Annual Report 2004 A new approach to annual reporting Forward-looking statements Philips is striving to combine timely reporting of its annual financial This document contains certain forward-looking statements with respect to the financial results with full disclosure and transparency. condition, results of operations and business of Philips and certain of the plans and This year, Philips has again accelerated the reporting of its annual objectives of Philips with respect to these items (including, but not limited to, cost financial results. The performance in 2004 has been summarized in savings), in particular the outlook paragraph of the Operating and financial review and a separate booklet entitled ‘Annual Review 2004’ of Koninklijke prospects in this Annual Report booklet. Philips Electronics N.V. (‘Royal Philips Electronics’, or the By their nature, forward-looking statements involve risk and uncertainty because they ‘Company’), which was published on January 27, 2005. relate to events and depend on circumstances that will occur in the future. There are a Full financial information and further statutory and other number of factors that could cause actual results and developments to differ materially information, including the Operating and financial review and from those expressed or implied by these forward-looking statements. These factors prospects, is contained in this Annual Report. include, but are not limited to, levels of consumer and business spending in major economies, changes in consumer tastes and preferences, changes in law, the performance of the financial markets, pension costs, the levels of marketing and promotional expenditures by Philips and its competitors, raw materials and employee costs, changes in exchange and interest rates (in particular changes in the euro and the US dollar can materially affect results), changes in tax rates and future business combinations, acquisitions or dispositions and the rate of technological changes, political and military developments in countries where Philips operates, the risk of a downturn in the semiconductor market, Philips’ ability to secure short-term profitability and invest in long-term growth in Lighting and product R&D in Medical Systems, and industry consolidation. Statements regarding market share, including as to Philips’ competitive position, contained in this document are based on outside sources such as specialized research institutes, industry and dealer panels in combination with management estimates. Where full-year information regarding 2004 is not yet available to Philips, those statements may also be based on estimates and projections prepared by outside sources or management. Rankings are based on sales unless otherwise stated. Use of non-GAAP information In presenting and discussing the Philips Group’s financial position, operating results and cash flows, management uses certain non-GAAP financial measures. These non-GAAP financial measures should not be viewed in isolation as alternatives to the equivalent GAAP measure(s) and should be used in conjunction with the most directly comparable US GAAP measure(s). A discussion of the non-GAAP measures included in this document and a reconciliation of such measures to the most directly comparable US GAAP measure(s) are contained on pages 210 and 211 in this document. Philips Annual Report 2004 1 Contents 4 Financial highlights 89 Report of independent registered public accounting firm 7 Message from the President Financial statements of the Philips Group 12 Governance 90 Consolidated statements of income 92 Consolidated balance sheets 14 Reporting and Control 94 Consolidated statements of cash flows 96 Consolidated statements of stockholders’ equity 17 Board of Management 97 Accounting policies 105 New accounting standards 18 Group Management Committee 106 Notes to the consolidated financial statements 20 Supervisory Board Dutch GAAP information 176 Accounting principles 21 Supervisory Board Report 176 Reconciliation US to Dutch GAAP 178 Philips Group Information on the Philips Group 178 Consolidated statements of income 28 The structure of the Philips Group 180 Consolidated balance sheets 28 Business overview 182 Consolidated statements of stockholders’ equity 29 Product sectors and principal products 183 Notes to the consolidated financial statements 39 Property, plant and equipment 187 Royal Philips Electronics 187 Balance sheets and statements of income 40 Cooperative business activities and 188 Notes to the financial statements unconsolidated companies Other information Operating and financial review and prospects 193 Auditors’ report 43 Introduction 194 Proposed dividend to shareholders 44 Group performance 2004 compared to 2003 195 Corporate governance 44 Management summary 45 Performance of the Group 210 Reconciliation of non-GAAP information 50 Performance by sector 58 Performance by region 212 The Philips