Annual Report Financial Statements and Analysis
This ’Financial Statements and Analysis booklet’ and the separate booklet entitled ‘Management Report’ together comprise the full Annual Report for the year 2003 of Koninklijke Philips Electronics N.V. (‘Royal Philips Electronics’). For a full understanding of the results of the Philips Group and the state of affairs, both booklets should be consulted.
‘Safe Harbor’ Statement under the Private Securities Litigation Reform Act of 1995 This document contains certain forward-looking statements with respect to the financial condition, results of operations and business of Philips and certain of the plans and objectives of Philips with respect to these items, (including, but not limited to, cost savings), in particular the outlook paragraph of the ‘Operating and Financial Review and Prospects’ in this ‘Financial Statements and Analysis’ booklet. By their nature, forward-looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future. There are a number of factors that could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements. These factors 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.
Market share estimates contained in this report are based on outside sources such as specialized research institutes, industry and dealer panels, etc. in combination with management estimates. 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 and should be used in conjunction with the most directly comparable US GAAP measure(s). Unless otherwise indicated in this document, 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) is contained in the ’Group Performance’ section of ’Operating and Financial Review and Prospects’ in this ’Financial Statements and Analysis’ booklet.
1 Philips Annual Report 2003
Contents
Financial statements and analysis
4 Financial highlights
Operating and Financial Review and Prospects 6 Management Summary 8 Group performance 8 Sales 10 Income from operations 15 Financial income and expenses 15 Income tax 16 Results relating to unconsolidated companies 17 Minority interests 17 Net income 18 Cash flows 21 Employment 22 Performance by sector 30 Performance by region
31 Liquidity and capital resources 31 Cash flow 31 Financing 33 Capital resources 35 Proposed dividend to shareholders of Royal
Philips Electronics
36 Critical Accounting Policies
39 Risk management
42 Governance 42 Corporate governance 42 Business Excellence 43 Sustainability 43 Audit fees
44 Subsequent events 44 Outlook
Financial statements 45 Auditors’ Report 46 Consolidated statements of income of the
Philips Group 48 Consolidated balance sheets of the Philips Group 50 Consolidated statements of cash flows of the
Philips Group 52 Consolidated statements of changes in stockholders’
equity of the Philips Group 53 Accounting policies 63 New accounting standards
2 Philips Annual Report 2003
Contents (continued)
66 Notes to the consolidated financial statements of the
Philips Group 66 1 Acquisitions and divestments 71 2 Income from operations 79 3 Financial income and expenses 80 4 Income taxes 82 5 Investments in unconsolidated companies 86 6 Minority interest 86 7 Cumulative effect of a change in accounting
principles 87 8 Earnings per share 87 9 Receivables 88 10 Inventories 88 11 Other current assets 88 12 Other non-current financial assets 89 13 Non-current receivables 89 14 Other non-current assets 90 15 Property, plant and equipment 91 16 Intangible assets excluding goodwill 92 17 Goodwill 92 18 Accrued liabilities 93 19 Provisions 94 20 Pensions 98 21 Postretirement benefits other than pensions 99 22 Other current liabilities 100 23 Short-term debt 100 24 Long-term debt 102 25 Other non-current liabilities 102 26 Commitments and contingent liabilities 107 27 Stockholders’ equity 108 28 Cash from derivatives 108 29 Proceeds from other non-current financial
assets 108 30 Assets received in lieu of cash from the sale of
businesses 108 31 Related party transactions 109 32 Stock-based compensation 113 33 Information on remuneration of the individual
members of the Board of Management and the Supervisory Board 117 34 Financial instruments and risks 123 35 Information relating to product sectors and
main countries
Dutch GAAP information
128 Accounting principles applied for Dutch GAAP
purposes 128 Presentation of financial statements 128 Dutch GAAP reconciliation 130 Consolidated statements of income of the
Philips Group 132 Consolidated balance sheets of the Philips Group 134 Consolidated statements of changes in stockholders’
equity of the Philips Group 135 Notes to the consolidated financial statements of the
Philips Group 135 36 Income from operations 135 37 Financial income and expenses 135 38 Income taxes 135 39 Unconsolidated companies 137 40 Other non-current assets 137 41 Goodwill – consolidated companies 137 42 Stockholders’ equity 138 Balance sheets and statements of income of Koninklijke
Philips Electronics N.V. (‘Royal Philips Electronics’) 139 Notes to the financial statements of Royal Philips
Electronics 139 A Receivables 139 B Investments in affiliated companies 140 C Other non-current financial assets 140 D Tangible fixed assets – net 140 E Intangible fixed assets – net 141 F Other liabilities 141 G Short-term debt 141 H Provisions 141 I Long-term debt 142 J Stockholders’ equity 142 K Net income 142 L Employees 143 M Obligations not appearing in the balance sheet
