-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IWD+gykU5SUvxuHqm0Tz5i4/6+mzvk6sL9PgdIShNjOJdZybpKbKMBpi7DrJrTM3 dyTwVVymPl4QWYGvxflkYA== 0000950123-99-002408.txt : 19990325 0000950123-99-002408.hdr.sgml : 19990325 ACCESSION NUMBER: 0000950123-99-002408 CONFORMED SUBMISSION TYPE: 20-F PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990323 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KONINKLIJKE PHILIPS ELECTRONICS NV CENTRAL INDEX KEY: 0000313216 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC & OTHER ELECTRICAL EQUIPMENT (NO COMPUTER EQUIP) [3600] STATE OF INCORPORATION: P7 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 20-F SEC ACT: SEC FILE NUMBER: 001-05146-01 FILM NUMBER: 99570868 BUSINESS ADDRESS: STREET 1: REMBRANDT TOWER AMSTELPLEIN 1 STREET 2: 1096 HA AMSTERDAM CITY: THE NETHERLANDS MAIL ADDRESS: STREET 1: REMBRANDT TOWER AMSTELPLEIN 1 STREET 2: 1096 HA AMSTERDAM CITY: THE NETHERLANDS FORMER COMPANY: FORMER CONFORMED NAME: PHILIPS ELECTRONICS N V DATE OF NAME CHANGE: 19930727 20-F 1 KONINKLIJKE PHILIPS ELECTRONICS N.V. 1 ------------------------------------------------------------------------------- As filed with the Securities and Exchange Commission on March 23, 1999 ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 20-F (Mark one) [ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ x ] ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 Commission file number 2-20193 KONINKLIJKE PHILIPS ELECTRONICS N.V. (Exact name of Registrant as specified in charter) The Netherlands (Jurisdiction of incorporation or organization) Rembrandt Tower Amstelplein 1, 1096 HA Amsterdam, The Netherlands (Address of principal executive office) Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common shares - par value Dutch guilders New York Stock Exchange (NLG) 10 per share Securities registered or to be registered pursuant to Section 12(g) of the Act: None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: Common Shares - par value Dutch guilders (NLG) 10 per share (Title of class) Indicate the number of outstanding shares of the issuer's classes of capital or common stock as of the close of the period covered by the annual report: Class Outstanding at December 31, 1998 Koninklijke Philips Electronics N.V. Priority Shares par value NLG 5,000 per share 10 shares Common Shares par value NLG 10 per share 368,494,824 shares Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes _ X _ No ____ Indicate by check mark which financial statement item the registrant has elected to follow. Item 17 __ Item 18 _ X _ Name and address of person authorized to receive notices and communications from the Securities and Exchange Commission: Donald C. Walkovik, Esq. Sullivan & Cromwell 125 Broad Street NEW YORK, NEW YORK 10004 - -------------------------------------------------------------------------------- 2
TABLE OF CONTENTS Page EXCHANGE RATES/INTRODUCTION 3 Item 1. DESCRIPTION OF BUSINESS 4 2. DESCRIPTION OF PROPERTY 12 3. LEGAL PROCEEDINGS 12 4. CONTROL OF REGISTRANT 12 5. NATURE OF TRADING MARKET 12 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS 13 7. TAXATION 13 8. SELECTED CONSOLIDATED FINANCIAL DATA 15 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 19 9A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 19 10. DIRECTORS AND OFFICERS OF REGISTRANT 19 11. COMPENSATION OF DIRECTORS AND OFFICERS 19 12. OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES 20 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS 21 14. DESCRIPTION OF SECURITIES TO BE REGISTERED 21 15. DEFAULTS UPON SENIOR SECURITIES 21 16. CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED SECURITIES 21 18. FINANCIAL STATEMENTS 21 19. FINANCIAL STATEMENTS AND EXHIBITS 21
2 3 EXCHANGE RATES In this report amounts are expressed in Dutch guilders ("guilders" or "NLG") or in US dollars ("dollars", "US $" or "$"). Unless otherwise stated, for the convenience of the reader the translations of guilders into dollars appearing in this report have been made at the balance sheet rate on December 31, 1998 (US $ 1 = NLG 1.89). This rate is not materially different from the Noon Buying Rate in New York City for cable transfers in foreign currencies as testified for customs purposes by the Federal Reserve Bank of New York (the "Noon Buying Rate") on such date (US $ 1 = NLG 1.8770). The following table sets forth, for the periods and dates indicated, certain information concerning the exchange rate for US dollars into Dutch guilders based on the Noon Buying Rate:
Calendar period Period End Average (1) High Low --------------------------------------------------------------------------------------------------------- (NLG per US $ 1) --------------------------------------------------------------------------------- 1994 1.7344 1.8184 1.9720 1.6675 1995 1.6025 1.6064 1.7475 1.5260 1996 1.7271 1.6823 1.7560 1.6075 1997 2.0278 1.9585 2.1177 1.7300 1998 1.8770 1.9825 2.0890 1.8142 1999 (through March 18) 2.0052 1.9706 2.0359 1.8657
(1) The average of the Noon Buying Rates on the last day of each month during the period. See also Item 8: "Selected Consolidated Financial Data". Philips publishes its financial statements in guilders while a substantial portion of its assets, earnings and sales are denominated in other currencies. Philips conducts its business in more than 50 different currencies. INTRODUCTION In order to utilize the "Safe Harbor" provisions of the United States Private Securities Litigation Reform Act of 1995, Philips is providing the following cautionary statement. 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. In particular, among other statements, certain statements in Item 1 "Description of Business" with regard to management objectives, market trends, market standing, product volumes and business risks, the statements in Item 3 "Legal Proceedings", the statements in Item 9 "Management's Discussions and Analysis of Financial Condition and Results of Operations" with regard to trends in results of operations, margins, overall market trends, risk management, exchange rates, matters relating to year 2000 issues and matters relating to the introduction of the euro and Item 9A "Quantitative and Qualitative Disclosures about Market Risks" are forward-looking in nature. 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 in addition to those matters set forth in the context of the forward looking statements 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, the levels of marketing and promotional expenditures by Philips and its competitors, raw materials and employee costs, changes in future exchange rates and interest rates, changes in tax rates and future business combinations, acquisitions or dispositions, and the rate of technical 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. Specific portions of Philips' Annual Report 1998 to Shareholders are incorporated by reference in this report on Form 20-F to the extent noted herein. 3 4 ITEM 1 DESCRIPTION OF BUSINESS THE STRUCTURE OF THE PHILIPS GROUP The following information is important for understanding the structure of the Philips group ("Philips" or the "Group"). Koninklijke Philips Electronics N.V. (the "Company" or "Royal Philips Electronics") is the parent company of Philips. Its shares are listed on the Amsterdam Stock Exchange, the New York Stock Stock Exchange, the London Stock Exchange and on several other stock exchanges. The management of the Company is entrusted to the Board of Management under the supervision of the Supervisory Board. The Group Management Committee, consisting of the members of the Board of Management, certain chairmen of product divisions and certain key officers, is the highest consultative body to ensure that business issues and practices are shared across Philips and to define and implement common policies. Members of the Board of Management and the Supervisory Board are appointed by the Annual General Meeting of Shareholders on the recommendation of the Supervisory Board and the Meeting of Priority Shareholders. See Item 4: "Control of Registrant". The other members of the Group Management Committee are appointed by the Supervisory Board. The general management of Philips' worldwide operations has been historically centered in Eindhoven, the Netherlands. However, in the first half of 1998 part of the Board of Management moved to Amsterdam, the Netherlands. The activities of the Philips group are organized in product divisions which are responsible for the worldwide business policy. Philips has manufacturing and sales organizations in over 60 countries. Products, systems and services are delivered in the fields of lighting, consumer electronics, domestic appliances and personal care, components, semiconductors, medical systems, business electronics and information technology. BUSINESS OF PHILIPS Since it started its activities in 1891, Philips has grown from a small incandescent lamp factory to a widely diversified multinational group of companies, engaged primarily in the manufacture and distribution of electronic and electrical products, systems and equipment, as well as, information technology services. Philips is engaged in a fundamental review of its portfolio of businesses, which started in the course of 1996. At present, rather than acquiring businesses in new areas, Philips is focusing on the strengthening of its existing core activities, including through the use of selected acquisitions, and the disposal of activities that are under-performing and not essential from a strategic viewpoint. A few examples are the sale of Philips' 75% equity interest in PolyGram N.V., the disposition of Philips' conventional (non-ceramic) Passive Components business group, the sale of Philips Car Systems the reduction of Philips' involvement in the German consumer electronics company Grundig AG, the streamlining of Philips' media portfolio, the divestiture of the data communication activities (for a further description see "Product Sectors and Principal Products"). In the course of 1996, Philips undertook a major review of its governance model, i.e. the organizational systems, procedures and structure by which the Group is managed. This review started at the corporate headquarters where the corporate staff has been refocused on a limited number of corporate functions and core processes, whereas the corporate services have been refocused on a few shared activities. As part of the new governance model a new set of performance processes, such as a rigorously applied budgeting system and monthly performance review, were developed. In the course of 1997, the new governance model was introduced at the level of businesses, product divisions, regions and countries. The key part of this model was to streamline corporate departments and decentralize decision-making. In addition to streamlining its portfolio of businesses and management, Philips engaged in a comprehensive review of its strategy and portfolio, involving the field of high-volume electronics - televisions, audio systems, telephones and PCs and PC-related equipment. Philips has decided to focus on high-volume electronics because the businesses in this field are strongly interrelated through brand, technologies, manufacturing and sales channels and already generate one third of Philips' total sales. That is why, as of January 1, 1998, Philips has grouped together the relevant operations of Sound & Vision, Philips Consumer Communications and Business Electronics into a single Consumer Electronics organization, and created a new Business Electronics division to coordinate business and professional applications. Given that the technologies of TV, audio, telecommunications and computing are increasingly converging, these combinations are appropriate. It is expected that they will capitalize on the strength of the Philips brand and make new business generation easier, market intelligence more coordinated and time-to-market shorter. With this new strategy, Philips is changing the way it thinks about products. Traditionally, the Company has tended to think in terms of the technological expertise it possesses and how it can apply that expertise. Now it is thinking about products in terms of where and how they are used. Accordingly, the new Consumer Electronics organization will be concentrating on developing video and audio entertainment and telecommunications products for two domains of everyday life, Home and Away. Home will center on the TV, with the addition of exciting new functions. Away will cover mobile communications, entertainment and computing. 4 5 Besides high-volume electronics, there are other very important building blocks that make up the Company. The Semiconductors and Components divisions play a crucial role, both as internal suppliers and through their leading positions on the external market. The capital expenditures required in this field place considerable demands on management in terms of ensuring adequate returns by means of flexible and cost-effective operations. See "Recent developments" below. The other building blocks include the Lighting division, a world leader with relatively consistent returns and cash flow in which Philips will continue to invest, Medical Systems and Domestic Appliances and Personal Care. The Company wants to extend Medical Systems' business scope with new diagnostic modalities and clinical solutions and services. In the case of Domestic Appliances and Personal Care, Philips wishes to see this division grow in the personal care field by offering new functionalities and an enhanced emotional appeal to the consumer. In the area of information technology services, Philips will continue to build Origin while monitoring closely the added value and rate of return offered by this business. Aggressive and able competition is encountered wordwide in virtually all of Philips' business activities. Competitors range from some of the world's largest companies offering a full range of products to small firms specializing in certain segments of the market. In many instances, the competitive climate is characterized by rapidly changing technology that requires continuing research and development commitments and by capital-intensive needs to meet customer requirements. Also, the competitive landscape is changing as a result of increased alliances between competitors. Recent developments Philips announced on March 4, 1999 that it had commenced a cash offer to acquire all of the outstanding common shares of VLSI Technology, Inc. in the USA at a price of US $ 17 per share, totaling an amount of approximately US $ 777 million. Product Sectors and Principal Products In 1998, Philips changed its product sector reporting to comply with the new requirements of Statement of Financial Accounting Standard No. 131, issued by the Financial Accounting Standards Board of the United States. As a consequence, the related activities are grouped together into seven product sectors based on similar markets and the use of similar technologies. The product sectors are as follows: Lighting, Consumer Products, Components, Semiconductors, Professional, Origin and Miscellaneous. For a description of the changes, and data related to aggregate sales, segment revenues and income from operations, see Note 26: "Information relating to product sectors and geographic areas" on pages 119 through 127 of the 1998 Annual Report incorporated herein by reference. For a discussion of revenues and income from operations of the product sectors, see Item 9: "Management's Discussion and Analysis of Financial Condition and Results of Operations". For a discussion of recent acquisitions and alliances, see also "Cooperative Business Activities and Unconsolidated Companies" under Item 1. Lighting Philips has been engaged in the lighting business since 1891 and is a leader in the world market for lighting products with recognized expertise in the development and manufacture of lighting products. A wide variety of applications is served by a full range of incandescent and halogen lamps, compact and normal fluorescent lamps, automotive lamps, high-intensity gas-discharge and special lamps, QL induction lamps, fixtures, ballasts, lighting electronics and batteries. Lighting products are manufactured in facilities worldwide. Philips' worldwide presence in the lighting market has given it a strong international position in lighting projects, both in design and full-scale turn key project installation. These activities require sophisticated expertise and help Philips to maintain its leading position in the professional lighting market. Philips Lighting's policy of leadership in innovation continues to bring rewards in the marketplace. Philips is the market leader in Xenon headlamps, which were introduced in 1997 and are achieving increasing penetration in the upper end of the market. Providing superb illumination of the road, these lamps dramatically improve road safety and driver comfort. 5 6 With Mercedes Benz, Philips is also developing a new high-performance signaling system that will last the car's entire lifetime, cut fuel consumption and enhance styling. Philips position as a supplier of headlights to the car industry is very strong in Japan, where Philips is the market leader, and Philips is rapidly establishing a full global presence in this field. Another innovation is the UHP (Ultra High Power) lamp which is applied in LCD projectors of leading companies for applications such as business presentations and large-screen consumer TVs. UHP will also increase the application possibilities of fiber-optic lighting. Philips Lighting's new PowerLife battery gives more power and longer life than conventional alkaline batteries. Advanced graphite technology is the key to PowerLife's success in answering consumer demand for batteries which perform better in "high-drain" products. Philips Lighting is concentrating on developments in the design of electronic lighting products, which play an increasingly important role in allowing better integration of fixture, ballast and lamp. The use of electronics permits the design of lighting products with improved quality and reduced size, weight and energy consumption. Major benefits for the end-user include flexibility and comfort. Philips Lighting is the market leader in light-regulating control gear for fluorescent lamps. In response to the greater demand for more efficient light sources and lighting systems, Philips has emphasized among other things the development of more energy-efficient lighting products and projects. In addition to the TL5 system, these include a range of electronic compact fluorescent lamps, Lighting Management Systems, as well as QL induction lamps, which are increasingly being used in general lighting applications. Philips Lighting is also conscious of the problem of hazardous waste. The small-diameter TL5 fluorescent lamp combines energy efficiency with a low mercury content. The low-mercury ALTO(TM) technology - the first to comply with the relevant US environmental protection legislation - is meeting with considerable success. In Europe, the TLD Super 80 Generation fluorescent lamps are now recyclable, minimizing end-of-life disposal problems and the burden on the environment, while the outstanding performance of the series is not appreciably affected. This technology enables virtually complete recycling of the lamp materials. Six of the ten stadiums staging the 1998 World Cup soccer finals in France were lit by Philips' highly versatile ArenaVision systems - demonstrating once more the company's global leadership in sports floodlighting. ArenaVision is specially designed for today's more dramatic, theatrical approach to sports events. While offering optimal low-glare conditions for players, it provides both spectators and TV audiences with more realistic action by creating accents and preserving natural colors. In recent years Philips Lighting has completed a number of strategic acquisitions and joint ventures, seeking to strengthen its presence in the historically faster-growing areas of the world, such as the Asia-Pacific region and Eastern Europe. The most recent acquisitions include, in Poland, the Farel Mazury luminaire operation and Polam Pabianice, which promises new opportunities for Philips Lighting's automotive business in Europe. In 1997, Philips and Hewlett-Packard established a joint venture company, LumiLeds Lighting B.V., for the development, manufacture and marketing of LED-based lighting products. The joint venture will initially focus on the integration of solid-state light-emitting diodes (LEDs) into lighting modules for colored-lighting applications. In 1997, the new organization of Philips Lighting worldwide became effective. This consists of five integrally responsible businesses: Lamps, Luminaires, Automotive, Lighting Electronics & Gear, and Batteries. Each of these is given complete control over all its processes. Philips Lighting is also shortening the time to market. In 1998 the company began implementing a program called BEST - Business Excellence through Speed and Teamwork. This involves a push forward on three fronts: focusing even more closely on business priorities, increasing the capability of our primary business processes, and stimulating better teamwork. Philips sees continued growth potential, with special opportunities in areas such as energy-saving lighting and technologically advanced lighting applications. 