 31, 2009:

The derivatives related to transactions are, for hedge accounting purposes, split into hedges of on-balance-sheet accounts receivable/payable and forecasted sales and purchases. Changes in the value of on-balance-sheet foreign-currency accounts receivable/payable, as well as the changes in the fair value of the hedges related to these exposures, are reported in the income statement under income from operations. Hedges related to forecasted transactions, where hedge accounting is applied, are accounted for as cash flow hedges. The results from such hedges are deferred in other comprehensive income within equity to the extent that the hedge is effective. As of December 31, 2009, a gain of EUR 10 million was deferred in equity as a result of these hedges. The result deferred in equity will be released to earnings mostly during 2010 at the time when the related hedged transactions affect the income statement. During 2009, a net gain of EUR 7 million was recorded in the income statement as a result of ineffectiveness of cash flow hedges.

The total net fair value of hedges related to transaction exposure as of December 31, 2009 was an unrealized gain of EUR 15 million. An instantaneous 10% increase in the value of the euro against all currencies would lead to an increase of EUR 28 million in the value of the derivatives; including a EUR 16 million increase related to foreign exchange transactions of the euro against the pound sterling, a EUR 11 million increase related to foreign exchange transactions of the euro against the Japanese yen, and a EUR 15 million decrease related to foreign exchange transactions of the euro against the US dollar. The EUR 28 million increase includes a loss of EUR 1 million that would impact the income statement, which would largely offset the opposite revaluation effect on the underlying accounts receivable and payable, and the remaining gain of EUR 29 million would be recognized in equity to the extent that the cash flow hedges were effective.

Philips does not hedge the translation exposure of net income in foreign entities.

Foreign exchange exposure also arises as a result of inter-company loans and deposits. Where the Company enters into such arrangements the financing is generally provided in the functional currency of the subsidiary entity. The currency of the Company’s external funding and liquid assets is matched with the required financing of subsidiaries either directly through external foreign currency loans and deposits, or synthetically by using foreign exchange derivatives. In certain cases where group companies may also have external foreign currency debt or liquid assets, these exposures are also hedged through the use of foreign exchange derivatives. Changes in the fair value of hedges related to this translation exposure are recognized within financial income and expenses in the income statement and are largely offset by the revaluation of the hedged items. The total net fair value of these derivatives as of December 31, 2009, was an unrealized loss of EUR 190 million. An instantaneous 10% increase in the value of the euro against all currencies would lead to an increase of EUR 303 million in the value of the derivatives, including a EUR 297 million increase related to the US dollar.

Translation exposure of foreign-currency equity invested in consolidated entities is partially hedged. If a hedge is entered into, it is accounted for as a net investment hedge. As of December 31, 2009, Philips had no outstanding derivatives accounted for as net investment hedges. During 2009, Philips recorded a gain of less than EUR 1 million in other comprehensive income under currency translation differences as a result of net investment hedges.

Philips does not currently hedge the foreign exchange exposure arising from equity interests in non-functional-currency equity-accounted investees and available-for-sale financial assets.

Interest rate risk

Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Philips had outstanding debt of EUR 4,267 million, which created an inherent interest rate risk. Failure to effectively hedge this risk could negatively impact financial results. At year-end, Philips held EUR 4,386 million in cash and cash equivalents, total long-term debt of EUR 3,640 million and total short-term debt of EUR 627 million. At December 31, 2009, Philips had a ratio of fixed-rate long-term debt to total outstanding debt of approximately 73%, compared to 76% one year earlier.

A sensitivity analysis shows that if long-term interest rates were to decrease instantaneously by 1% from their level of December 31, 2009, with all other variables (including foreign exchange rates) held constant, the fair value of the long-term debt would increase by approximately EUR 222 million. If there was an increase of 1% in long-term interest rates, this would reduce the market value of the long-term debt by approximately EUR 221 million.

If interest rates were to increase instantaneously by 1% from their level of December 31, 2009, with all other variables held constant, the annualized net interest expense would decrease by approximately EUR 31 million. This impact was based on the outstanding net cash position at December 31, 2009.

Equity price risk

Equity price risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in equity prices.

Philips is a shareholder in several publicly listed companies, including TCL Corporation and TPV Technology Ltd. As a result, Philips is exposed to potential financial loss through movements in their share prices. The aggregate equity price exposure of publicly listed investments in its main available-for-sale financial assets and listed equity-accounted investees amounted to approximately EUR 357 million at year-end 2009 (2008: EUR 659 million including shares that were sold during 2009). As of December 31, 2009, Philips also held options on the shares of TPV through a convertible bond issued to Philips in September 2005, the face value of the bond being the USD equivalent of EUR 146 million and the fair value of the option at year-end EUR 25 million. Furthermore, Philips also held options on the shares of CBAY through a convertible bond issued to Philips in August 2008, the face value of the bond being the USD equivalent of EUR 67 million and the fair value of the option at year-end EUR 2 million. Philips does not hold derivatives in its own stock or in the above-mentioned listed companies except for the embedded derivatives in the convertible bonds already mentioned.