Other information 145 Auditors’ Report 146 Proposed dividend to shareholders of Royal Philips
Electronics 146 Corporate governance of the Philips Group 162 The Philips Group in the last ten years 164 Shareholder services
3 Philips Annual Report 2003
Financial highlights
all amounts in millions of euros unless otherwise stated
2001 2002 2003
Sales 32,339 31,820 29,037
Income (loss) from operations (1,395) 420 488 As a % of sales (4.3) 1.3 1.7
Results relating to unconsolidated companies (608) (1,346) 506
Net income (loss) (2,475) (3,206) 695 Per common share in euros - basic (1.94) (2.51) 0.54 - diluted (1.94) (2.51) 0.54
Dividend paid per common share in euros 0.36 0.36 0.36
Net operating capital 14,309 10,539 8,071
Cash flows before financing activities (3,316) 1,980 2,734
Stockholders’ equity 19,160 13,919 12,763 Per common share in euros 15.04 10.91 9.97
Net debt : group equity ratio 26:74 27:73 18:82
Employees at December 31 188,643 170,087 164,438
4 Philips Annual Report 2003
Operating and Financial Review and Prospects
all amounts are expressed in millions of euros unless otherwise stated
The following discussion is based on the consolidated financial statements and should be read in conjunction with those statements and the other financial information.
Philips’ consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (US GAAP). These accounting principles differ in some respects from generally accepted accounting principles in the Netherlands (Dutch GAAP). In addition to the US GAAP consolidated financial statements, Dutch GAAP financial statements on a consolidated and single company basis are provided. A reconciliation of material differences between the two is provided in the separate section entitled ‘Dutch GAAP information’ on page 128. For purposes of Dutch corporate law, the Company’s balance sheet under Dutch GAAP is determinative of the amount available for distribution to shareholders. Net income determined in accordance with Dutch GAAP amounted to a profit of 705 million in 2003, compared with a loss of 3,602 million in 2002. These aggregate amounts result in basic earnings per common share of a profit of 0.55 in 2003 and a loss of 2.83 in 2002. Diluted earnings per common share amounted to a profit of 0.55 in 2003 and a loss of 2.83 in 2002.
The Company believes that an understanding of sales performance is enhanced when the effects of currency movements and acquisitions and divestitures (changes in consolidation) are excluded. Accordingly, in addition to presenting ‘nominal growth’, ‘comparable growth’ is also provided. Comparable sales levels exclude currency and consolidation effects. As indicated in the Accounting Policies, sales and income are translated from foreign currencies into the reporting currency of the Company, the euro, at weighted average exchange rates during the respective years. As a result of the significant currency fluctuations during the years presented, the effects of translating foreign currency sales amounts into euros had a material impact that has been excluded in arriving at the comparable sales level in euros. Currency effects have been calculated by translating previous years’ foreign currency sales amounts into euros at the current year’s exchange rates in comparison with the sales in euros as historically reported. The years 2001 through 2002 were characterized by a number of acquisitions and divestments, as a result of which activities were consolidated or deconsolidated as disclosed in note 1 to the consolidated Financial Statements of the Philips Group on pages 66 through 71 of the 2003 Annual Report – Financial Statements and Analysis. The effect of consolidation changes has also been excluded in arriving at the comparable sales level. Philips discontinues consolidating companies (‘deconsolidation’) under the following circumstances. On sale of a controlling interest in a subsidiary to unrelated parties, the sold entity is excluded from the consolidated results prospectively from the date of sale. On contribution of a previously consolidated subsidiary to a joint venture, consolidation is discontinued as of the formation of the joint venture.
5 Philips Annual Report 2003
Financial Statements and Analysis
Special items, as presented in the Report on the performance of the Philips Group, relate to income and expenses resulting from normal business operations, which, because of their size or nature, are disclosed separately to give a better understanding of the underlying result for the period. Special items are items such as restructuring and impairment charges, acquisition-related charges and significant gains and/or losses on the disposal of businesses or participations and real estate.
As of January 1, 2003, the Components division was dissolved. Parts of the division’s activities were moved to Semiconductors, Consumer Electronics and the Miscellaneous sector. Also as of January 1, 2003 the activities belonging to Digital Networks have been relocated within the Consumer Electronics sector and partly to the Miscellaneous sector. As a consequence, segment reporting for Semiconductors, Consumer Electronics and Miscellaneous has been restated retroactively to 2002 and 2001.