6 7 Consumer Products This sector comprises the divisions Consumer Electronics and Domestic Appliances and Personal Care. The Consumer Electronics division encompasses all Philips-branded products in the fields of audio, television, video equipment, PC peripherals and communications. The division retained its No. 3 position in the global market for audio and video products in 1998 and its No. 2 position in Europe. Philips has a leading role in the development of flatscreen and widescreen television sets featuring the 16:9 format. Philips is increasingly focusing on new digital consumer applications and products which exploit the convergence of audio and video technologies with telecommunications and information technology. The Consumer Electronics division is a pioneer in, for instance, Digital TV, a medium that brings a new dimension to home entertainment, offering a wider choice of channels, true widescreen pictures, optimum sound quality and interactive services. The division has launched Digital TV in the UK and introduced a widescreen rear-projection HDTV set in the US. Philips markets audio systems, portable audio products, speakers and accessories under the Philips name, as well as high-end audio products and systems under the Marantz brand. Philips was instrumental in the revolution unleashed by CD Audio, which now has an installed base of some 700 million units worldwide, and continues to play a leading role in the development of related standards such as DVD, CD Recordable and CD ReWritable. In the US, Philips runs a DVD-video rental program together with Blockbuster. In Europe, Philips and Warner Home Video have launched a joint marketing effort focusing on DVD-Video as the ultimate medium for a cinema-style viewing and listening experience in the home. A full-length feature movie fits onto a single DVD-Video disc. Philips' latest CD Recorders allow you to hear your choice of music as you really want to. With the dual-deck CDR 765, you can make your own personal CDs without the need for a second CD player. In the field of PC Peripherals, Philips is -- in volume terms -- the world's No. 2 and Europe's No. 1 supplier of computer monitors. Philips makes not only a full range of CRT monitors, but also LCD monitors and Net displays (monitors with a built-in processor and video card). The world leader in PC video cameras and observation systems, Philips also markets USB peripherals, optical data storage products and multimedia sound systems, LCD projectors and input devices for the PC. Wireless interconnectivity for home networking will be a key focus for the coming years. Philips develops, manufactures and markets a wide range of consumer communications products, including cellular, corded and cordless phones. In volume terms, Philips is one of Europe's leading providers of corded and cordless phones and answering machines. For the future, the main focus of cellular wireless products is on GSM technology, which represents 65% of the global cellular market. Meanwhile, development continues on third-generation digital mobile phone technology, involving the deployment of wideband wireless networks which will provide consumers with voice, data and multimedia services on their phones. On October 1, 1997 Philips (60%) and Lucent Technologies (40%) formed a joint venture for mobile communications comprising the Philips Consumer Communications business and the Lucent Consumer Products division. Despite ambitious plans for break-even results in the second half of 1998, PCC continued to incur substantial losses and consequently the joint venture was dissolved on September 27, 1998. Ambitions for the remaining activities have been scaled back and the product offering streamlined. The division also markets handheld PCs. In 1998, Philips introduced the Nino 300, a small, pen-based companion featuring the Windows CE operating system. The Nino 300 has a sleek, ergonomic design and features one-handed operation, full handwriting recognition and voice command and control. The Nino 300, the natural extension of the Philips Velo handheld PC, is geared towards data retrieval, data reference and communications and synchronizes automatically with the user's host PC. The Domestic Appliances and Personal Care division includes home comfort and kitchen appliances, shavers and other personal care products. Philips produces the Philishave, a dry shaver which is based on the Philips-invented rotary shaving technique. The division is the world market leader in dry shaving with leading positions in Europe, Latin America and the United States. Other personal care products include female depilatory products, skin care, dental care, haircare, fitness and sun care products. Philips provides products for all stages of food preparation, such as mixers, blenders, food processors and kitchen machines, toasters, coffee makers, deep fryers, grills, table-top cooking and general kitchen appliances. Philips manufactures and markets vacuum cleaners, irons, air cleaners and heating appliances. The division holds the world No. 2 position in ironing. Domestic appliances and personal care products are sold under the Philips brand and other brand names. 7 8 Philips has long been successful on the US market under the brand name Norelco and will continue to use this brand name for the male shaving and grooming products. To further boost growth, Philips introduced the Philips brand name there in 1998, with the focus on body beauty and health. The first product to be launched under the Philips name was the Natura hairdryer with an infrared heat-sensor. Philips has also started re-launching products formerly sold under the Norelco brand name as Philips products. Components Philips Components is a main supplier of components and sub-systems, both to third parties and to Philips. The division produces a broad range of products such as picture tubes, liquid crystal displays (LCDs), ceramic and ferrite products, optical storage and general system components. Philips is the world's No. 1 manufacturer of color picture tubes for televisions and monitors, market leader in modules for CD-ReWritable (CD-RW) and Video CD, and a major supplier of flat displays. Philips is also an important producer of customized key components sub-systems. It has major production facilities in Europe, the United States, Latin America and the Asia Pacific region. Based on world-class technology and customer knowledge, Philips Components provides a competitive advantage for Original Equipment Manufacturers (OEMs) in the consumer electronics, electronic data-processing, telecommunications and automotive industries. Philips Components has initiated a strategic refocus on innovative products for these markets, exploiting the synergies available within Philips and, where necessary, entering into alliances to access the required competences. In 1998, this led to an agreement on the divestiture of the Non-Ceramic Passive Components business, which transaction was completed in January 1999. In 1997 a majority shareholding was established in Hua Fei Colour Display Systems Co. Ltd. in Hua Fei, China; the financials of this joint venture are consolidated as from January 1, 1997. On April 1, 1998, Philips increased its ownership in Hosiden and Philips Display Corp., a joint venture in Japan for the development, production and sale of active matrix LCDs, from 50% to 80%. As from the same date, Hosiden and Philips Display Corp. is reported as a consolidated company. In the area of large-display, the PALC (Plasma Addressed Liquid Crystal) technology, has been developed in conjunction with Sharp and Sony and offers high brightness, excellent daylight contrast and a wide viewing angle. These characteristics make it ideally suited to wall-hanging digital and multimedia TV and other applications in bright ambient lighting conditions. Together with Pioneer, Philips is also working on the next generation of Plasma Display Panel (PDP) technology, one of the most promising technologies for large flat displays. Semiconductors Philips Semiconductors is a leading supplier of integrated circuits (ICs) and discrete semiconductors for applications in consumer, telecommunication, multimedia and automotive electronics. Ranking No. 8 in the world and No. 4 in Europe, the division has a significant market position with chipsets for TV, audio, wired and wireless telephony, computer monitors, desk-top video and PC peripherals and is world leader in one-chip TV circuits. The division's products are supplied to a large customer base worldwide, including leading multinational corporations. Philips' Silicon Systems Platform approach takes the concept of integration - the `system on a chip'- one step further. It involves creating platforms geared to specific applications and markets (e.g., digital video or digital communication). On the basis of a well chosen architecture, high-quality blocks and modules can be used and re-used quickly and reliably in various combinations. In this way, Philips provides clients with total solutions based on cost-effective and easy-to-use `toolkits'. Major production facilities are located in Europe, the United States and Asia. Philips, Taiwan Semiconductor Manufacturing Company (TSMC) and EDB Investments are together investing US $ 1.2 billion in a new chip factory in Singapore. This will enable the company to benefit from the forecast growth in demand for logic chips for consumer electronics and communications applications toward the end of 2000. The factory will produce the latest type of chip, with circuits as thin as 0.25 micron (1/400th of the thickness of a human hair). 8 9 Professional This sector comprises two divisions: Medical Systems and Business Electronics. Philips Medical Systems ranks among the top three diagnostic imaging companies in the world. The company offers healthcare providers a full range of innovative imaging modalities - including x-ray, computed tomography, magnetic resonance and ultrasound systems as well as imaging IT solutions. Using the IT systems, imaging departments can become completely digital, with improved access to images and seamless integration with hospital-wide IT networks. Services include management consultancy, training and technical services to help hospitals operate more efficiently and cost-effectively. Philips has technology agreements with Hewlett Packard and Analogic Corporation of the United States and Hitachi Medical Corporation of Japan for the development, production and sale of medical equipment. Philips Medical Systems, already the world leader in x-ray imaging systems, has significantly strengthened its position in the field of diagnostic imaging with the acquisition of ATL Ultrasound as per October 1, 1998. This company is one of the leaders in ultrasound imaging systems - one of the fastest growing sectors of the market - and the clear leader in all-digital ultrasound systems. The quality of its products and their performance is widely recognized, and its leading ultrasound product has been selected by NASA for use in the international space station scheduled to become operational in 2001. Demand for diagnostic imaging products and services is expected to continue to grow as new markets emerge and advances are made in functionality, e.g. through the further integration of IT solutions. The Business Electronics division focuses on the business-to-business sector, digital information distribution being the principal area of activity. The market for Business Electronics products, software and services in the fields of digital video and natural speech recognition is expected to grow substantially in the near future, as voice, video and data communication technologies converge. Philips also expects their scope to extend gradually into the consumer market: that is why Philips sees its business units in this field as not only creating value in their own right, but also serving as a breeding ground for new high-volume electronics products. Philips is currently the world's No. 2 supplier of digital video-communication systems, which includes digital set-top decoders. The businesses in analytical x-ray, optical metrology, electron microscopes and electronic manufacturing technology provide smart R&D and manufacturing solutions for the semiconductor industry based on the knowledge of materials science. By providing sophisticated communication, security, lighting and control systems, Philips helps customers to create intelligent infrastructures and turnkey solutions. Demand for such intelligent infrastructures is growing due to the needs of emerging markets and the increasing sophistication of software. Philips is also applying the know-how to create office/home networking solutions, including faxes and desktop video-conferencing systems. In August 1998, Philips Business Electronics acquired Active Impulse Systems (AIS) of Natick, Massachussets (USA). AIS is a semiconductor metrology equipment manufacturer with a strong reputation for the development of leading-edge opto-acoustic technology products in the growing field of thin film metrology. On December 3, 1998, it was announced that FEI Company, a majority owned subsidiary of Philips Business Electronics, and Micrion Corporation have signed an Agreement and Plan of Merger. Philips has the option to purchase additional newly issued shares to maintain its majority shareholder position in FEI Company. Origin Origin (in which Philips holds a 88% majority interest) provides the full spectrum of information technology services for global corporations through its presence in over 30 countries around the world and is ranked No. 3 in Europe. Its customer base includes over 100 of the world's Fortune 500 companies. Origin has strategic partnerships with SAP, Baan and QAD, the acknowledged leaders in the field of Enterprise Resource Planning (ERP) software. Thanks to its considerable experience and expertise in this field, Philips Origin is also able to offer advanced ERP full-life-cycle solutions incorporating supply chain management and electronic relationship management. 9 10 Companies are finding it increasingly important to coordinate their business activities with those of their suppliers, their customers and even, in some cases, their customers' customers. Origin assists clients in implementing this rapidly evolving concept, known as the `extended enterprise'. Origin provides, operates and manages the complex technical environments necessary to support the full ERP life cycle. This includes global data centers, helpdesks and communications networks. Origin also installs, operates and modifies both the ERP and follow-on supply-chain application software. Additionally, Origin provides consulting services in the design and development of software applications, as well as sophisticated transformational consulting, where the implementation of the supporting information technology is secondary to the change in the business itself. Philips welcomes the opportunity to learn together with our customers and to share its understanding of the new extended enterprise. From this solid base, Philips expects to continue to develop innovative ways of delivering full life-cycle support for ERP and Supply Chain Management environments. In 1997 Origin formed a strategic alliance with the then Price Waterhouse, a leading global professional services and consulting firm. Philips and Price Waterhouse signed a Letter of Intent to investigate the possibility of Price Waterhouse acquiring an interest in Origin. In February 1998, it was announced that the parties had not been able to agree terms for Price Waterhouse to acquire a minority interest in Origin. However, the strategic business relationship is being continued. Miscellaneous This sector comprises various ancillary businesses, including Philips Research, Corporate Patents & Trademarks, Philips Design, Hearing Instruments, Philips Machinefabrieken, Philips Plastics and Metalware Factories. Philips Plastics and Metalware Factories, a group of 13 operating companies predominantly located in Europe, is engaged in the development and production of plastic and metal components. The printed circuit board activities that belong to the group have been divested. Philips Machinefabrieken manufactures customer-specific machinery, tools and precision components for high-quality professional equipment. Research and Development Management believes that continuous efforts to establish a strong performance in the field of research and development activities are of the utmost importance to Philips in order to preserve and strengthen the competitive position Philips now holds in the various markets. Philips continuously adapts its research and development strategy. To provide a direct response to the needs of the market, Philips has in recent years adopted a more product-oriented approach to research and development, with expenditures directed at projects with more apparent short-term commercial prospects. In addition, projects with a mid-term range are agreed upon with the product divisions to secure an innovative product offering a few years from now. With a view to the longer term, Philips will seek to establish more research alliances with the academic world. Also, Philips believes that the geographic spread of research and development activities is increasingly determined by the technological capabilities offered by countries and regions. These capabilities are influenced by industrial policies which will increasingly determine the geographic allocation of Philips' resources and its policy with regard to alliances. This change in strategy for research and development activities is designed to enhance the effectiveness of expenditures in this area. In recent years, Philips has placed greater emphasis on research projects that are relevant to the entire group, while the main responsibility for the development of products and production methods in Philips currently lies with the product divisions, which have at their disposal development laboratories and implementation departments in 25 countries throughout the world. Approximately 20,500 employees are engaged in advanced development, product development and in the development of production methods and equipment. In addition, approximately 3,000 employees work in Philips' corporate research laboratories. Exploratory research and research leading to the conception of new products and technologies is carried out in four corporate laboratories in Europe, one in the United States and one in Taiwan. 