Message from the CEO

Dear stakeholder,
Accelerate! – the journey to unlock our ...

Progress on our path to value by 2013
Looking forward

“Accelerate! is all about bringing meaningful innovations to our customers in local markets – and doing so faster and better than the competition!”

Frans van Houten, CEO

Dear stakeholder,

Philips is a great company with a wealth of talent and powerful assets – e.g. outstanding innovation capabilities, a strong brand, a global footprint, leading positions in healthcare, lighting and lifestyle growth businesses, and a solid balance sheet. We have tremendous potential in terms of margin improvement, growth and higher returns. But as our 2011 results reaffirmed, we cannot be satisfied with our current performance, and we will step up to deliver fully on that potential.

In September 2011 we celebrated 120 years of Philips innovation – a landmark achievement. 2011 was also a year of radical change, both on the world stage and within our company. It was the first year of Accelerate! – a fundamental change and performance improvement program designed to unlock our full potential, and so make Philips an even stronger company capable of bringing meaningful innovations to market for many years to come. Together with my colleagues on the Executive Committee – our new leadership team, spanning businesses, markets and functions – I am honored to lead our company through this transformation and am encouraged by the start we have made to what will be a multi-year journey to a bright future.

Despite a challenging and volatile economic environment and ongoing market weakness, especially in Europe, important parts of the company performed well in 2011, and we ended the year with strong balance sheet and cash positions. At the same time, across the company near-term operational issues are being tackled with vigor and urgency. Our passion to improve and aim higher is shared by our 120,000 employees.

At Group level, we achieved 4% comparable sales growth – at the lower end of our mid-term performance bandwidth, but with a strong contribution from growth geographies (33% of sales, up from 31% in 2010) and Green Products (39% of sales).

At 7.4% of sales, reported EBITA was below our mid-term 2013 profitability target, primarily due to continued pressure on gross margins, as well as higher costs and non-recurring charges related to, for example, inventory adjustments. Earnings were also impacted by investments for growth – to drive market penetration and accelerate innovation. These include an investment of some EUR 470 million in Green Innovation.

Each year we review and assess the value of past acquisitions. Last year’s analysis found the economy posed a higher risk, with recovery slow and uncertain. We adjusted our business plans and discount rates accordingly, resulting in an impairment of EUR 1.4 billion in the second quarter.

One of the major developments in 2011 was the signing of an agreement to transfer our Television business to a joint venture with TPV, in which we will hold a 30% stake. This joint venture will leverage the strengths of both companies to improve the position of Philips Television in the market, and will enable us to focus on expanding leadership positions in health and well-being markets across our three operating sectors. The deal is expected to close at the end of the first quarter of 2012 after the necessary merger clearance and governmental approvals are obtained.

In 2011 we concluded a number of acquisitions, primarily aimed at strengthening our product portfolio in growth geographies. I would like to welcome all our new employees from these acquisitions to Philips.

Reflecting our confidence in our plans to step up profitability and free cash flow through organic growth and operational excellence, we launched a EUR 2 billion share buy-back program in the summer. This will also improve the efficiency of our balance sheet. By the end of the year we had completed 35% of this program, which will run until the end of the second quarter of 2013.

As a further sign of our conﬁdence in Philips’ future, we are proposing to the upcoming General Meeting of Shareholders to maintain this year’s dividend at EUR 0.75 per common share, in cash or stock – resulting in a yield (as of December 31, 2011) of 4.6% for shareholders.

Dividend per common share
¹⁾ Subject to approval by the 2012 Annual General Meeting of Shareholders

Accelerate! – the journey to unlock our full potential

For the past 120 years our meaningful innovations have improved the quality of life for millions, creating a strong and trusted Philips brand with market access all over the world. But with lack of consistent growth in recent years, and lean, agile new competitors winning over customers, it was clear that we urgently needed to speed up in order to improve our performance and competitiveness.

To this end, in the second quarter of 2011 we launched our Accelerate! program – the first step on our journey to unlock our full potential and seed the ground for our future success. Accelerate! aims to significantly boost profitable growth by stepping up meaningful innovation and competitiveness, expanding margins, driving productivity and reducing complexity and working capital. It is designed to ensure that we empower and strengthen our customer-facing teams to win profitable market share, that we reduce complexity costs and deliver our innovations faster and more efficiently along the end-to-end chain to the customer, that we drive performance with transparency and accountability for granular business/market plans. And that we carry through our strategies with the resources and determination to win our critical market battles and achieve leadership in our chosen markets.

Of course, making the turn to growth also requires a new, shared mindset – a customer-focused, agile, can-do mentality. And with Accelerate! we are creating a new performance and growth culture centered around three key behaviors – Eager to win, Take ownership and Team up to excel – that are crucial for success and anchored by our General Business Principles.

With Accelerate! providing the roadmap toward growth, in the summer of 2011 we announced our mid-term performance goals, to be realized by the end of 2013:

Comparable sales growth CAGR of 4-6%, assuming real GDP growth of 3-4% per annum
Reported EBITA margins of 10-12% for the Group; 15-17% for Healthcare; 8-10% for Consumer Lifestyle (excluding unrelated licenses); 8-10% for Lighting
Return on invested capital of 12-14%

Progress on our path to value by 2013

A key part of Accelerate! has been the implementation of our new operating model, the Philips Business System, which defines how all parts of the company should work together to create a faster, less complex and more competitive Philips. This system has begun to improve granular performance insights, enhancing transparency and management accountability, and enabling rapid corrective action where required.