Philips is also a shareholder in several privately owned companies including NXP. As a result, Philips is exposed to potential value adjustments.

Commodity price risk

Commodity price risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in commodity prices.

Philips is a purchaser of certain base metals, precious metals and energy. Philips hedges certain commodity price risks using derivative instruments to minimize significant, unanticipated earnings fluctuations caused by commodity price volatility. The commodity price derivatives that Philips enters into are accounted for as cash flow hedges to offset forecasted purchases. As of December 2009, a gain of less than EUR 1 million was deferred in equity as a result of these hedges. A 10% increase in the market price of all commodities as of December 31, 2009 would increase the fair value of the derivatives by less than EUR 1 million.

Credit risk

Credit risk represents the loss that would be recognized at the reporting date if counterparties failed completely to perform their payment obligations as contracted. Credit risk is present within Philips trade receivables. To have better insights into the credit exposures, Philips performs ongoing evaluations of the financial and non-financial conditions of its customers and adjusts credit limits when appropriate. In instances where the creditworthiness of a customer is determined not to be sufficient to grant the credit limit required, there are a number of mitigation tools that can be utilized to close the gap including reducing payment terms, cash on delivery, pre-payments and pledges on assets.

Philips invests available cash and cash equivalents with various financial institutions and is exposed to credit risk with these counterparties. The analysis below includes short-term deposits which were the main component of cash and cash equivalents totaling EUR 3,740 million as of December 31, 2009 (2008: 2,847 million). Philips is also exposed to credit risks in the event of non-performance by financial institutions with respect to financial derivative instruments.

Philips actively manages concentration risk and on a daily basis measures the potential loss under certain stress scenarios, should a financial institution default. These worst-case scenario losses are monitored and limited by the company. As of December 31, 2009 Philips had credit risk exceeding EUR 25 million with the following number of financial institutions:

The company does not enter into any financial derivative instruments to protect against default by financial institutions. However, where possible the company requires all financial institution with whom it deals in derivative transactions to complete legally enforceable netting agreements under an International Swap Dealers Association master agreement or otherwise prior to trading, and whenever possible, to have a strong credit rating from Standard & Poor’s and Moody’s Investor Services. Philips also regularly monitors the development of the credit risk of its financial counterparties. Wherever possible, cash is invested and financial transactions are concluded with financial institutions with strong credit ratings or with governments or government-backed institutions. For an overview of the overall maximum credit exposure of the group’s financial assets, please refer to note (32) Fair value of financial assets and liabilities for details of carrying amounts and fair value.

Country risk

Country risk is the risk that political, legal, or economic developments in a single country could adversely impact our performance. The country risk per country is defined as the sum of the equity of all subsidiaries and associated companies in country cross-border transactions, such as intercompany loans, accounts receivable from third parties and intercompany accounts receivable. The country risk is monitored on a regular basis.

As of December 31, 2009, the company had country risk exposure in the United States of EUR 9 billion and in the Netherlands of EUR 8 billion. Other countries exceeding EUR 1 billion but less than EUR 3 billion are China (including Hong Kong) and Belgium. Countries where the risk exceeded EUR 500 million but was less than EUR 1 billion are Germany and Japan. Countries where the risk exceeded EUR 200 million but was less than EUR 500 million are Poland, Italy, Canada and France. The degree of risk of a country is taken into account when new investments are considered. The company does not, however, use financial derivative instruments to hedge country risk.

Other insurable risks

Philips is covered for a range of different kinds of losses by global insurance policies in the areas of property damage, business interruption, general and product liability, transport, directors’ and officers’ liability, employment practice liability, fraud, and aviation product liability.

To lower exposures and to avoid potential losses, Philips has a worldwide Risk Engineering program in place. The main focus in this program is on property damage and business interruption risks, which also include interdependencies. Philips sites, and also a limited number of sites of key suppliers, are inspected on a regular basis by the Risk Engineering personnel of the insurer. Inspections are carried out against predefined Risk Engineering standards which are agreed between Philips and the insurers. Recommendations are made in a Risk Management report and are reviewed centrally. This is the basis for decision-making by the local management of the business as to which recommendations will be implemented. For all policies, deductibles are in place, which vary from EUR 250,000 to EUR 500,000 per occurrence and this variance is designed to differentiate between the existing risk categories within Philips. Above this first layer of working deductibles, Philips operates its own re-insurance captive, which during 2009 retained EUR 2.5 million per occurrence for the property damage and business interruption losses and EUR 5 million in the aggregate per year. For general and product liability claims, the captive retained EUR 1.5 million per claim and EUR 6 million in the aggregate. New contracts were signed on December 31, 2009 for the coming year, whereby the reinsurance captive retentions remained unchanged.