10 11 Product development laboratories and the manufacturing operations are supported by the Center for Manufacturing Technology. This organization has its headquarters in Eindhoven and regional support centers in the Asia Pacific region and in the USA. In the USA, this center also provides pilot line facilities for advanced products. As a highly professional organization of over 900 employees, the Center for Manufacturing Technology is specialized in the innovation and improvement of production processes, improvement in the Product Creation Process and has the capability to develop specialized advanced production equipment. The Center also gives corporate level support in the field of standardization issues and in the preparation of corporate environmental policy. The achievements of Philips' laboratories in the fields of lighting, consumer electronics, optics, magnetics, mechanics and information technology have been of global significance. Achievements in research and/or development by Philips alone or, in certain circumstances, in cooperation with others, include flat-panel displays, lighting electronics, speech recognition and dialogue systems, optical and magnetic recording (DVD and DigaMax), low-power electronics (new batteries and asynchronous IC design), IC technology and others. Philips participates in various European research and development projects such as the projects for submicron IC technology (MEDEA), information technology and telecommunications (ACTS). In the United States, Philips has played a role in the "Grand Alliance" developing a fully digital high-definition television system for terrestrial broadcasting. The standard has now been adopted by the FCC, and the path has been cleared to launch a service in 1998. This event will usher in a new generation of fully digital television receivers, and a major opportunity for Philips. Philips has a strong IPR position consisting of approximately 60,000 patent rights, registered trademarks and design rights and a substantial number of license agreements. In 1998, Philips filed over 1,300 new patent applications and more than 1,000 worldwide patent families based upon the new patent filings of 1997. Although many of Philips' patents and licenses are significant, none is individually material to Philips' business as a whole. Patent protection is extremely important to Philips' operations. It expends significant resources to protect its intellectual property rights and intellectual property licenses. COOPERATIVE BUSINESS ACTIVITIES AND UNCONSOLIDATED COMPANIES The information set forth under the heading "Cooperative business activities and unconsolidated companies" on pages 52 and 53 of the 1998 Annual Report of the Company, is incorporated herein by reference. EMPLOYMENT The information set forth under the heading "Employees" on pages 63 and 64 of the 1998 Annual Report of the Company, is incorporated herein by reference. MILLENNIUM Philips' business activities may suffer from the unanticipated impact of year 2000 issues, including the failure of products from major suppliers to function properly in the year 2000. For a more detailed discussion of these issues and Philips' state of preparedness, see pages 135 through 138 of the 1998 Annual Report incorporated herein by reference. 11 12 ITEM 2 DESCRIPTION OF PROPERTY Philips' manufacturing facilities, warehouses and office facilities are mostly located in the Netherlands, the rest of Europe, the Far East and the United States and Canada. These plants are generally in good condition and adequate for the manufacturing requirements of Philips. The geographic allocation of assets employed as shown in Note 26: "Information relating to product sectors and geographic areas" on pages 119 through 127 of the 1998 Annual Report and incorporated herein by reference is generally indicative of the location of manufacturing facility. ITEM 3 LEGAL PROCEEDINGS Philips is involved in proceedings concerning environmental problems including proceedings relating to the closure of discontinued chemical operations and the clean-up of various sites, including Superfund sites, in the United States. The potential costs related to these proceedings and the possible impact thereof on future operations are uncertain. However, based on current information, management does not believe, that the outcome of these matters or other litigation incidental to its extensive international operations and involving, among other matters, competition issues and commercial transactions, will result in a liability which would have a material adverse effect on the consolidated financial position and results of operations of Philips at December 31, 1998. ITEM 4 CONTROL OF REGISTRANT The information required by this Item is incorporated by reference herein on pages 139 through 141 of the 1998 Annual Report. As of March 2, 1999, no person is known to the Company to be the owner of more than 10% of its Common Shares. ITEM 5 NATURE OF TRADING MARKET The Common Shares of the Company are listed on the Amsterdam Stock Exchange, on fourteen other European stock exchanges and on the New York Stock Exchange. The principal markets for the Common Shares are the Amsterdam, New York and London Stock Exchanges. The following table shows the high and low sales prices of the Common Shares on the Amsterdam Stock Exchange as reported in the Official Price List of the Amsterdam Stock Exchange and the high and low sales prices on the New York Stock Exchange:
AMSTERDAM NEW YORK STOCK EXCHANGE (NLG) STOCK EXCHANGE (US $) ----------------------- --------------------- High Low High Low ------------------------------------------------------------------------------------------------------------ 1997 1st quarter 94.70 67.90 48 7/8 39 2nd quarter 144.00 81.50 73 3/4 43 1/4 3rd quarter 177.00 136.70 84 1/2 69 9/16 4th quarter 178.80 111.00 88 7/8 54 1/8 1998 1st quarter 162.50 112.50 78 1/4 54 7/16 2nd quarter 204.30 148.50 102 7/8 71 3rd quarter 193.00 79.60 94 13/16 42 4th quarter 135.80 81.20 71 5/16 44 5/8 1999 1st quarter (through March 2) 153.71 124.62 80 7/16 67 5/8
12 13 The Common Shares are held by shareholders worldwide in bearer and registered form. Outside the United States, shares are held primarily in bearer form. As of March 2, 1999, approximately 74% of the Common Shares were held in bearer form. In the United States shares are held primarily in the form of registered Shares of New York Registry ("Shares of New York Registry") for which Citibank, N.A., 111 Wall Street, New York, New York 10043 is the transfer agent and registrar. As of March 2, 1999, approximately 25% of the total number of outstanding Common Shares were represented by Shares of New York Registry issued in the name of approximately 3,700 holders of record. Only bearer shares are traded on the Amsterdam Stock Exchange and other European stock exchanges. Only Shares of New York Registry are traded on the New York Stock Exchange. Bearer shares and registered shares may be exchanged for each other. Since certain shares are held by brokers and other nominees, these numbers may not be representative of the actual number of United States beneficial holders or the number of Shares of New York Registry beneficially held by US residents. ITEM 6 EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS There are currently no limitations, either under the laws of the Netherlands or in the Articles of Association of the Company, to the rights of non-residents to hold or vote Common Shares of the Company. Cash dividends payable in Dutch guilders on Netherlands registered shares and bearer shares may be officially transferred from the Netherlands and converted into any other currency without Dutch legal restrictions, except that for statistical purposes such payments and transactions must be reported to the Dutch Central Bank, and furthermore, no payments, including dividend payments, may be made to jurisdictions subject to sanctions, adopted by the government of the Netherlands, implementing resolutions of the Security Council of the United Nations. The Articles of Association of the Company provide that cash distributions on Shares of New York Registry shall be paid in US dollars, converted at the rate of exchange on the Amsterdam Exchanges N.V. ("AEX") at the close of business on the day fixed and announced for that purpose by the Board of Management in accordance with the Company's Articles of Association. ITEM 7 TAXATION The statements below are only a summary of the present Netherlands tax laws and the Tax Convention of December 18, 1992 between the United States of America and the Kingdom of the Netherlands (the "US Tax Treaty") and are not to be read as extending by implication to matters not specifically referred to herein. As to individual tax consequences, investors in the Common Shares should consult their own tax advisors. Withholding tax In general, a dividend distributed by a company resident in the Netherlands (such as the Company) is subject to a withholding tax imposed by the Netherlands at a rate of 25%. Stock dividends paid out of the Company's paid-in share premium recognized for Netherlands tax purposes are not subject to the above mentioned withholding tax. Pursuant to the provisions of the US Tax Treaty, dividends paid by the Company to a shareholder who is a resident of the United States (as defined in the US Tax Treaty), are generally eligible for a reduction in the rate of Dutch withholding tax to 15%, unless (i) the beneficial owner of the dividends carries on business in the Netherlands through a permanent establishment, or performs independent personal services in the Netherlands from a fixed base, and the Common Shares form part of the business property of such permanent establishment or pertain to such fixed base, or (ii) the beneficial owner of the dividends is not entitled to the benefits of the US Tax Treaty under the "treaty-shopping" provisions thereof. Dividends paid to qualifying exempt US pension trusts and qualifying exempt US organizations are exempt from Dutch withholding tax under the US Tax Treaty. However, for qualifying exempt US organizations no exemption at source upon payment of the dividend can be applied for; such exempt US organizations should apply for a refund of the 25% withholding tax. The gross amount (including the withheld amount) of dividend distributed on Common Shares will be dividend income to the US shareholder, not eligible for the dividends received deduction generally allowed to corporations. However, subject to certain conditions and limitations, the Dutch withholding tax will be treated as a foreign income tax that is eligible for credit against the shareholders' US income taxes. 13 14 Capital gains Capital gains upon the sale or exchange of Common Shares by a non-resident individual or by a non-resident corporation of the Netherlands are exempt from Dutch income tax, corporation tax or withholding tax, unless (i) such gains are effectively connected with a permanent establishment in the Netherlands of the shareholders' trade or business or (ii) are derived from a direct, indirect or deemed substantial participation in the share capital of a company (such substantial participation not being a business asset). In general, an individual has a substantial participation if he holds either directly or indirectly and either independently or jointly with his spouse or steady partner, at least 5% of the total issued share capital or particular class of shares of a company. For determining a substantial participation, other shares held by close relatives are taken into account. The same applies to options to buy shares. A deemed substantial participation amongst others exists if (part of) a substantial participation has been disposed of, or is deemed to have been disposed of, on a non-recognition basis. Under the US Tax Treaty however, the Netherlands may only tax a capital gain derived from a substantial participation if the alienator has been a resident of the Netherlands at any time during the five-year period preceding the alienation, and owned at the time of alienation either alone or together with his relatives, at least 25% of any class of shares. Net wealth tax No net wealth tax is imposed by the Netherlands in respect of Common Shares owned by non-resident corporations. A non-resident individual shareholder is not subject to Netherlands net wealth tax unless he has a permanent establishment in the Netherlands and the Common Shares are effectively connected with that permanent establishment. Estate and gift taxes No estate, inheritance or gift taxes are imposed by the Netherlands on the transfer of Common Shares if, at the time of the death of the shareholder or the transfer of the Common Shares (as the case may be), such shareholder or transferor is not a resident of the Netherlands, unless such Common Shares are attributable to a permanent establishment or permanent representative of the shareholder in the Netherlands. Inheritance or gift taxes (as the case may be) are due, however, if such shareholder or transferor: (a) has Dutch nationality and has been a resident of the Netherlands at any time during the ten years preceding the time of the death or transfer; or (b) has no Dutch nationality but has been a resident of the Netherlands at any time during the twelve months preceding the time of transfer (for Netherlands gift taxes only). 14 15 ITEM 8 SELECTED CONSOLIDATED FINANCIAL DATA I. In accordance with Dutch GAAP * **
(Millions, except per share data) ---------------------------------------------------------------------------------- 1994 1995 1996 1997 1998 1998 (a) NLG NLG NLG NLG NLG US $ ------------------------------------------------------------------------------------------------------------------------- INCOME STATEMENT DATA: Sales 52,377 55,664 59,707 65,358 67,122 35,514 Income from operations 2,704 2,975 929 3,777 1,509 798 Financial income and expenses-net (874) (688) (890) (703) (686) (363) Income from continuing operations 1,506 2,139 278 2,712 1,192 631 Net income (loss) 2,125 2,518 (590) 5,733 13,339 7,058 BASIC EARNINGS PER COMMON SHARE (NLG 10 par value): Income from continuing operations 4.53 6.29 0.81 7.76 3.31 1.75 Net income (loss) 6.39 7.41 (1.73) 16.41 37.05 19.60 DILUTED EARNINGS PER COMMON SHARE: Income from continuing operations 4.37 6.06 0.81 7.61 3.29 1.74 Net income (loss) (b) 6.15 7.13 (1.73) 16.09 36.75 19.44 Dividend per Common Share 1.25 1.60 1.60 2.00 2.20 (c) 1.16 (c) BALANCE SHEET AND OTHER DATA: Working capital 1,993 2,515 788 3,471 1,785 944 Total assets 42,083 46,236 48,278 51,394 62,041 32,826 Short-term debt 2,692 4,228 5,391 1,810 1,765 934 Long-term debt 5,847 6,253 7,512 7,072 6,140 3,249 Short-term provisions (d) 2,660 2,253 1,937 2,066 2,128 1,126 Long-term provisions (d) 5,198 5,372 5,600 5,098 4,450 2,354 Other group equity 740 1,093 616 1,232 533 282 Stockholders' equity 12,683 14,055 13,956 19,457 31,292 16,557 Net cash provided by operating activities 4,697 1,458 2,008 7,073 4,715 2,495 Cash flow (before financing activities) 1,922 (1,917 ) (2,038) 7,173 1,540 815 Net cash (used for) provided by financing activities (1,612 ) 1,882 1,711 (5,863) (1,794) (949) Increase (decrease) in cash and cash equivalents 310 (35 ) (327) 1,310 (254) (134)
15 16 ITEM 8 SELECTED CONSOLIDATED FINANCIAL DATA (continued) I. In accordance with Dutch GAAP (continued) * **
----------------------------------------------------------------------- 1994 1995 1996 1997 1998 NLG NLG NLG NLG NLG ----------------------------------------------------------------------- KEY RATIOS: Income from operations: - as a % of sales 5.2 5.3 1.6 5.8 2.2 - as a % of net operating capital (RONA) 15.2 15.4 4.2 16.4 6.5 Turnover rate of net operating capital 2.95 2.88 2.70 2.84 2.91 Inventories as a % of sales 18.2 20.1 16.0 15.2 14.0 Outstanding trade receivables (in months' sales) 1.5 1.5 1.3 1.3 1.3 Income from continuing operations: - as a % of stockholders' equity (ROE) 12.6 16.1 1.9 16.1 5.2 Net debt to group equity ratio 33:67 36:64 43:57 22:78 (e)
DEFINITIONS: Working capital : current assets excluding cash and cash equivalents less current liabilities Net operating capital : intangible assets, property, plant and equipment, non-current receivables and current assets excluding cash and cash equivalents and deferred tax positions, after deduction of provisions (with the exception of pension liabilities) and other liabilities RONA : income from operations as a % of average net operating capital ROE : net income from continuing operations as a % of average stockholders' equity Net debt : long-term and short-term debt net of cash and cash equivalents (a) For the convenience of the reader, the Dutch guilder amounts have been converted into US dollars at the exchange rate used for balance sheet purposes at December 31, 1998 (US $ 1 = NLG 1.89). (b) See Note 8 of "Notes to the Consolidated Financial Statements" on page 98 of the 1998 Annual Report incorporated herein by reference for a discussion of net income (loss) on a diluted basis. (c) Subject to approval by the Annual General Meeting of Shareholders on March 25, 1999. (d) Includes provision for pensions, severance payments, restructurings and taxes among other items; see Note 17 of "Notes to the Consolidated Financial Statements" on pages 103 through 106 of the 1998 Annual Report incorporated herein by reference. (e) The current net cash situation renders the net debt to group ratio meaningless. * Restated to reflect the sale of PolyGram N.V. and to present the Philips Group accounts on a continuing basis for all years presented. ** Selected pro forma consolidated figures for 1998 after implementation of the share reduction program, are incorporated by reference herein on page 57 of the 1998 Annual Report. 16 17 II. Approximate amounts in accordance with US GAAP * (See Note 25 of "Notes to Consolidated Financial Statements" on pages 115 through 118 of the 1998 Annual Report incorporated herein by reference)
(Millions, except per share data) ---------------------------------------------------------------------------------- 1994 1995 1996 1997 1998 1998 (a) NLG NLG NLG NLG NLG US $ ------------------------------------------------------------------------------------------------------------------------- INCOME STATEMENT DATA: Income (loss) from continuing operations 1,467 1,866 (1,254) 5,464 2,346 1,241 Discontinued operations 480 477 388 513 10,778 5,703 Extraordinary items, net - - - (96) (34) (18) Net income (loss) in accordance with US GAAP 1,947 2,343 (866) 5,881 13,090 6,926 BASIC EARNINGS PER COMMON SHARE (NLG 10 par value): Income (loss) from continuing operations 4.28 5.30 (3.67) 15.64 6.52 3.45 Net income (loss) 5.68 6.66 (2.53) 16.83 36.36 19.24 DILUTED EARNINGS PER COMMON SHARE: Income (loss) from continuing operations 4.25 5.29 (3.67) 15.34 6.46 3.42 Net income (loss) 5.64 6.63 (2.53) 16.51 36.06 19.08 Dividend per Common Share 1.25 1.60 1.60 2.00 2.20 (b) 1.16 (b) BALANCE SHEET AND OTHER DATA (period end): Stockholders' equity 14,304 15,437 15,003 20,735 32,362 17,123 Total assets 42,584 46,473 48,387 51,634 62,289 32,957
Note: According to US GAAP, divestments which cannot be regarded as discontinued segments of business are required to be accounted for as income from continuing operations. Under Dutch GAAP, certain material transactions such as disposals of lines of activities, including closures of substantial production facilities or substantial results from disposals of interests in unconsolidated companies have been accounted for as extraordinary items, which under US GAAP would be recorded in income from operations. (a) For the convenience of the reader, the Dutch guilder amounts have been converted into US dollars at the exchange rate used for balance sheet purposes at December 31, 1998 (US $ 1 = NLG 1.89). (b) Subject to approval by the Annual General Meeting of Shareholders on March 25, 1999. * Restated to reflect the sale of PolyGram N.V. and to present the Philips Group accounts on a continuing basis for all years presented. 17 18 III. Cash dividends and distributions declared per Common Share (NLG 10 par value) For the financial years 1994 and 1995, dividend payments of NLG 421 million (NLG 1.25 per Common Share) and NLG 547 million (NLG 1.60 per Common Share), were made respectively. For the financial year 1996, a distribution to shareholders of NLG 555 million (NLG 1.60 per Common Share) was paid. For the financial year 1997, a dividend of NLG 716 million (NLG 2.00 per Common Share) was paid. For the financial year 1998, a dividend payment will be proposed to the Annual General Meeting of Shareholders of the Company on March 25, 1999. The following table sets forth in Dutch guilders the gross dividends paid on the Common Shares in respect of the financial years indicated and such amounts as converted into US dollars and paid to holders of Shares of New York Registry.