Management Summary
Over the past year the Company has made considerable progress on its journey to create One Philips – a single, focused and clearly identifiable company geared to sustained profitability. Strict financial discipline, focused execution of the management agenda and resolute pursuit of the strategy have guided us in this endeavor. In 2003 the change programs and the asset management and cost control measures implemented over the previous two years delivered significant benefits. Excluding the impact of the weakening of the US dollar and related currencies (10%) and the impact of various divestments (3%), comparable annual sales rose by 4%, reversing the downward trend of the last two years. Nominal sales in 2003 declined by 9% compared to 2002. Income from operations totaled 488 million (2002: 420 million), driven by an improved performance from Medical Systems, Consumer Electronics (including Licenses) and Semiconductors. Income from operations benefited from significant cost savings resulting from the various cost-saving programs implemented over the last two years. The improvement in income was, however, negatively affected by restructuring and impairment charges, as well as higher pension costs. Especially encouraging is the fact that in the fourth quarter all five product divisions delivered healthy levels of profitability. The unconsolidated companies, in particular TSMC and LG.Philips LCD, made strong contributions. The other joint venture with LG – LG.Philips Displays – had a more difficult year, forcing us to take a non-cash impairment charge. Group net income rose sharply to 695 million. Cash flow from operating activities totaled 2 billion, as a result of the Company’s improved operating performance combined with its undiminished focus on supply chain management and tight capital management.
Delivering on commitments A year ago, the Company committed to delivering on the following management agenda: G achieve cost savings of 1 billion G restore Semiconductors to profitability by the end of the year G bring Consumer Electronics in the USA to full profitability from the fourth quarter
onward G improve Medical Systems’ profitability G make Philips a truly market-driven company.
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Achieve cost savings of EUR 1 billion In 2003, the Company again made excellent progress with its two-year program to cut costs, exceeding its ambitious target of 1 billion savings by the end of the year. During the past year alone, the Company achieved consolidated savings of 486 million. The savings were realized through a reduction in overhead costs, post-merger integration savings at Medical Systems, and other initiatives designed to lower the cost base, e.g. in the fields of non-product-related purchasing and R&D. However, this was more than a cost-cutting exercise: it was an essential part of the program to create a simpler, more responsive organization. The Company anticipates that the continued implementation of shared services in Finance and HRM will deliver additional benefits in the future.
Restore Semiconductors to profitability Semiconductors delivered on all points of their improvement plan, resulting in a profitability level of 11% in the fourth quarter. Capacity was rationalized, primarily through the closure of the production facilities in San Antonio and Albuquerque. R&D efforts have been focused on connected consumer applications, structures simplified and throughput times reduced. Most importantly, sequential revenue in the fourth quarter increased 22% in terms, signaling good market acceptance of the system solutions based on the Nexperia platform. This gives the Company confidence for the future.
Consumer Electronics in the USA Consumer Electronics made progress in 2003, with its US operations reaching break-even in the fourth quarter while taking additional measures to further lower the cost base for 2004. On a global level, Consumer Electronics has in recent years continually lowered its risk exposure and reduced costs. As a result, the division has emerged a good deal leaner and fitter, and it expects to be able to achieve further annual savings of 400 million within two years by executing the business renewal program. On the revenue side, the division is focusing on winning market share in key categories, with exciting, leading-edge products such as our Flat TV and DVD+RW ranges.
Improved profitability for Medical Systems Medical Systems progressed according to plan, realizing synergy benefits of almost 350 million. Income from operations (IFO) increased by 39% to 431 million and is on track for the EBITA objective of 14% in 2004 (equal to 12.2% IFO). Having completed the imaging portfolio with the recent acquisitions, and inspired by a long-term vision of removing traditional healthcare boundaries, the focus over the coming years will shift to expanding customer services and healthcare IT while developing new initiatives in the areas of personal healthcare and molecular medicine. An important step in 2003 was the alliance with Epic Systems Corporation to provide enterprise software, medical imaging and monitoring IT solutions that integrate patient information enterprise-wide.
Making Philips a truly market-driven company The objective of transforming Philips into a truly market-driven company involves an ongoing effort to build strong customer intimacy across the entire organization, develop a superior brand strategy and foster best-in-class marketing competencies to drive profitable growth. The Company made good progress on this front in 2003, strengthening the key account management, identifying the core target group for the marketing message, and developing a clear positioning for the Philips brand, which will be rolled out in 2004. The Company also consolidated to one advertising agency to enhance consistent delivery.