Group in the last eleven years 59 Employment 60 Group performance 2003 compared to 2002 214 Shareholder information 67 Restructuring and impairment charges 70 Liquidity and capital resources 76 Risk management 82 Critical accounting policies 85 IFRS information 86 Other information 86 Proposed dividend to shareholders 86 Share repurchase program 86 MedQuist 87 Outlook 2 Philips Annual Report 2004 Financial statements of the Philips Group Dutch GAAP information Notes to the consolidated financial statements of the Philips Group Notes to the consolidated financial statements of the Philips Group 106 O1 Acquisitions and divestments 183 O36 Income from operations 112 O2 Income from operations 183 O37 Financial income and expenses 120 O3 Financial income and expenses 183 O38 Income taxes 120 O4 Income taxes 184 O39 Unconsolidated companies 124 O5 Investments in unconsolidated companies 185 O40 Other non-current assets 129 O6 Minority interests 186 O41 Goodwill – consolidated companies 129 O7 Cumulative effect of a change in accounting principles 186 O42 Stockholders’ equity 130 O8 Earnings per share 130 O9 Receivables Notes to the financial statements of Royal Philips Electronics 131 O10 Inventories 188 OA Receivables 131 O11 Other current assets 188 OB Investments in affiliated companies 132 O12 Other non-current financial assets 189 OC Other non-current financial assets 133 O13 Non-current receivables 189 OD Tangible fixed assets 133 O14 Other non-current assets 189 OE Intangible fixed assets 134 O15 Property, plant and equipment 190 OF Other liabilities 135 O16 Intangible assets excluding goodwill 190 OG Short-term debt 136 O17 Goodwill 190 OH Provisions 137 O18 Accrued liabilities 190 OI Long-term debt 137 O19 Provisions 191 OJ Stockholders’ equity 139 O20 Pensions 192 OK Net income 144 O21 Postretirement benefits other than pensions 192 OL Employees 146 O22 Other current liabilities 192 OM Obligations not appearing in the balance sheet 146 O23 Short-term debt 147 O24 Long-term debt 149 O25 Other non-current liabilities 149 O26 Commitments and contingent liabilities 153 O27 Stockholders’ equity 154 O28 Cash from derivatives 154 O29 Proceeds from other non-current financial assets 154 O30 Assets received in lieu of cash from the sale of businesses 155 O31 Related-party transactions 155 O32 Share-based compensation 160 O33 Information on remuneration of the individual members of the Board of Management and the Supervisory Board 165 O34 Financial instruments, derivatives and risks 171 O35 Information relating to product sectors and main countries Philips Annual Report 2004 3 Financial highlights Sales Income (loss) from operations in billions of euros and % growth in millions of euros 50 5,000 4,258 4,000 40 37.9 32.3 31.8 3,000 29.0 30.3 30 2,000 1,607 1,000 20 420 488 0 10 (1,000) 20% (15%) (2%) (9%) 4% (1,395) 0 (2,000) 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 Net income (loss) Cash flows from operating activities in millions of euros in millions of euros 12,500 3,500 9,662 2,996 10,000 3,000 2,697 7,500 2,500 2,228 1,992 5,000 2,000 2,836 2,500 1,500 695 1,248 0 1,000 (2,500) 500 (2,475) (3,206) (5,000) 0 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 Net operating capital Employees (FTEs) in billions of euros position at year-end 20 300,000 250,000 219,429 15 14.4 14.3 200,000 188,643 170,087 10.5 164,438 161,586 10 150,000 8.1 7.2 100,000 5 50,000 0 0 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 4 Philips Annual Report 2004 all amounts in millions of euros unless otherwise stated 2002 2003 2004 Sales 31,820 29,037 30,319 Income from operations 420 488 1,607 Asa%ofsales 1.3 1.7 5.3 Results relating to unconsolidated companies (1,346) 506 1,422 Net income (loss) (3,206) 695 2,836 Per common share in euros - basic (2.51) 0.54 2.22 - diluted (2.51) 0.54 2.21 Dividend paid per common share in euros 0.36 0.36 0.36 Net operating capital 10,539 8,071 7,192 Cash flows before financing activities 1,980 2,734 3,350 Stockholders’ equity 13,919 12,763 14,860 Per common share in euros 10.91 9.97 11.60 Net debt : group equity ratio 27:73 18:82 1:99 Employees at December 31 170,087 164,438 161,586 Philips Annual Report 2004 5 6 Philips Annual Report 2004 Message from the President Dear shareholder, 2004 was a year of major progress for Philips. Driven by our focus on operational performance and cost management, our financial results showed considerable improvement, delivering a return well in excess of our cost of capital. With the consistent execution of our management agenda for 2004 we also took an important step forward in implementing our strategy to transform Philips into a truly market-driven healthcare, lifestyle and technology company. And with the introduction of our new brand promise ‘Sense and simplicity’ we are creating a unique, differentiated positioning that will further enhance our value proposition to our customers.