1994 1995 1996 1997 1998 ------------------------------------------------------------------------------------ - In NLG 1.25 1.60 1.60 2.00 2.20 (a) - In US $ 0.80 0.97 0.85 0.97 (b)
(a) Subject to approval by the Annual General Meeting of Shareholders on March 25, 1999. (b) The dollar amount of the 1998 dividend to shareholders of NLG 2.20, which is subject to approval by the Annual General Meeting of Shareholders on March 25, 1999, will be calculated at the guilder/dollar rate of the official Amsterdam daily fixing rate (transfer rate) on the date fixed and announced for that purpose by the Company. IV. Exchange rates US $ : NLG
1994 1995 1996 1997 1998 -------------------------------------------------------------------------------------- - Rate at December 31, (as reported) 1.73 1.60 1.74 2.02 1.89 - Average rate (a) 1.81 1.61 1.69 1.95 1.98 - Highest rate (b) 1.97 1.75 1.76 2.12 2.09 - Lowest rate (b) 1.66 1.53 1.61 1.73 1.81
(a) The average rates are the accumulated average rates based on daily quotations. (b) Official Amsterdam daily fixing rate (transfer rate) as announced by 'De Nederlandsche Bank'. 18 19 ITEM 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item is incorporated by reference herein on pages 32 through 64 and the section entitled "Information on the Millennium Program" on pages 135 through 138 of the 1998 Annual Report. ITEM 9A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The information required by this Item is incorporated by reference herein on pages 57 through 59 of the 1998 Annual Report. As of December 31, 1997, a 1% decrease in market interest rates would result in an NLG 300 million increase in the fair market value of Philips' net debt position. As of December 31, 1998, the same decrease would result in an increase of NLG 210 million in the fair market value of long-term debt. Causes of this change, from NLG 300 million to NLG 210 million, include reduction in long-term debt, lower absolute interest rates and shorter remaining tenor. As of December 31, 1997, a 1% increase in market rates would result in a change in the annualized cost of finance that is not material. As of December 31, 1998 such an increase would result in an increase in annualized interest income of NLG 115 million. This change is due to a higher level of interest income to be received on, among others, the proceeds of the sale of PolyGram N.V. ITEM 10 DIRECTORS AND OFFICERS OF REGISTRANT The information required by this Item is incorporated by reference herein on pages 66 through 70 and pages 139 and 140 of the 1998 Annual Report. Mr. F.A. Maljers is also Chairman of the Board of the Dr. A.F. Philips Stichting. Messrs. A. Leysen, L.C. van Wachem, C.J. Oort and C. Boonstra are also member of the Board of the Dr. A.F. Philips Stichting. ITEM 11 COMPENSATION OF DIRECTORS AND OFFICERS The remuneration of the members of the Group Management Committee is determined by the Supervisory Board. The total remuneration of members of the Group Management Committee and the other officers include a variable part, which is determined annually by the Supervisory Board as far as the members of the Group Management Committee are concerned and by the Board of Management for other officers, taking into account the financial results and other factors. The remuneration of the members of the Supervisory Board is determined by the Annual General Meeting of Shareholders. The remuneration for individual members is NLG 90,000 and for the Chairman NLG 165,000. For information on the remuneration of members of the Board of Management and the Supervisory Board, see page 89 of the 1998 Annual Report incorporated herein by reference. The aggregate direct remuneration paid in 1998 to, or for the benefit of, the members of the Supervisory Board, the Board of Management and 54 officers in the Netherlands, taken as a group, was as follows: Aggregate direct remuneration NLG 60,777,000 Contribution to retirement plans in 1998 NLG 4,358,000 The registrant does not report to its shareholders, or otherwise make public, the information specified in this Item for individually named directors and officers. 19 20 ITEM 12 OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES During 1998, 1,943,800 stock options to purchase Common Shares of Koninklijke Philips Electronics N.V. were issued. In 1998 3,163,060 options were exercised; 223,744 initially allocated options were forfeited due to resignations/dismissals prior to vesting, and, to a lesser extent, the achievement of a lower than targeted number of options, with respect to the 1995 - 1997 cycle. Until February 24, 1999, 724,750 stock options were newly issued and 221,958 stock options were exercised. As of February 24, 1999 the number of shares issuable upon exercise of stock options outstanding was 6,169,326 (December 31, 1998: 5,666,534 stock options). For a discussion of the options and the employee debentures, see also Note 20: "Long-term debt", Note 22: "Share premium and other reserves" and Note 23: "Stock-based compensation" of "Notes to the Consolidated Financial Statements" on pages 107 through 109 of the 1998 Annual Report incorporated herein by reference. The registrant does not report to its shareholders, or otherwise make public, the information specified in this Item for individually named directors and officers. The following table provides more detailed information about the stock options outstanding at February 24, 1999. See also Note 23: "Stock-based compensation" on page 109 of the 1998 Annual Report incorporated herein by reference.
Fixed option plans: options outstanding options exercisable number exercise exercise number weighted outstanding price per period exercisable average at Feb. 24, share (ending) at Feb. 24, price per 1999 (price in 1999 share NLG) (price in NLG) ---------------------------------------------------------------------- ------------------------- 1994 65,650 50.00 March 3, 1999 65,650 50.00 1995 303,900 55.60 Feb. 21, 2000 303,900 55.60 1996 692,200 66.40 Feb. 14, 2001 692,200 66.40 1996 24,000 58.30 Oct. 23, 2001 24,000 58.30 1997 1,012,400 81.00 Feb. 12, 2002 1,012,400 81.00 1997 25,000 97.00 Apr. 22, 2002 - 97.00 1997 196,000 171.30 July 23, 2002 - 171.30 1997 54,500 160.20 Oct. 22, 2002 - 160.20 1998 1,161,900 145.00 Feb. 11, 2003 - 145.00 1998 56,000 185.30 Apr. 21, 2003 - 185.30 1998 3,000 171.30 July 22, 2003 - 171.30 1998 96,000 102.00 Oct. 21, 2003 - 102.00 1999 724,750 138.90 Feb. 10, 2004 - 138.90 (price in (price in US$) US$) 1998 621,150 51.75 - 94.37 Oct. 1, 2008 - 69.34 -------------- ------------ 5,036,450 2,098,150 Variable plans: (price in (price in US$) US$) 1991 - 1992 41,716 11.81-21.38 Dec. 31, 2000 41,716 12.82 1993 - 1994 177,885 11.00-27.56 Dec. 31, 2002 177,885 11.66 1995 - 1997 913,275 30.00-56.81 Dec. 31, 2004 543,661 31.46 -------------- ------------ 1,132,876 763,262
20 21 ITEM 13 INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS The registrant does not report to its shareholders, or otherwise make public, the information specified in this Item for individually named directors and officers. ITEM 14 DESCRIPTION OF SECURITIES TO BE REGISTERED Omitted pursuant to Form 20-F General Instruction G(b). ITEM 15 DEFAULTS UPON SENIOR SECURITIES None. ITEM 16 CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED SECURITIES None. ITEM 18 FINANCIAL STATEMENTS The following portions of the Company's 1998 Annual Report as set forth on pages 72 through 127 are incorporated herein by reference and constitute the Company's response to this Item: "Accounting principles" "Consolidated statements of income of the Philips Group" "Consolidated balance sheets of the Philips Group" "Consolidated statements of cash flows of the Philips Group" "Consolidated statements of changes in stockholders' equity" "Notes to the consolidated financial statements of the Philips Group" Schedules: Schedules are omitted as they are either not required or not applicable. ITEM 19 FINANCIAL STATEMENTS AND EXHIBITS (a) INDEX TO FINANCIAL STATEMENTS See Item 18 above. The total amount of long-term debt securities of the Registrant and its subsidiaries authorized under any one instrument does not exceed 10% of the total assets of Philips and its subsidiaries on a consolidated basis. Philips agrees to furnish copies of any or all such instruments to the Securities and Exchange Commission upon request. (b) INDEX OF EXHIBITS I Independent auditors' report and consent of the independent auditors. II The 1998 Annual Report to Shareholders of the Company, which is furnished to the Securities and Exchange Commission for information only and is not filed except for such specific portions that are expressly incorporated by reference in this report on Form 20-F. III Articles of Association, as amended, dated as of April 1, 1998 (English translation). IV Offer Agreement, dated as of June 21, 1998, among The Seagram Company Ltd. ("Seagram"), the Company and PolyGram N.V. ("PolyGram") (incorporated by reference to Exhibit 2.1 to Seagram's Amendment No. 1 to Current Report on Form 8-K/A dated June 22, 1998). V Tender Agreement, dated as of June 21, 1998, between Seagram and the Company (incorporated by reference to Exhibit 2.2 to Seagram's Amendment No. 1 to Current Report on Form 8-K/A dated June 22, 1998). 21 22 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant certifies that it meets all the requirements for filing on Form 20-F and has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized. KONINKLIJKE PHILIPS ELECTRONICS N.V. /s/ C. Boonstra /s/ J. Hommen C. Boonstra J. Hommen (President, Chairman (Executive Vice-President, of the Board of Management and Member of the Board of the Group Management Committee) Management and the Group Management Committee, and Chief Financial Officer) Registrant Date: March 23, 1999 22 23 EXHIBIT INDEX Exhibit Number Description of Exhibit I Independent auditors' report and consent of the independent auditors. II The 1998 Annual Report to Shareholders of the Company which is furnished to the Securities and Exchange Commission for information only and is not filed except for such specific portions that are expressly incorporated by reference in this report on Form 20-F. III Articles of Association, as amended, dated as of April 1, 1998 (English translation). IV Offer Agreement, dated as of June 21, 1998, among Seagram, the Company and PolyGram (incorporated by reference to Exhibit 2.1 to Seagram's Amendment No. 1 to Current Report on Form 8-K/A dated June 22, 1998). V Tender Agreement, dated as of June 21, 1998, between Seagram and the Company (incorporated by reference to Exhibit 2.2 to Seagram's Amendment No. 1 to Current Report on Form 8-K/A dated June 22, 1998). EX-99.I 2 INDEPENDENT AUDITORS' REPORT 1 I INDEPENDENT AUDITORS' REPORT ------------------------------------------------------------------------- To the Supervisory Board and Board of Management of Koninklijke Philips Electronics N.V. We have audited the consolidated financial statements of Koninklijke Philips Electronics N.V. (`Royal Philips Electronics') and subsidiaries as listed in Item 18. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards in the Netherlands which are substantially equivalent to generally accepted auditing standards in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Royal Philips Electronics and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles in the Netherlands. Generally accepted accounting principles in the Netherlands vary in certain significant respects from generally accepted accounting principles in the United States. Application of accounting principles generally accepted in the United States of America would have affected results of operations for each of the years in the three-year period ended December 31, 1998 and shareholders' equity as of December 31, 1998 and 1997 to the extent summarized in Note 25 to the Consolidated Financial Statements. Eindhoven, The Netherlands /s/ KPMG Accountants N.V. February 9, 1999 KPMG ACCOUNTANTS N.V. CONSENT OF THE INDEPENDENT AUDITORS ------------------------------------------------------------------------- To the Supervisory Board and Board of Management of Koninklijke Philips Electronics N.V. We consent to incorporation by reference in the registration statement (No. 33-80027) on Form S-8 and in the registration statement (No. 333-4582) on Form F-3 of Koninklijke Philips Electronics N.V. (`Royal Philips Electronics') of our report dated February 9, 1999, relating to the consolidated balance sheets of Royal Philips Electronics and subsidiaries as of December 31, 1998 and 1997, and the consolidated statements of income, cash flows and stockholders' equity for each of the years in the three-year period ended December 31, 1998, included in the December 31, 1998 annual report on Form 20-F of Royal Philips Electronics. Eindhoven, The Netherlands /s/ KPMG Accountants N.V. March 23, 1999 KPMG ACCOUNTANTS N.V. EX-99.II 3 1998 ANNUAL REPORT TO SHAREHOLDERS 1 II ANNUAL REPORT TO SHAREHOLDERS FOR 1998 See attachment. Note: the Annual Report to Shareholders for 1998 is furnished to the Securities and Exchange Commission for information only and is not filed except for such specific portions that are expressly incorporated by reference in this report on Form 20-F. 2 [Cover page to page 31 intentionally omitted] 3 MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion is based on the consolidated financial statements included in this report and should be read in conjunction with those statements and the other financial information contained herein. The consolidated financial statements were prepared in accordance with generally accepted accounting principles in the Netherlands (Dutch GAAP). These accounting policies differ in some respects from generally accepted accounting principles in the United States (US GAAP), which are discussed in note 25 to the consolidated financial statements. Sales in 1998 rose to NLG 67,122 million, an increase of 3% (1997: NLG 65,358 million). Income from continuing operations was down from last year's NLG 2,712 million (NLG 7.76 per share) to NLG 1,192 million (NLG 3.31 per share), mainly as a result of fourth-quarter charges amounting to NLG 1,568 million net after taxes and losses at Philips Consumer Communications (PCC). Divestments yielded non-recurring gains of NLG 12,014 million. As a result, the cash flow before financing activities, including the proceeds from the sale of PolyGram, was significantly higher at NLG 12,887 million, compared to NLG 7,173 million in 1997. Despite the turmoil in the world economy, a number of business sectors of the Philips Group ('Philips') achieved significant performance improvements in 1998. In many areas Philips outperformed its competitors. All sectors realized sales growth on a comparable basis (excluding the impact of consolidations and currency effects) and many achieved significant growth in market share: Consumer Electronics, Components, Semiconductors, Business Electronics and Origin. Practically all geographic areas, except Latin America, reported higher sales. However, only Lighting and Origin showed improvements in income from operations. In 1998, various fundamental steps were taken towards making Philips a stronger company. The program to refocus Philips on its core businesses, which was started in 1996, was continued throughout the year. It included the sale or discontinuance of a number of businesses or parts of businesses that failed to meet our performance standards or were considered not to fit into our strategic portfolio of businesses. In addition, production facilities have been closed or integrated with other facilities, and in a number of cases relocated to countries where employment costs are lower. This process of consolidation of manufacturing units will be continued in 1999 and beyond, in order to increase efficiency and enhance profitability. In line with our belief, and our undertaking to our shareholders, that the creation of value should always be the focal point of our decision-making, over a thousand senior business managers have committed themselves to the principles of value-based management. Economic Profit Realized (EPR) is now used to measure the financial performance of all our businesses. In the course of 1999, the value-based management approach will be incorporated in our incentive compensation program to reward managers for creating shareholder value. In order to strengthen the businesses in which we seek to be among the top 3 worldwide players, for example in Medical Systems, we succeeded in acquiring ATL Ultrasound, one of the leaders in ultrasound imaging. While ATL added to operating income in 1998, Philips recorded a one-off charge of NLG 401 million relating to in-process research and development acquired in connection with the purchase, and various one-time charges totaling NLG 112 million, which reduced the income of the Medical Systems division. 