7 Philips Annual Report 2003
Financial Statements and Analysis
Group performance
Sales
2002 versus 2001
2003 versus 2002
Nominal growth (1.6) (8.7) Impact of: Consolidation changes 2.6 (3.0) Currency effects (3.5) (9.9) Comparable change (0.7) 4.2
Sales in 2003 totaled 29,037 million, 8.7% less than in 2002. Due to the depreciation of the US dollar in 2003 the improving market trends are not reflected in nominal sales: slightly more than half of our business is done in US dollar and US dollar-related currencies. Translation of these sales into euros reduced total sales by 9.9%. Various divestments had a negative effect of 3.0%. Comparable sales increased 4.2%, reversing the downward trend from the two years before. Sales in euros decreased in all sectors. On a comparable basis, sales in all sectors excluding Miscellaneous rose, predominantly in Semiconductors and Medical Systems. Semiconductors (11%) benefited from a market that improved rapidly in the second half of the year and from increased Nexperia product sales, predominantly in mobile communications. Strong comparable sales growth in Medical Systems (7%) was the result of increased revenue synergies in the sales organization. DAP posted 3% comparable growth based on successful new product introductions. Consumer Electronics’ growth (2%) was mainly driven by Television and DVD in the second half of the year. Lighting’s growth (2%) exceeded the soft lighting markets. Sales in 2002 totaled 31,820 million, 1.6% lower than in 2001. Changes in consolidation had a net positive effect of 2.6%, while the weakening of the dollar and related currencies had a 3.5% negative effect, particularly in the second half of the year. Growth in 2002 was mainly achieved in the sectors DAP and Medical Systems. Sales were somewhat lower at Lighting and Semiconductors. The lower sales in the Consumer Electronics sector were caused by lower volumes for mobile phones and set-top box products (as a consequence of the changed business models in 2001) which were not offset by solid growth in TV and DVD products in particular.
8 Philips Annual Report 2003
Below, a breakdown of the components of the sales development and a reconciliation of nominal sales to comparable sales is presented:
Sales growth composition 2003 versus 2002 (in %)
Sectors Nominal growth
Currency effects
Consol. changes
Comparable growth
Lighting (6.7) (9.1) – 2.4 Consumer Electronics (6.8) (8.6) (0.5) 2.4 DAP (6.2) (8.7) (0.5) 2.9 Semiconductors (0.9) (12.3) – 11.4 Medical Systems (12.5) (12.7) (6.6) 6.8 Miscellaneous (25.3) (6.3) (13.8) (5.2)
Philips Group (8.7) (9.9) (3.0) 4.2
Sales growth composition 2002 versus 2001 (in %)
Sectors Nominal growth
Currency effects
Consol. changes
Comparable growth
Lighting (4.7) (3.3) 0.8 (2.2) Consumer Electronics (7.3) (2.8) (0.1) (4.4) DAP 2.2 (3.2) (0.9) 6.3 Semiconductors (1.2) (3.3) 0.0 (2.1) Medical Systems 41.6 (4.6) 41.3 4.9 Miscellaneous (33.5) (3.8) (25.3) (4.4)
Philips Group (1.6) (3.5) 2.6 (0.7)
Philips Annual Report 2003
9
Financial Statements and Analysis
Income from operations The following overview aggregates sales, income from operations and net operating capital by product sector.
2003
sales income (loss) from operations
net operating capital
Lighting 4,522 577 1,521 Consumer Electronics 9,188 248 (82) DAP 2,131 398 464 Semiconductors 4,988 (342) 2,676 Medical Systems 5,990 431 3,671 Miscellaneous 2,218 (263) 150 Unallocated – (561) (329) Total 29,037 488 8,071
2002
sales income (loss) from operations
net operating capital
Lighting 4,845 602 1,723 Consumer Electronics 9,855 208 46 DAP 2,273 401 529 Semiconductors 5,032 (524) 3,814 Medical Systems 6,844 309 4,849 Miscellaneous 2,971 (246) (181) Unallocated – (330) (241) Total 31,820 420 10,539
2001
sales income (loss) from operations
net operating capital
Lighting 5,083 582 1,979 Consumer Electronics 10,633 (585) 655 DAP 2,224 334 652 Semiconductors 5,094 (716) 4,993 Medical Systems 4,834 (163) 5,418 Miscellaneous 4,471 (726) 477 Unallocated – (121) 135 Total 32,339 (1,395) 14,309
Special items significantly affecting the comparability of the income from operations reported in 2001, 2002 and 2003 are as follows:
2001 2002 2003
Write-down of inventories in connection with
restructuring (cost of sales) (307) (10) – Restructuring and impairment charges (786) (503) (555) Acquisition-related costs incl. in-process R&D (437) (96) – Gain on sale of participations/fixed assets 295 569 124
10 Philips Annual Report 2003