We also needed to free up money to invest in our customer-facing activities and innovation – and so pave the way for profitable growth. For this purpose, we are optimizing all overhead and support costs not directly involved in the operational customer value chain. This will create a lighter overhead structure comprising a single value-adding layer above the businesses, thereby reducing complexity and speeding up decision-making. It will also enable a cost saving of EUR 800 million by 2014. The overhead cost reduction program is on track, with the first savings already visible in the fourth quarter of 2011. In order to ‘resource to win’ we are also making a targeted additional investment of EUR 200 million to increase the number of business/market combinations in which we are the outright leader.

Customer-centricity is an integral element of Accelerate! Across Philips, we are empowering and strengthening our customer-facing teams to win in markets by delivering superior products and services that meet the specific needs of local populations and bringing them to market faster. To this end, for example, we moved the leadership of our Kitchen Appliances business to Shanghai and acquired leading kitchen appliances companies Preethi (India) and Povos (China) in 2011. This will ensure we are better placed to harvest local consumer insights and match our competitors’ time-to-market.

One of the key drivers of our Accelerate! journey is the strengthening of our ‘end-to-end customer value chain’. We can only speed up our time-to-market and become truly competitive if we take a holistic view – from product idea and manufacturing to order intake and delivery. Philips is transforming itself from a predominantly functional organization to a process-driven end-to-end collaboration model, embracing business excellence principles such as LEAN. This should allow us to deliver innovations to market much faster – and at lower cost and with lower working capital. Pilots at Lighting, for instance, show that the collaborative end-to-end approach is having a significant impact. Breakthroughs in factory and demand planning, for example, mean our business group Lamps no longer needs to stock the majority of its portfolio in commercial warehouses, but instead ‘packs to order’, which allows much lower inventory levels and, ultimately, better profitability. And this approach offers our customers increased service flexibility, thanks to improved response times.

We are pleased that people engagement continues to be high and that Philips is able to attract and retain outstanding talent to strengthen the company. Our new behaviors – central to our efforts to establish a culture of entrepreneurship and accountability – have been made an integral part of our employee performance appraisal and reward system. And the incentive system for our executives has been changed to reflect line-of-sight accountability and is now fully aligned with the key performance indicators of our 2013 mid-term financial targets.

We also continued to deliver on our EcoVision sustainability commitments in 2011, as we strive to bring care to more than 500 million people, to improve the energy efficiency of our overall portfolio by 50%, and to double the global collection and recycling of our products, as well as the amount of recycled materials in our products. Our sustainability performance received widespread recognition during the year. For instance, Newsweek named Philips the 9^th greenest company in the world, we regained our sector and super-sector leadership in the Dow Jones Sustainability Index, and our Lighting sector received a United Nations Leader of Change Award for its contribution to sustainable lighting solutions.

Looking forward

Our mission remains to improve people’s lives through meaningful innovation. And we have now tightened the vision that guides us:

At Philips, we strive to make the world healthier and more sustainable through innovation. Our goal is to improve the lives of 3 billion people a year by 2025. We will be the best place to work for people who share our passion. Together we will deliver superior value for our customers and shareholders.

In light of key global trends and challenges – e.g. the demand for affordable healthcare, the energy efﬁciency imperative, and people’s desire for personal well-being – we are confident in our chosen strategic direction.

We have a focused portfolio, with strong potential in both mature and growth geographies such as China and India. The large majority of our businesses have the right fundamentals for profitable growth, and we are seeing growth in our core businesses. And where there are pressing operational issues, we are working tirelessly to turn things round and increase productivity.

The value potential in our portfolio is underpinned by talent and strong assets. As demonstrated at our Innovation Experience event, held in September 2011 to mark 120 years of Philips, our innovation and design capabilities are rightly world-renowned, and we hold strong technology and intellectual property positions. In 2011 we also secured our highest-ever placing (41^st) on the annual Interbrand ranking of the world’s most valuable brands, as well as being named one of China’s top ten consumer brands by Superbrands. And, crucially, we have capable and motivated people and leadership: our 2011 Employee Engagement Survey showed an Employee Engagement Index of 76%, down one percentage point, and a People Leadership Index of 78%, up two percentage points. And all of this is supported by a solid balance sheet.

We are still in the early stages of a multi-year transformation of our company, and I am delighted that the organization is responding well to the Accelerate! initiatives. Accelerate! will drive granular execution of our plans and enable the necessary investments in innovation, people, systems, and markets to deliver profitable growth and return on invested capital. And we will reap the benefits of our new culture of entrepreneurship and accountability, and commitment to business excellence.

We are cautious about 2012, given the uncertainty in the global economy, and Europe in particular. In addition, we expect our 2012 results to be affected by the previously communicated restructuring charges and one-time investments aimed at improving our business performance trajectory, as part of Accelerate! Excluding these additional charges, we anticipate that underlying operating margins and capital efficiency in the sectors will improve in the latter part of 2012. While we are concerned about the economic environment, all of us at Philips are fully committed to improve our operational performance to achieve our mid-term (2013) financial targets.

On behalf of the Executive Committee, I would like to thank our customers for their loyalty to Philips over this past year. I would also like to thank all our employees for their hard work – as well as for their willingness to embrace change. And finally I would like to thank our other stakeholders, in particular our shareholders, for their continued support in these challenging times. We have set out on a demanding and exciting journey. More than ever, we are resolved to accelerate, unlock Philips’ full potential, and grow the value of your investment.