32 4 At the beginning of 1998, Philips announced its plans to make a substantial investment in the backbone of the Philips Group, notably in the Philips brand and in IT infrastructure. As part of the brand management program, a major global campaign was initiated under the name "Star Products". This campaign -- based on a comprehensive survey of 14,000 consumers in 17 different countries -- will be continued in 1999 and has already produced a very positive response in terms of enhanced brand awareness, brand image and increased market shares. The additional investment in IT consists of streamlining various IT processes to obtain greater uniformity and standardization in infrastructure among the global Philips population, as well as addressing the challenges of the euro and the Millennium issue. This program will reduce IT spending in the year 2000 and beyond, and enhance efficiency within Philips. While Philips continues to make significant investments in strategic areas that have increased the costs of the organization, there are several programs in place to optimize our spending. The Other Costs of Organization (OCOO) program that was started in late 1996 is aimed at reducing the cost of purchased services. This program has yielded significant savings and is being continued. During 1998 the Company also initiated a program in which disciplines such as purchasing, IT/Networks, real estate, finance and accounting and human resource management perform benchmark studies aimed at process improvement and cost reduction through the sharing of services and infrastructure. The performance of the joint ventures Philips Consumer Communications (PCC) and Hosiden and Philips Display Corporation (HAPD), as well as certain parts of Business Electronics, failed to meet our expectations for 1998. Hence we decided to invest an additional sum in the restructuring of these businesses in order to advance their respective break-even points. These realignments have led to considerable charges to the income of the respective divisions and product sectors. PolyGram, which was 75%-owned by Philips, was sold in December 1998 because it failed to contribute to enhancing Philips' brand recognition and because both PolyGram's and Philips' interests would be best served by this divestment. A portion of the considerable proceeds from the sale will be used to reduce the number of common shares outstanding. In 1998, Philips announced a share reduction program that is expected to begin in mid-1999 after the adoption of this proposal by the General Meeting of Shareholders. The plan involves a cash distribution to shareholders of approximately NLG 3.3 billion and a reduction by approximately 8% of the shares outstanding. Following the sale of Philips' 75% interest in PolyGram to The Seagram Company Ltd. of Canada on December 10, 1998, it should be noted that PolyGram, formerly a separate product sector, is presented in this report as a discontinued operation for the three years ended December 31, 1998. Management's discussion and analysis focuses on the performance of the Group on a continuing basis (excluding PolyGram) for all periods presented, unless otherwise stated. 33 5 SALES AND INCOME FROM OPERATIONS Sales in 1998 totaled NLG 67,122 million, 3% higher than the 1997 figure of NLG 65,358 million, which in turn was 9% higher than the total of NLG 59,707 million in 1996. Sales growth in 1998 on a comparable basis was 6%, compared with 8% in 1997. This consisted of a volume increase of 16% that was offset to a considerable extent by an average decrease in selling prices of 9%, which particularly affected Consumer Electronics, Components and Semiconductors. Currency fluctuations had a negative effect on sales of 2%, primarily due to the depreciation of virtually all of the Asian currencies and a weakening of the us dollar against the Dutch guilder. Various changes in consolidations resulted in a negative effect of 2% on sales. The main deconsolidations related to the sale of Philips Car Systems, Pie Medical, Philips Financial Services in the UK, the Smart Card business and various other Industrial Electronics and Components activities. Positive effects on sales arose from the consolidation of the activities of the PCC joint venture with Lucent Technologies for 9 months in 1998 (until September 27, 1998, when the venture was dissolved) as compared to only 3 months in 1997, the consolidation of Hosiden and Philips Display Corporation (HAPD) from April 1, 1998, and the acquisitions of ATL Ultrasound, Philips Mietsysteme and Payer Lux. SALES
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- in billions of guilders 52.4 55.7 59.7 65.4 67.1 % comparable growth 7% 11% 6% 8% 6%
In 1997, the nominal sales growth of 9% included a positive effect of 8% arising from currency fluctuations, mainly due to the stronger us dollar, while consolidation changes had a net negative impact of 7%. This consisted of the deconsolidations of Grundig, the radiotherapy business of Medical Systems and Data Communications, and new consolidations of Hua Fei Colour Display Systems of China, FEI Company of the USA, Pabianice Lighting of Poland and PCC. Adjusted for the combined effects of currency and consolidation changes, the comparable sales growth in 1997 over 1996 totaled 8%, consisting of 16% sales volume growth offset by a 8% decrease in the average level of selling prices. Income from operations in 1998 totaled NLG 1,509 million, or 2.2% of sales, compared to last year's record of NLG 3,777 million, or 5.8% of sales. The latter was four times the income of NLG 929 million, or 1.6% of sales, realized in 1996. When comparing figures with previous years, it should be noted that the 1998 income from operations was influenced by some special charges: Effective September 27, 1998, the Philips Consumer Communications (PCC) joint venture with Lucent Technologies was dissolved. The 1998 income from operations incorporated losses related to the unwinding of the joint venture, including value adjustments for obsolete 34 6 inventories (NLG 351 million) and the subsequent restructuring of the returned PCC activities (NLG 475 million); A major charge for the restructuring of the Hosiden and Philips Display Corporation (HAPD) joint venture affected income from operations by NLG 103 million; The write-off of in-process R&D obtained in the acquisition of ATL Ultrasound and an adjustment made to align ATL to Philips' accounting principles resulted in a non-recurring loss of NLG 513 million; The write-off of in-process R&D resulting from the acquisition of Active Impulse Systems (AIS) resulted in a charge of NLG 44 million. At the same time the Company incurred charges, making actuarial adjustments to the value of pension benefit plans due to declining interest rates in various countries (NLG 102 million), to cover the increased risk of non-collection of trade receivables following a major downturn in the Brazilian economy (NLG 88 million) and for other restructuring programs (NLG 148 million). On January 26, 1999, Philips made a statement to the press, announcing pre-tax charges totaling approximately NLG 2.0 billion in the fourth quarter of 1998. Taking into account some positive special gains, the net impact of all fourth-quarter charges on the 1998 income from operations came to NLG 1,824 million. Corrected for the gain on the sale of security investments and the lower effective tax rate in 1998 (11%), the net impact on income from continuing operations was NLG 1,568 million. In addition to these charges, income from operations in 1998 was adversely affected by the operational losses at PCC, together with declining profits at Components, which were only partly offset by performance improvements in the Lighting sector and at Origin. In 1997, income from operations reached an all-time high of NLG 3,777 million (5.8% of sales) compared to NLG 929 million (1.6% of sales) in 1996. Income in 1996 had been affected by substantial restructuring charges of NLG 565 million compared to only NLG 105 million in 1997. Disregarding the impact of lower restructuring costs, the income improvement in 1997 over 1996 was primarily attributable to a strong volume increase, the favorable impact of exchange rates and the elimination of loss-making activities. The erosion of selling prices represented a negative factor that was only partly offset by lower purchase prices and other cost reductions. At 6.5%, return on net assets (RONA) was significantly below last year's 16.4% (4.2% in 1996) and well short of the long-term RONA target of 24%. The principal reason for the decline was the decrease in income from operations as a percentage of sales, due in large part to the various charges this year. Excluding these charges the RONA would be 14.5%. The turnover rate INCOME FROM OPERATIONS as a % of net operating capital (RONA)
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 15.2 15.4 4.2 16.4 6.5
35 7 of net operating capital (2.91) was slightly above that of 1997 (2.84). RESTRUCTURING The competitive environment in which Philips organizations operate requires rapid adjustments in organizational structure, product portfolio and customer orientation. In order to accelerate the process of reorganization, a major restructuring program was initiated in 1996 as a result of disappointing profitability and the need to make the organization more flexible to react adequately to changing market conditions. The program led to an ongoing process of restructuring and/or discontinuance of underperforming or non-core activities in 1996, which was continued in 1997 and 1998. Substantially all of the underperforming and non-strategic businesses identified during portfolio analysis have been either discontinued or sold. The main loss-making operations that have been restructured or eliminated over the past two years include Grundig, Philips Media (including Superclub's video rental business), the Data Communication activities and various activities of Industrial Electronics. Businesses that have also been sold include PolyGram, Philips Car Systems, Optoelectronics, a number of Components businesses (Magnetic Heads & Modules, Mechatronics, Photonique, Flat Shadow Masks, Rare Earth and Hard Ferrites), Consumer Electronics' retail and rental activities in Australia and sundry activities such as Philips' travel agency. Moreover, a preliminary agreement was signed on September 27, 1998, for the sale of the conventional Passive Components activities, which transaction was completed in January 1999. The resulting gain will also be recognized in 1999. The Philips Group has also initiated various projects to improve the performance of its operations, including such measures as the closure of factories, the (partial) shift of production facilities to low-wage areas, the consolidation of production centers and the realignment of sales organizations. Two areas of particularly serious concern in 1998 were the disappointing performance of the liquid crystal display joint venture Hosiden and Philips Display Corporation (HAPD) and the joint venture with Lucent Technologies -- PCC. HAPD was established in April 1997 as a 50/50 joint venture with Hosiden, and in April 1998 Philips increased its shareholding to 80% due to the expected strategic importance of the AM-LCD technology. In view of the continuing losses incurred by this business, it has been decided to restructure large parts of this operation. This resulted in a substantial restructuring charge of NLG 103 million against income from operations in the fourth quarter of 1998. The PCC joint venture with Lucent Technologies was established on October 1, 1997. Despite ambitious plans for break-even results in the second half of 1998, PCC continued to incur substantial losses due to delays in product introductions of cellular phones, quality problems and product returns. In October 1998, Philips and Lucent agreed to end the joint venture (effective September 27). In connection with the dissolution, Philips received the assets it originally contributed to the joint venture. Subsequently, Philips recognized a restructuring charge of NLG 475 million in the fourth quarter of 1998, including write-offs of inventory totaling NLG 264 36 8 million for activities terminated. Further costs relating to the unwinding of the joint venture amounted to NLG 351 million. Ambitions for the short term have been scaled back, the product offering has been streamlined and cost reduction is under way in order to achieve profitability. The Company believes that the consumer communications business is of strategic importance to its Consumer Electronics business because of the synergy effects and natural spin-off to our 'home and away' product areas and the capabilities for our future digital products and home networks. Furthermore, consumer communications is a rapidly growing market in which the Company believes it has the brand, the skill and the technologies to be a successful player. As part of the ongoing process of realigning Philips to the anticipated economic environment and in order to enhance efficiency and profitability, the Company has developed plans for a further reduction of the number of manufacturing units over the next four years. This should create a more cost-efficient organization through the sharing of infrastructure and economies of scale. By integrating manufacturing facilities in larger units, closing a number of factories, and outsourcing a portion of its production, Philips envisions a reduction of about one-third of its manufacturing units by the year 2002. The ultimate number will depend on how markets develop over that period. The Company is in the early stage of evaluating the financial consequences of these plans. Any related costs will be expensed in future periods as Philips commits itself to detailed plans. The total restructuring charges recorded against income from operations in 1998 totaled NLG 726 million, principally for the sectors Consumer Products and Components. In 1997, these charges totaled NLG 105 million, including the release of a provision no longer required. In addition to the NLG 565 million restructuring charge to income from operations in 1996, an extraordinary charge of NLG 1,226 million was recognized, of which NLG 800 million related to the structural realignment of the former Sound & Vision division. The costs of the organization in 1998 were 8% higher than in 1997. The relative increase is attributable, in part, to the substantial investments the Company has made in certain strategic areas. In 1998, the Company announced that it would invest an additional NLG 1 billion in brand management and information technology. Various brand management initiatives, including the establishment of Customer Care Centers throughout the world and a Marketing Competence Center, have taken off. Additionally, a major global brand image campaign that will continue into 1999 was launched in the fourth quarter. In the area of IT, the Company has begun upgrading its communications infrastructure to facilitate global communication. Additionally, significant investments have been made in systems in order to address the challenges presented by the euro and Millennium issues. Employee costs showed a relative decrease of 1% compared to 1997, reflecting the relocation of production facilities to low-wage countries. Geographically, sales growth in 1998 showed a divergent pattern. In Europe, sales growth 37 9 increased, but decreased slightly in North America, while growth in Asia was positive but at a substantially lower level than in the previous year. The negative sales trend in Latin America that began in 1997 continued in 1998. In Europe, all sectors contributed to the comparable sales growth of 10%. The largest increases came from Consumer Products (particularly Consumer Electronics), Origin, Components and Semiconductors. Within Europe, sales growth was principally attributable to the Netherlands, Italy, the United Kingdom and Eastern Europe. The 6% sales increase in the USA and Canada was largely attributable to Consumer Products, while the Professional sector also contributed, particularly Medical Systems. The decline in sales in Latin America (6%) related solely to Brazil, where sales slumped by 14%. The remainder of the region, particularly Mexico, saw continued growth. All sectors realized positive growth rates in Asia (overall growth 4% in 1998, following 12% in the previous year), with the largest increases at Consumer Electronics and Semiconductors. By contrast, sales were significantly lower at Domestic Appliances and Personal Care, principally due to the market collapse in the five countries most affected by the financial crisis in Asia: Malaysia, Thailand, Indonesia, South Korea and the Philippines. The countries that made the strongest contribution to the region's sales increase were China, Taiwan and India. With the exception of Europe, all regions recorded lower operating income. In Europe, notably in Germany, Austria, Belgium, UK and France, income exceeded 1997 levels, with the main contributions from Semiconductors, Lighting and Components. North America was significantly affected by the PCC losses. In Asia, income was lower due to Consumer Products (PCC and other CE) as well as lower results from Components (Display Components and HAPD losses, including a substantial restructuring charge) and Semiconductors. The reduction in income in Latin America, relating entirely to Brazil, was attributable to Consumer Electronics and Components. SALES PER GEOGRAPHIC AREA In billions of guilders
1997 1998 ---- ---- North America 14.8 16.4 Latin America 4.9 4.6 Europe 30.9 32.3 Africa 0.6 0.6 Asia 12.9 12.3 Australia and New Zealand 1.3 0.9
The net cost of finance in 1998 amounted to NLG 686 million, which was down from last year's NLG 703 million and considerably less than the NLG 890 million in 1996. In 1998, the net cost included non-recurring gains totaling NLG 87 million from the sale of equity investments, principally in Flextronics, which were lower than INCOME/(LOSS) FROM OPERATIONS PER GEOGRAPHIC AREA AS A % OF SEGMENT REVENUES
1997 1998 ------ ------ North America 0.1 (5.5) Latin America (2.6) (10.2) Europe 4.0 3.8 Africa 2.8 (0.7) Asia 6.5 2.9 Australia and New Zealand (2.4) (1.6)
38 10 the non-recurring gains in 1997 of NLG 158 million, mainly related to Viacom Inc. and Fluke Corporation. Net interest expense decreased by NLG 212 million in 1998, mainly reflecting the lower average debt position, which declined from NLG 12.7 billion in 1997 to NLG 9.0 billion in 1998. In 1998, exchange differences resulted in a loss of NLG 87 million, to a large extent related to increased hedging expenses in emerging markets. Furthermore, some losses were incurred in Eastern Europe, where hard-currency loans were used to finance the US dollar and euro-denominated export-oriented activities. The 1997 gain on exchange differences of NLG 27 million was principally due to the gain on US dollar deposits held in Taiwan, partially offsetting losses in South-East Asia. Income tax charges totaled NLG 91 million in 1998, compared to NLG 607 million in 1997 and an income tax benefit of NLG 15 million in 1996. This corresponds to an effective tax rate in 1998 of 11%, down from 20% in 1997, and negative 40% in 1996. The decrease in the effective tax rate in 1998 resulted from the utilization of operating loss carryforwards in various countries, mainly in Europe, and releases of valuation allowances. These positive effects were only partly offset by unrecognized losses and by the incidental write-off related to ATL, which are not tax-deductible. Results relating to unconsolidated companies in 1998 totaled NLG 86 million, compared with NLG 206 million in the year 1997. The principal businesses, Taiwan Semiconductor Manufacturing Co. (TSMC) and ASM Lithography, generated significantly lower income than in 1997 due to the global slump in the semiconductor industry and the crisis in Asia. This was partially offset by lower losses at Navigation Technologies Corporation (NavTech). Income in 1997 of NLG 206 million was below the NLG 320 million in 1996 due to TSMC's lower income and substantial losses at NavTech. Additionally, the 1997 figure included the Company's share in the Grundig losses through June 30 and the HAPD losses from April 1. These were only partly offset by incidental gains from the sale of business interests such as the 25% shareholding in Bang & Olufsen. The share of other group equity in group income totaled a positive NLG 374 million in 1998, compared with NLG 39 million in 1997 and NLG 96 million negative in 1996. The positive figure in 1998 is accounted for by third parties sharing in the substantial losses incurred by the PCC and HAPD joint ventures. As such, the minority interest in the losses partially offset the operating losses included in income from operations. Compared to 1996, the reduction in third-party minority interests in 1997 group income was due to the settlement in relation to Grundig involving the discontinuance of dividend payments and other obligations. NET INCOME Income from continuing operations was NLG 1,192 million in 1998, or NLG 3.31 per common share, compared to NLG 2,712 million, or NLG 7.76 per common share, in 1997 and NLG 278 million, or NLG 0.81 per common share, in 1996. 39 11 Income from discontinued operations represents Philips' 75% share in the operations of PolyGram N.V. through December 10, 1998, and amounted to NLG 462 million in 1998, NLG 579 million in 1997 and NLG 445 million in 1996. Philips sold its shares in PolyGram to The Seagram Company Ltd. on December 10, 1998, and in connection with this sale recognized a gain of NLG 10,675 million, free of taxes. Extraordinary items in 1998 totaled a net gain of NLG 1,010 million, compared to a NLG 2,442 million gain in 1997. Major items were Car Systems at a net gain of NLG 836 million and Optoelectronics at a net gain of NLG 171 million. Several smaller items were also included, such as provisions for the costs relating to early repayment of debt. The 1997 gain was principally attributable to the sale of part of Philips' shareholding in TSMC (net gain NLG 1,979 million), the sale of the 50% shareholding in United & Philips Communications, the sale of a third tranche of the Company's shares in ASM Lithography and various other divestments. These gains were partially offset by the final settlement relating to Grundig, which resulted in a significant extraordinary loss. Included in 1996 was an extraordinary loss of NLG 1,313 million, primarily attributable to the Grundig losses, the structural realignment of the former Sound & Vision division and the restructuring and discontinuance of various businesses. These were partly offset by gains from the sale of the second tranche of ASM Lithography shares. Net income in 1998 -- including PolyGram -- reached an all-time high of NLG 13,339 million (NLG 37.05 per common share), compared to the previous record of NLG 5,733 million (NLG 16.41 per common share) in 1997. The Company incurred a net loss of NLG 590 million (NLG 1.73 per common share) in 1996. US GAAP The Group financial statements have been prepared in accordance with Dutch GAAP, which differs in certain respects from US GAAP. Net income determined in accordance with US GAAP would result in a profit of NLG 13,090 million in 1998, compared with NLG 5,881 million in 1997 and a loss of NLG 866 million in 1996. These aggregate amounts correspond to basic earnings per common share of NLG 36.36 in 1998, NLG 16.83 in 1997 and a loss of NLG 2.53 per common share in 1996. The difference between income in accordance with Dutch GAAP versus US GAAP arises from, among other things, amortization of goodwill for acquisitions prior to 1992 and pension accounting. Certain losses relating to higher accumulated benefit obligations compared to the market value of the plan assets or the existing level of pension provisions were reported as a charge to income under Dutch GAAP totaling NLG 74 million in 1998 (1997: NLG 139 million), whereas under US GAAP these amounts have been capitalized as an intangible asset or included in comprehensive income. Part of the restructuring charge in 1998, NLG 51 million, failed to meet the US GAAP requirements, because the restructuring had not 40 12 been publicly announced in sufficient detail before the balance sheet date, and as a consequence has to be recorded in the 1999 income statement. For US GAAP purposes a major restructuring provision for Grundig was recognized in 1996 whereas under Dutch GAAP it had been taken in 1995; 1996 financials also included the reversal of the put option liability to outside shareholders of Grundig which under US GAAP had been recognized in 1995. Furthermore, in 1997 the US GAAP adjustments included the NLG 127 million gain on the sale of a 50% shareholding in UPC that under Dutch GAAP had already been recognized in 1995. Reference is made to note 25 to the consolidated financial statements for a description of the primary differences between Dutch and US GAAP and the earnings per share information. DIVIDEND A proposal will be submitted to the General Meeting of Shareholders to declare a dividend of NLG 2.20 per common share (compared with a dividend to shareholders of NLG 2.00 per common share for 1997). The consolidated financial statements presuppose the adoption of this proposal, which will result in a total dividend payment of NLG 794 million (compared with NLG 716 million for 1997). SHARE REDUCTION PROGRAM As part of the share reduction program and apart from the dividend proposal, a proposal will be submitted to the General Meeting of Shareholders to reduce the nominal share capital by distributing a cash amount of NLG 9.07 per common share to all Philips shareholders. This program will be combined with the redenomination of the share capital in the euro, whereby each common share will have a par value of 1 euro. The transaction is expected to be effected mid-1999. SEGMENT SALES AND INCOME FROM OPERATIONS In order to comply with the additional segment reporting requirements outlined in SFAS No. 131 'Disclosures about Segments of an Enterprise and Related Information', issued by the Financial Accounting Standards Board of the USA in June 1997, the Board of Management has adjusted the Company's external segmentation as of January 1, 1998. For the sake of comparability, the segment information for 1997 and 1996 has been restated. The following segments are reported separately: Lighting, Consumer Products, Components, Semiconductors, Professional, Origin, Miscellaneous and Unallocated. For a comprehensive business description of the various Product Divisions, refer to the relevant section in the consolidated financial statements (note 26). In order to facilitate a unified marketing approach for all consumer products and to pave the way for the implementation of an integrated strategy for high-volume electronics, the former divisions Sound & Vision, Business Electronics and Industrial Electronics have been regrouped as of January 1, 1998. The PC Peripherals activities of Business Electronics, Philips Consumer Communications and Sound & Vision now form a new division called Philips Consumer Electronics. The 'new' Business Electronics 41 13 division comprises its former professional businesses, plus the activities of the former Industrial Electronics division. At year-end 1997, Philips signed an agreement with Mannesmann VDO of Germany to sell the Philips Car Systems business. For the sake of comparability, the 1997 and 1996 contributions of this division have been included in the Miscellaneous sector. Similar reclassifications to Miscellaneous were made in prior years for the Grundig and Philips Media activities that were sold and/or discontinued towards the end of 1996 and 1997, respectively. LIGHTING Sales in the Lighting sector in 1998 decreased to NLG 9.8 billion from NLG 10.0 billion in 1997, reflecting a nominal decrease of 2%. Adjusted for currency movements (a decrease of 3%), sales on a comparable basis were 1% higher, with volume growth of 4% being largely offset by price erosion of 3%. For the division as a whole, growth continued in Europe and in Asia, partly offset by minor decreases in North America and Latin America. Income from operations in 1998 rose to NLG 1,311 million, or 13.2% of segment revenues, compared to NLG 1,151 million, or 11.3% of segment revenues, in 1997. Income benefited from cost savings associated with prior restructuring actions, purchasing efficiencies and an improved product mix. Income included a non-recurring gain of NLG 67 million from the sale of a factory building in Spain. LIGHTING in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 0.2 0.1 0.1 0.1 0.1 sales (excluding intersegment sales) 8.1 8.4 8.9 10.0 9.8
The nominal sales increase in 1997 over 1996 was 13%, with sales increasing to NLG 10.0 billion from NLG 8.9 billion. Changes in currency rates had a positive effect on sales of 8%, while changes in consolidations had a minor positive effect. Excluding these factors, sales growth on a comparable basis was 5%, comprising 8% volume growth that was partly offset by 3% price erosion. Income from operations in 1997 improved to NLG 1,151 million, or 11.3% of segment revenues, up from 1996 income of NLG 702 million, or 7.8% of segment revenues. Income in 1997 benefited from cost savings associated with prior restructuring actions, ongoing development of Philips' manufacturing base in low-cost countries, better control of costs throughout the organization and an improved product mix. Currency movements also had a minor positive influence. LIGHTING income from operations in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 0.94 0.98 0.70 1.15 1.31
42 14 CONSUMER PRODUCTS Sales in this sector rose 9% to NLG 27.5 billion from NLG 25.3 billion in 1997. On a comparable basis the growth was 7%. Consolidation changes -- notably the consolidation of Lucent Technologies' Consumer Products division as of October 1, 1997, through its subsequent dissolution effective September 27, 1998 -- had a positive effect on sales of 3%, partly offset by the negative effect of lower currency exchange rates of almost 2%. Prices suffered a 13% decrease and volume increased by 20%. Income from operations in the sector fell to a loss of NLG 613 million, or 2.2% of segment revenues, compared with a profit of NLG 738 million, or 2.7% of segment revenues, in 1997. The 1998 figure included the significant losses at the PCC joint venture of NLG 1,839 million, in part relating to various non-recurring charges of NLG 826 million in connection with the dissolution of the joint venture, part of which related to restructuring charges totaling NLG 475 million. In 1997, PCC incurred operating losses of NLG 602 million. Excluding the PCC losses, income in the sector was almost at the same level as in 1997, helped by a significant increase in license revenues and benefiting from restructuring programs carried out in prior years. CONSUMER PRODUCTS in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 2.2 2.4 1.8 1.6 0.6 sales (excluding intersegment sales) 19.2 19.1 21.2 25.3 27.5
CONSUMER PRODUCTS income/(loss) from operations in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 0.83 0.46 0.42 0.74 (0.61)
At NLG 25.3 billion, sales in 1997 were 19% higher than the 1996 sales of NLG 21.2 billion. However, adjusted for the favorable effects of higher currency exchange rates (8%) and consolidation changes (4%), comparable growth totaled 7%. Lower prices had a negative impact of 10%, whereas sales volume had a positive effect of 17%. Income from operations in the sector rose to NLG 738 million, or 2.7% of segment revenues, in 1997, up from NLG 421 million, or 1.8% of segment revenues, in 1996. The improvement was primarily attributable to higher income for Domestic Appliances and Personal Care, higher license revenues and the fact that 1996 income had been affected by a restructuring charge of NLG 48 million (in addition to the NLG 800 million restructuring provisions charged to extraordinary income in 1996). CONSUMER ELECTRONICS Sales on a comparable basis increased by 9%. Steep volume growth of 24% was partly offset by price erosion of 16%, which was particularly strong in peripherals (monitors), video products and communications (telephony). Sales in Video increased strongly in spite of decreased markets, particularly in Western Europe and North 43 15 America. Most of the increase was attributable to TV and TV/VCR combinations. The sales growth in Audio was primarily from CD-Recordable and Portable Audio products and was substantially in excess of the declining markets. Booming sales in Digital Video (e.g. DVD and Internet TV) contributed strongly to the division's growth. Despite the pressure on worldwide PC markets and increasing price erosion, sales in PC Peripherals (Monitors, Add-on Cards etc.) maintained substantial growth. The strong sales increase in Communication products occurred primarily in GSM mobile phones in Europe, Asia and Latin America. Market shares increased in all business segments (Wireless and Wired). Income from operations showed a loss, primarily due to the PCC losses, compared with a profit in 1997. In addition to the non-recurring and restructuring charges, the losses were caused by delays in the introduction of new products, among many other factors. The investment in a restructuring program is designed to streamline the product offering and to reduce costs in order to achieve profitability for the remaining business, which will focus on core strengths in GSM technology, corded and cordless phones. Most of the other consumer electronics businesses reported a profitable performance in 1998, but at a lower level than in 1997, partly due to the impact of the difficult economic situation in Brazil. Higher start-up costs for new activities, development costs, and continuing price erosion -- especially in Monitors -- further contributed to the decline in income. Sales in 1997 grew by 21%. Disregarding the positive effects of consolidation changes (5%) -- notably the start-up of the PCC joint venture from October 1, 1997 -- and currency changes (8%), the growth was 8% on a comparable basis. This comprised 12% lower prices and 20% higher volume. Income from operations in 1997 showed a higher loss, primarily attributable to the PCC joint venture, whose losses related to the development and introduction of new products, delayed product launches affecting operating margins and substantial costs for the integration and ramping-up of a global organization. Disregarding PCC, income from operations in this division rose sharply in 1997, benefiting strongly from prior-year restructuring actions designed to streamline business processes and reduce costs. The streamlining process and savings on purchases from other parties led to improved productivity, which -- in combination with outsourcing -- led to a significant reduction in the workforce. DOMESTIC APPLIANCES AND PERSONAL CARE Sales in 1998 decreased slightly compared with 1997, mainly in connection with sharply decreasing markets in Asia, Latin America and Eastern Europe. Overall sales growth in Western Europe and North America was maintained at a high level. From a business perspective, sustained strong growth was achieved in Personal Care products, with Cool Skin shavers contributing strongly. In the Domestic Appliances and Cooking & Comfort businesses, sales ended lower than in 1997 due to higher exposure to the regions affected by the economic slowdown. Income from operations in 1998 was lower -- following last year's steep increase -- and reflects 44 16 the lagging sales development. In addition, costs increased partly because of restructuring charges and higher expenses for advertising and promotion relating to new product introductions. Restructuring involved the relocation of various industrial facilities. In spite of unfavorable market conditions, Personal Care maintained its strong income level, while Cooking & Comfort recorded good results, especially in Irons. Restructuring charges affected income in Domestic Appliances, which was further affected by its high exposure to the regions where markets have decreased. Nominal sales growth in 1997 was 10%. However, excluding currency impacts, sales grew 3% on a comparable basis, primarily driven by 4% higher volume. Income from operations in 1997 rose steeply, continuing a rise that started in the year before. The 1997 results reflected the strong performance of the Reflex Action shaver and successful introductions of new products, as well as the effect of the discontinuance of the loss-making Regina vacuum cleaner business in the USA. COMPONENTS Sales in 1998 grew by 4% to NLG 8.4 billion from NLG 8.1 billion in 1997. Consolidation changes -- principally HAPD, which was consolidated from April 1 upon acquisition of an additional 30% shareholding -- had a net positive effect on sales of 1%, while currency changes had a negative effect of 2%. Comparable sales growth came to 5% and was in excess of the market, which fell by 9%. Substantial volume growth of 21% was partly offset by strong price erosion of 16%, principally relating to Color Monitor Tubes, due to excess capacity in the industry, and Optical Storage. Nearly all businesses contributed to the division's growth, predominantly Optical Storage, General System Components and Flat Display Systems (particularly LCD displays). The largest increase was in Europe; Asia also recorded positive growth in spite of the economic crisis, while North America was slightly down, and sales in Brazil were significantly lower, due to worsening economic conditions. COMPONENTS in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 2.9 3.1 3.3 3.1 3.2 sales (excluding intersegment sales) 4.6 5.4 6.3 8.1 8.4
Income from operations in 1998 totaled NLG 98 million, or 0.8% of segment revenues, compared to NLG 562 million, or 5.0% of segment revenues, in 1997. The decline in income is partly due to the NLG 223 million losses of HAPD, of which NLG 103 million was charged to income for the planned restructuring in Japan, in order to bring forward the point in time when this strategic business in active matrix LCDs starts contributing to income. Significant price erosion in Display Components (monitors), Optical Storage and Passive Components accounted for a further decrease in results, in spite of being partly offset by higher results in General System Components and Magnetic Products. In 1997, sales in this sector increased to NLG 8.1 billion from NLG 6.3 billion in 1996, a 45 17 COMPONENTS income from operations in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 0.42 0.67 0.70 0.56 0.10
27% nominal increase. Adjusted for consolidation changes (12%, principally Hua Fei Colour Display Systems -- China) and exchange rate fluctuations (10%), comparable sales growth was 5%, which was in line with the market. Significant price erosion (14%) was more than offset by the 19% volume increase. Income from operations in 1997 fell to NLG 562 million, or 5.0% of segment revenues, from NLG 696 million, or 7.3% of segment revenues, in 1996. This was substantially due to a non-recurring charge to 1997 income in connection with the discontinuance of some business operations in Eastern Europe. SEMICONDUCTORS Sales in 1998 were NLG 7.1 billion, 2% up from NLG 6.9 billion in 1997. Adjusted for currency changes (decrease of 3%), the comparable sales growth was 5%. Volume growth was 15%, more than offsetting price erosion of 10%. The strongest contribution to the division's growth came from Consumer Systems and Telecom ICs. The regions that accounted for the increase were Europe and Asia. The division's sales growth was clearly in excess of that of the total semiconductor market, which decreased as a consequence of gloomy PC markets and deteriorating economic conditions in Asia. In the provisional Dataquest ranking, Philips Semiconductors climbed from ninth position to eighth. Income from operations of NLG 1,687 million, or 19.3% of segment revenues, was almost level with last year's NLG 1,700 million, or 20.3% of segment revenues. This achievement is mainly attributable to product, manufacturing and investing policies that have been pursued in an industry that as a whole has been sharply affected by the Asian crisis and by overcapacity. Weakening of the market led to lower capacity utilization in the second half of the year and increased price erosion. In 1997 sales of NLG 6.9 billion were 24% higher than the previous year's NLG 5.6 billion. On a comparable basis, mainly adjusted for the 9% positive currency effect, growth was 14%. Price erosion in 1997 was relatively high at 10% -- up from 8% in 1996 -- but this was more than offset by 24% growth in terms of volume compared with 9% in 1996. Nevertheless, income from operations more than doubled compared to 1996 due to higher levels of activity, which led to much-improved factory utilization and to positive currency effects, SEMICONDUCTORS in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 0.9 0.9 1.2 1.5 1.6 sales (excluding intersegment sales) 4.2 5.3 5.6 6.9 7.1
46 18 SEMICONDUCTORS income from operations in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 1.18 1.56 0.80 1.70 1.69
especially from the US dollar. Income was affected both in 1997 and 1996 by costs relating to the start-up of the MOS-4 submicron facility in Nijmegen, the Netherlands. PROFESSIONAL Sales in the Professional sector totaled NLG 10.0 billion in 1998, a 5% nominal increase over sales of NLG 9.5 billion in 1997. Adjusted for the impact of consolidation changes (down 1%, the net effect of the sale of the radiotherapy business in 1997 partially offset by the ATL Ultrasound acquisition in 1998) and the negative influence of exchange rate fluctuations (down 1%), comparable sales growth amounted to 7%. Sales volumes were up 12%, more than offsetting the impact of price erosion of 4%. Both Medical Systems and Business Electronics contributed to the sector's growth by 6% and 9%, respectively. Income from operations in 1998 was a loss of NLG 122 million, or 1.2% of segment revenues, compared with income of NLG 456 million, or 4.6% of segment revenues, in 1997. Disregarding the NLG 557 million non-recurring charges for in-process R&D, goodwill amortization relating to the new consolidations of ATL Ultrasound and Active Impulse Systems, and other charges to align ATL to Philips' accounting policies, income for the sector totaled NLG 435 million. The remaining decrease from 1997 was attributable to the lower sales in some of the businesses of Business Electronics, which required additional restructuring charges of NLG 49 million and other non-recurring charges in 1998. However, despite higher one-time costs of the organization, Medical Systems' income was positively affected by the additional contribution from the ATL Ultrasound operations. In 1997, this sector generated sales of NLG 9.5 billion, compared to NLG 8.5 billion in 1996, a nominal increase of 12%. Excluding consolidation changes (8% negative) and changes in currency exchange rates (9% positive), sales on a comparable basis increased by 11%, consisting of 5% growth in Medical Systems and 16% in Business Electronics. In terms of volume, sales rose 14%, while the average price level was 3% lower than in 1996. Income from operations was NLG 456 million, or 4.6% of segment revenues, in 1997, up from NLG 40 million, or 0.5% of segment revenues, in 1996. Income benefited primarily from the turnaround in income of the Business Electronics activities. PROFESSIONAL in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 0.2 0.2 0.2 0.3 0.2 sales (excluding intersegment sales) 6.8 7.5 8.5 9.5 10.0
47 19 PROFESSIONAL income/(loss) from operations in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ----- 0.39 0.38 0.04 0.46 (0.12)
MEDICAL SYSTEMS In 1998, Medical Systems recorded 6% comparable sales growth. Excluding ATL, the business grew virtually in line with the development of the market. The remaining growth was due to the acquisition of ATL. Volume increased by 10%, which was partly offset by price erosion of 4%. The regions North America and Eastern Europe, in particular, contributed to this increase, while Western Europe recorded limited growth. The businesses which contributed most were Ultrasound -- through the acquisition of ATL -, Universal, Cardio/Vascular and Customer Support. Income from operations showed a loss in 1998. Excluding ATL write-off, income increased by 10%. The acquisition of ATL resulted in a fourth-quarter charge of NLG 401 million for the write-off of in-process R&D obtained in this strategic acquisition. Disregarding this charge and certain other charges totaling NLG 112 million in connection with ATL, income benefited from the contribution of ATL's normal operations from the time of acquisition. The 1997 sales increased by 5% on a comparable basis in line with the development of the market, consisting of 9% volume growth and 4% price erosion. IN-PROCESS R&D As of the acquisition date there were three main products in development. Specific projects under development in different technology areas are those related to, among other things, scanheads, image acquisition, signal and image processing, 3-dimensional techniques and contrast agents. All of these projects have specific goals in areas such as breakthrough technologies, cost reduction and efficiency, and application-oriented developments. The outcome of these projects will strengthen Medical Systems' offerings in the cardiology area and in general imaging, while ultimately core functionality for the next-generation platform will become available. The products in which these new developments are to be used will be ready between 1999 and 2002. The acquired in-process R&D consists of ATL's work to date on the projects described above. This work is very specific to the tasks and markets for which it is intended. There are no alternative uses for the in-process work in the event that the proposed products do not prove feasible and none of the future products involved have demonstrated their technological or commercial feasibility as of the valuation date. Significant risks exist because it is uncertain what obstacles will be encountered in the form of time and cost necessary to produce technologically feasible products. It is unlikely that the Company will be able to realize any value from the sale of this technology to another party. Furthermore, it is reasonable to assume that the projects would require significant amounts of time and research and development to complete the product. An income approach was used in valuing the 48 20 acquired in-process R&D, which reflects the present value of the operating cash flows generated by the in-process R&D taking into account the costs to complete the projects, the relative risks of the projects, the contribution of other assets and an appropriate discount rate to reflect the time value of invested capital. Income from operations in 1997 was flat compared to 1996 because of the impact of non-recurring charges in 1997. Disregarding these items, income benefited mainly from efficiency improvements and stronger currencies, which outweighed the effects of price erosion and higher cost levels. BUSINESS ELECTRONICS Sales growth on a comparable basis was 9% in 1998. The growth was mainly attributable to Digital Videocommunication Systems (DVS), Projects and Electronic Manufacturing Technology. Latin America and Europe contributed the larger part of the increase. The decrease in the Asia Pacific region is related to the completion of the Telstra project in Australia, which more than offset the significant increase in Asia as a whole. Sales in North America were virtually flat. Income from operations was a loss in 1998 compared with a profit in 1997. The loss primarily arose due to the write-off of in-process R&D of NLG 44 million related to the acquisition of AIS-USA and to charges for the restructuring of DVS/BTS-USA and FEI-USA. Positive income developments arose in Electronic Manufacturing Technology, Fax equipment and DVS-Digital Receivers. In 1997, sales growth was 16% on a comparable basis as adjusted for consolidation changes (7% negative) and currency changes (10% positive), thus outpacing the market in a number of businesses. Income from operations saw a major turnaround to a profit in 1997, from a significant loss in 1996. This reflects the benefits of restructuring processes, volume increases and tight cost control in the businesses. ORIGIN Origin's 1998 sales increased to NLG 2.3 billion from NLG 1.9 billion in 1997, a nominal increase of 25%. Exchange rate differences had a positive effect of 1%, resulting in comparable sales growth of 24%. This was primarily due to Enterprise Solutions and partly to Millennium-related services. Sales growth was mainly achieved in Europe, particularly in the Netherlands, the United Kingdom, Germany and France. Income from operations rose to NLG 130 million, or 3.6% of segment revenues, which reflected a major turnaround from last year's break-even situation. This was primarily attributable to the strong sales growth and the focus on improving operational efficiency throughout the organization. ORIGIN in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 0.5 0.6 1.0 1.0 1.3 sales (excluding intersegment sales) 0.2 0.3 1.4 1.9 2.3
49 21 ORIGIN income/(loss) from operations in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 0.04 0.03 (0.16) 0.00 0.13
Sales in 1997 were NLG 1.9 billion, an increase of 30% in nominal terms. Excluding favorable currency effects (9%), the growth was 21% on a comparable basis following the start-up year of 1996. Income from operations was zero in 1997 compared to a substantial loss of NLG 160 million in 1996, which included restructuring charges of NLG 96 million mainly relating to the merger of Philips C&P with BSO/Origin. Origin's loss-making screenphone business was discontinued in 1997 and the related costs were recorded as an extraordinary loss. MISCELLANEOUS The businesses grouped in this sector recorded sales of NLG 2.0 billion in 1998, which was 45% below the NLG 3.7 billion sales in the preceding year. Changes in consolidation -- principally Philips Car Systems -- resulted in a decrease of 46%. On a comparable basis, sales growth was 6%, which was predominantly caused by growth in Philips Machinefabrieken and PMF, offsetting decreases in various other activities. Income from operations fell to a loss of NLG 102 million, or 4.1% of segment revenues, from a profit of NLG 30 million, or 0.6% of segment revenues, in 1997. This was primarily due to the fact that activities divested in previous years, such as Philips Car Systems and some Communication Systems activities, no longer contributed to income in 1998. In addition, certain activities experienced lower profitability, principally Machinefabrieken (as a result of the downturn in the semiconductor industry) and Hearing Instruments. Philips' Plastics and Metalware Factories on the other hand maintained income performance at 1997's level. Research activities increased in 1998. A reduction in operating losses occurred as a result of a higher activity level of internal contract research and lower organization costs due to lower staffing levels. MISCELLANEOUS in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- intersegment sales 1.9 2.2 1.3 0.9 0.5 sales (excluding intersegment sales) 9.3 9.7 7.8 3.7 2.0
Sales in 1997 amounted to NLG 3.7 billion, down 52% from the year-earlier sales of NLG 7.8 billion. This was substantially due to consolidation changes, including Grundig and Philips Media (both divested), ASM Lithography (deconsolidated March 31, 1996) and the former Communication Systems and Superclub activities (both phased out). Disregarding the consolidation changes (negative impact 67%) and currency influences (8%), sales growth on a comparable basis was 6%, attributable to a 10% volume increase that was partly offset by more than 4% lower prices. 50 22 MISCELLANEOUS income/(loss) from operations in billions of guilders
1994 1995 1996 1997 1998 ------ ------ ------ ----- ------ (0.68) (0.52) (0.72) 0.03 (0.10)
Income from operations in 1997 totaled NLG 30 million, or 0.6% of segment revenues, compared to a loss of NLG 722 million, or 8.0% of segment revenues, in 1996. The turnaround was largely attributable to the divestiture and phasing-out of various unprofitable businesses such as Grundig, Philips Media and Superclub. RESEARCH AND DEVELOPMENT Management believes that continuous efforts to sustain the strong performance in the field of R&D are of the utmost importance to Philips in order to preserve and strengthen the competitive position the Company now holds in its various markets. Through substantial investments in R&D, Philips has created a huge knowledge base. Each year, new technological breakthroughs are added to Philips' long list of research successes. Recent advances applied in consumer products include Natural Motion, a system that eliminates judder from television and film pictures and is applied in high-end TV sets and video-conferencing systems, and Incredible Surround sound and UltraBass, two innovations in digital signal processing that have enhanced the perception of sound. Our speech recognition technology is to be found in a growing number of products in both the business and consumer sectors. R&D spending in 1998 was NLG 4,513 million, compared to NLG 4,057 million in 1997 and NLG 4,050 million in 1996. R&D spending in 1998 equates to 6.7% of Group sales (or 7.0% of sales excluding Origin, which does not engage in R&D) compared with 6.2% in 1997 and 6.8% in 1996. Expenditures on R&D are included in direct cost of sales and reported in the Miscellaneous product sector. RESEARCH AND DEVELOPMENT expenditures as a % of sales
1994 1995 1996 1997 1998 ----- ----- ----- ----- ----- 7.1 6.9 6.8 6.2 6.7
INTELLECTUAL PROPERTY MANAGEMENT An indicator of Philips' innovative activity is its significant portfolio of intellectual property rights, a key asset that is managed to enhance the competitive position of the various Philips businesses. In a business environment that is becoming increasingly knowledge-driven, it is Philips' policy to protect and develop its intellectual property. Corporate Patents and Trademarks is responsible for the creation of a balanced portfolio that will give Philips maximum freedom in its commercial activities. It also provides support in respect of standard-setting and license revenues. The control of the size and composition of the Philips patent portfolio is proactive and intended to meet the needs of the various businesses. 51 23 In 1998, Philips filed 1,300 new patent applications and more than 1,000 worldwide patent families based on new patent filings made in 1997. In today's marketplace, branding has become a crucial issue. Corporate Patents and Trademarks ensures that Philips is able to conduct commercial activities in all relevant countries under the Philips brand name and certain trademarks selected for individual products. COOPERATIVE BUSINESS ACTIVITIES AND UNCONSOLIDATED COMPANIES Since its founding, Philips has engaged from time to time in cooperative activities with other organizations. Philips' principal cooperative business activities and participations, and the main changes therein, are set out below. Taiwan Semiconductor Manufacturing Company Limited (TSMC) is a semiconductor foundry operation in which Philips has 27.6% ownership. During 1998, Philips' interest was reduced by 0.6% due to dilution arising from incentive plans for TSMC management. Nevertheless, Philips remains the largest shareholder in TSMC. The global slump in the semiconductor business as well as the Asian crisis significantly affected TSMC's income performance in 1998, which fell by approximately 15%. Philips, TSMC and EDB Investments have announced a new joint venture which plans to build a new USD 1.2 billion wafer fab plant in Singapore. Construction will start in 1999, and production is planned to start in 2000. Philips expects to have a 48% interest in this joint venture once it is formed and will be entitled to use 60% of production capacity. ASM Lithography Holding N.V. (ASML), based in the Netherlands and ranking second in the world lithography market, develops, manufactures and markets waferstepper equipment for the semiconductor industry. As part of a long-standing relationship, Philips Research and Philips' Center for Manufacturing Technology perform contract work for ASML. Philips has agreed not to sell its 23.9% shareholding until after March 2000. Philips' share in 1998 income of ASML was affected by adverse developments in the semiconductor industry resulting in a drastic cut in investment levels in new equipment. In the People's Republic of China, Philips currently has some 20 operational business alliances that engage in manufacturing and marketing activities. Generally, these companies are not wholly owned; most of them are consolidated and some are reported as unconsolidated companies. The total investments in China have exceeded USD 1 billion, and with approximately 17,000 employees in China and more than 5,000 in Hong Kong, Philips is one of the larger private employers in the region. Philips is active in a wide range of activities, but has particularly strengthened its position in consumer electronics, cellular phones and components, maintaining strong positions in shavers, CD, energy-saving lamps and semiconductors. All product divisions in China are profitable, and posted considerable sales growth in 1998. Navigation Technologies Corporation (NavTech) of the USA is engaged in the development of software databases for digital maps to be used 52 24 for car navigation purposes. In 1999, Philips has found a new business partner and sold part of its shares in NavTech: this is of considerable importance to the future development of NavTech. As a consequence, Philips' interest in NavTech has been reduced to a minority shareholding. CASH FLOWS The dominant factor in this year's cash flow is the sale of Philips' 75% shareholding in PolyGram to The Seagram Company of Canada, which produced NLG 11.3 billion net cash proceeds. The total compensation from the sale of PolyGram was NLG 14.4 billion, of which NLG 3.1 billion in Seagram shares. The 1998 cash flow before financing activities was NLG 1,540 million, compared with NLG 7,173 million in 1997 and a cash outflow of NLG 2,038 million in 1996. Our objective of achieving a 'free' cash flow (cash flow minus the net proceeds from the sale and purchase of business interests and non-current financial assets) of more than NLG 1 billion was again achieved in 1998, when it totaled NLG 1,642 million. This compares to NLG 3,984 million in 1997 and a cash outflow of NLG 2,453 million in 1996. CASH FLOW in billions of guilders
1996 1997 1998 ---- ---- ---- net cash provided by operating activities 2.0 7.1 4.7 purchase/proceeds businesses and financial assets 0.4 3.2 (0.1) net investments property, plant and equipment (4.4) (3.1) (3.1) cash flows before financing activities (2.0) 7.2 1.5
The cash flow from operating activities totaled NLG 4,715 million, which is significantly less than last year's NLG 7,073 million (NLG 2,008 million in 1996). The primary causes of this reduction were the decline in income from operations and a decrease in cash generated by working capital to NLG 0.6 billion, compared to NLG 1.1 billion in 1997. The lower increase in accounts payable compared with last year was the main factor, with an additional effect of a higher increase in receivables. The reduced investment in inventories had an offsetting effect on total cash flow from working capital compared to 1997. Expressed as a percentage of sales, inventories fell to an all-time low of 14.0% in 1998, compared to 15.2% at year-end 1997 and 16.0% at the end of 1996. On a comparable basis, excluding currency effects and consolidation changes, the ratios are 14.8%, 15.3% and 16.7%, respectively. Outstanding trade receivables at the end of 1998 were the equivalent of 1.3 months' sales and remained unchanged from 1997 and 1996, respectively. Investing activities required a net cash flow of NLG 3.2 billion, compared to a cash inflow of NLG 0.1 billion in 1997 and a cash requirement of NLG 4.0 billion in 1996. Capital expenditures of NLG 3.6 billion were level with the amount of NLG 3.6 billion in 1997, but substantially below the NLG 4.8 billion in 1996. Cash required for the purchase of and investment in businesses amounted to NLG 1.9 billion. The acquisition of ATL Ultrasound and Active Impulse Systems required NLG 1.7 billion, and the additional debt funding of NavTech amounted to 53 25 INVENTORIES as a % of sales
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 18.2 20.1 16.0 15.2 14.0
NLG 0.2 billion. The sale of Philips Car Systems produced cash revenues of NLG 1.1 billion. By comparison, the sale and acquisition of business interests in 1997 produced net cash totaling NLG 3.0 billion, which included the sale of a 5.4% shareholding in TSMC, an 11.5% shareholding in ASM Lithography, a 50% shareholding in United & Philips Communications, the Smart Card activities, a 25% shareholding in Bang & Olufsen and various Philips Media activities. Acquisitions included a 50% shareholding in HAPD Japan, an additional shareholding in Origin and debt funding of NavTech. The net cash proceeds of NLG 0.3 billion in 1996 comprised the sale of ASML shares, parts of PKI Germany and TRT France, versus investments made in shares in La Radiotechnique and BSO/ Origin. The cash flow before financing activities of NLG 1.5 billion was used to repay interest-bearing debt totaling NLG 1.0 billion and for the payment of dividends in 1998 amounting to NLG 719 million. Furthermore, NLG 345 million net cash was used for treasury stock transactions. In 1997, the larger part of the net cash inflow of NLG 7.2 billion was used to repay interest-bearing debt totaling NLG 5.0 billion, while the dividend payment in 1997 amounted to NLG 557 million. Additionally, NLG 251 million net cash was used for treasury stock transactions. In 1996, the net cash outflow of NLG 2.0 billion required NLG 2.2 billion additional borrowings. OUTSTANDING TRADE RECEIVABLES in months' sales
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 1.5 1.5 1.3 1.3 1.3
FINANCING Total debt was NLG 7.9 billion at December 31, 1998, compared with NLG 8.9 billion at the end of 1997 and NLG 12.9 billion at the end of 1996. Following the sale of PolyGram, the Company had a net cash surplus at December 31, 1998, with cash exceeding total debt by NLG 6.5 billion. The net debt at the end of 1997 amounted to NLG 5.8 billion and NLG 11.2 billion the year before. CAPITAL EXPENDITURES:DEPRECIATION
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 1.2 1.7 1.5 1.1 1.0
54 26 The current net cash situation renders the net debt to group equity ratio meaningless. That ratio was 22:78 at the end of 1997 and 43:57 at the end of 1996. In 1998 long-term debt was reduced by NLG 1.0 billion, from NLG 7.1 billion to NLG 6.1 billion. The reduction was the result of net repayments totaling NLG 0.8 billion and currency and consolidation effects of NLG 0.2 billion. Philips has two 'putable' bonds outstanding for a total amount of NLG 548 million for which the investor may require prepayment at one specific month during the lifetime of the respective bonds. If we assume that investors require repayment at the relevant put dates, the average term of long-term debt was 6.4 years compared to 7.0 years in 1997. However, assuming that the 'putable' bonds will be repaid at final maturity dates, the average term at the end of 1998 was 8.3 years. Long-term debt in proportion to the total debt at the end of 1998 was 78% compared to 80% at the end of 1997. Short-term debt stood at NLG 1.8 billion at December 31, 1998, which was virtually unchanged from 1997 as a result of net repayments totaling NLG 0.2 billion offset by currency and consolidation effects of NLG 0.2 billion. The cash position increased substantially in 1998 by NLG 11.3 billion from NLG 3.1 billion at the end of 1997 to NLG 14.4 billion at the end of 1998. This increase was the result of net cash receipts of NLG 11.3 billion and currency and consolidation effects of virtually nil. At the end of 1998, the Group had long-term committed and undrawn credit lines available to the value of USD 2.5 billion, unchanged from a year earlier. The USD 2.5 billion committed credit line is a multi-currency revolving standby facility, which was signed in July 1996 and matures in July 2003. Stockholders' equity rose to NLG 31.3 billion in 1998, up from NLG 19.5 billion at the end of 1997. The NLG 11.9 billion increase was largely due to 1998 net income of NLG 13.3 billion. Of the net income, an amount of NLG 794 million has been provisionally appropriated for a proposed distribution as a dividend to shareholders of NLG 2.20 per common share, subject to the approval of the Annual General Meeting of Shareholders. The number of outstanding common shares of Koninklijke Philips Electronics N.V. ('Royal Philips Electronics') increased by 3.7 million to 368.5 million. This increase was the result of the exercise of the Superclub warrants and of convertible personnel debentures. As part of the financial restructuring of Superclub in 1992, warrants for common shares of Royal Philips Electronics were issued. These warrants expired in June 1998. During 1998, 3,636,861 warrants INCOME FROM CONTINUING OPERATIONS as a % of stockholders' equity (ROE)
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 12.6 16.1 1.9 16.1 5.2
55 27 ASSETS in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- current assets 21.7 24.0 23.1 25.1 35.8 non-current assets 20.4 22.2 25.2 26.3 26.2
were exercised at the exercise price of NLG 34 per common share, which resulted in an increase of stockholders' equity by NLG 123 million. Currency effects had an unfavorable effect of NLG 421 million on stockholders' equity. At year-end 1998 the Group held 7.8 million shares in treasury as a hedge against 7.2 million rights overhang at the end of 1998. At year-end 1997 the number of shares in treasury was equal to 6.8 million shares, while the overhang was equal to 12.2 million rights. The overhang at the end of 1997 included the above-mentioned warrants. Additionally, a number of shares were purchased as a partial hedge against the future issuance of such rights. On December 17, 1998, Royal Philips Electronics revealed that its previously announced share reduction of 8% would be implemented by reducing the share capital, resulting in a total cash distribution of approximately NLG 3.3 billion to all shareholders and a subsequent reduction of the number of outstanding common shares by 8%. This share reduction program will be combined with the redenomination of the share capital into the euro. EQUITY AND LIABILITIES in billions of guilders
1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- current liabilities 12.3 13.0 13.3 14.6 15.7 provisions 7.9 7.6 7.5 7.2 6.6 total debt 8.5 10.5 12.9 8.9 7.9 group equity 13.4 15.1 14.6 20.7 31.8
Consequently, Philips will propose at its General Meeting of Shareholders the conversion of part of its surplus paid-in capital into nominal share capital, the reduction of the adjusted nominal share capital by distributing a cash amount of NLG 9.07 per common share to all Philips' shareholders, which amount equaled 8% of the December 17, 1998, closing price of NLG 113.40 in Amsterdam and the exchange of all presently existing 100 common shares into 92 shares, each of which will have a par value of 1 euro. A detailed proposal will be sent to shareholders in connection with the General Meeting of Shareholders to be held on March 25, 1999, together with an explanation of the series of steps and resolutions required under Dutch civil and tax law. Upon adoption, consummation is expected in mid-1999 following completion of the required legal procedures and formalities. 5-YEAR RELATIVE PERFORMANCE: PHILIPS AND AEX base 100 = January 3, 1994
DATE PHILIPS AEX DATE PHILIPS AEX DATE PHILIPS AEX - ---- ------- --- ---- ------- --- ---- ------- --- 03-Jan-94 100.000 100.000 21-Aug-95 184.746 110.243 07-Apr-97 212.349 173.083 10-Jan-94 104.843 100.963 28-Aug-95 177.966 109.763 14-Apr-97 208.717 170.376 17-Jan-94 106.538 100.609 04-Sep-95 182.082 110.460 21-Apr-97 219.855 177.206 24-Jan-94 114.044 102.231 11-Sep-95 187.409 111.190 28-Apr-97 239.467 178.357 31-Jan-94 118.644 104.363 18-Sep-95 185.714 111.752 05-May-97 259.080 185.449 07-Feb-94 113.075 101.917 25-Sep-95 188.378 110.650 12-May-97 257.143 187.473 14-Feb-94 113.801 102.001 02-Oct-95 186.925 110.645 26-May-97 264.165 193.208 21-Feb-94 113.317 101.227 09-Oct-95 173.123 109.061 02-Jun-97 266.344 192.088 28-Feb-94 114.528 100.090 16-Oct-95 172.397 109.225 09-Jun-97 284.019 197.286 07-Mar-94 127.361 101.044 23-Oct-95 162.470 106.851 16-Jun-97 292.978 202.200 14-Mar-94 130.024 100.840 30-Oct-95 145.763 106.556 23-Jun-97 327.119 204.786 21-Mar-94 131.961 99.018 06-Nov-95 144.068 107.838 30-Jun-97 340.436 204.950 28-Mar-94 130.024 97.754 13-Nov-95 148.184 108.811 07-Jul-97 352.785 218.581 04-Apr-94 123.729 96.070 20-Nov-95 139.952 110.262 14-Jul-97 360.291 225.556 11-Apr-94 133.414 100.557 27-Nov-95 147.700 113.143 21-Jul-97 358.354 221.552 18-Apr-94 138.015 100.252 04-Dec-95 147.942 113.681 28-Jul-97 408.717 236.194 25-Apr-94 130.751 98.713 11-Dec-95 148.184 114.011 04-Aug-97 400.000 232.973 02-May-94 134.140 98.418 18-Dec-95 139.952 112.817 11-Aug-97 400.242 231.479 09-May-94 125.666 96.589 25-Dec-95 142.857 114.547 18-Aug-97 366.344 218.255 16-May-94 130.993 98.247 01-Jan-96 140.436 115.458 25-Aug-97 366.344 219.376 23-May-94 129.056 98.192 08-Jan-96 155.206 119.802 01-Sep-97 360.291 209.796 30-May-94 123.729 95.730 15-Jan-96 150.847 119.364 08-Sep-97 374.576 215.334 06-Jun-94 128.329 96.903 22-Jan-96 154.964 120.948 15-Sep-97 358.354 206.842 13-Jun-94 126.877 95.556 29-Jan-96 160.533 120.277 22-Sep-97 371.186 216.581 20-Jun-94 120.581 91.072 05-Feb-96 162.228 118.555 29-Sep-97 387.167 215.275 27-Jun-94 118.886 89.707 12-Feb-96 161.017 119.787 06-Oct-97 415.981 228.801 04-Jul-94 124.697 92.300 19-Feb-96 159.322 119.595 13-Oct-97 398.305 223.189 11-Jul-94 122.518 92.119 26-Feb-96 166.344 120.670 20-Oct-97 393.462 215.850 18-Jul-94 121.792 93.634 04-Mar-96 164.649 123.475 27-Oct-97 369.249 204.858 25-Jul-94 128.571 95.927 11-Mar-96 157.143 120.772 03-Nov-97 374.092 209.998 01-Aug-94 134.625 98.042 18-Mar-96 161.501 124.847 10-Nov-97 361.501 203.878 08-Aug-94 136.562 100.236 25-Mar-96 142.857 125.480 17-Nov-97 332.203 208.633 15-Aug-94 140.194 98.765 01-Apr-96 143.341 127.811 01-Dec-97 338.015 216.497 22-Aug-94 137.530 97.374 08-Apr-96 142.857 127.728 08-Dec-97 330.751 220.394 29-Aug-94 142.615 101.006 15-Apr-96 145.763 130.599 15-Dec-97 269.976 211.428 05-Sep-94 140.436 99.429 22-Apr-96 148.426 131.391 22-Dec-97 289.104 210.486 12-Sep-94 138.257 97.964 29-Apr-96 146.489 131.931 29-Dec-97 296.126 216.053 19-Sep-94 134.140 96.841 06-May-96 149.153 133.173 05-Jan-98 316.707 223.401 26-Sep-94 130.751 95.266 13-May-96 145.521 132.186 12-Jan-98 276.029 212.182 03-Oct-94 127.361 94.864 20-May-96 147.458 132.783 19-Jan-98 307.264 225.958 10-Oct-94 128.814 94.888 27-May-96 147.700 134.234 26-Jan-98 311.138 223.008 17-Oct-94 134.625 97.162 03-Jun-96 144.794 135.405 02-Feb-98 339.225 229.610 24-Oct-94 127.845 95.471 10-Jun-96 145.521 135.669 09-Feb-98 328.087 231.694 31-Oct-94 135.109 98.156 17-Jun-96 142.373 133.471 16-Feb-98 357.385 234.517 07-Nov-94 130.993 97.191 24-Jun-96 131.235 131.905 23-Feb-98 379.903 246.849 14-Nov-94 128.814 97.276 01-Jul-96 134.867 133.223 02-Mar-98 389.346 259.226 21-Nov-94 128.329 97.816 08-Jul-96 132.446 131.896 09-Mar-98 376.755 261.451 28-Nov-94 127.119 97.162 15-Jul-96 123.002 128.277 16-Mar-98 370.944 265.678 05-Dec-94 130.266 98.330 22-Jul-96 120.339 125.037 23-Mar-98 358.596 267.122 12-Dec-94 122.276 96.222 29-Jul-96 123.002 125.109 06-Apr-98 368.039 282.021 19-Dec-94 125.424 97.735 05-Aug-96 132.688 130.866 20-Apr-98 384.504 281.041 26-Dec-94 126.392 98.580 12-Aug-96 132.203 130.530 11-May-98 484.988 281.264 02-Jan-95 125.908 99.244 19-Aug-96 135.109 133.418 18-May-98 478.692 273.942 09-Jan-95 127.119 98.620 26-Aug-96 135.835 132.310 25-May-98 477.240 290.178 16-Jan-95 131.961 98.813 02-Sep-96 136.077 132.022 08-Jun-98 456.416 288.610 23-Jan-95 128.814 96.356 09-Sep-96 134.625 133.606 15-Jun-98 410.412 274.679 30-Jan-95 130.508 97.973 16-Sep-96 134.867 135.160 22-Jun-98 411.864 272.203 06-Feb-95 132.688 98.347 23-Sep-96 144.552 133.613 06-Jul-98 434.625 295.390 13-Feb-95 135.835 98.663 30-Sep-96 149.637 137.251 20-Jul-98 432.446 312.970 20-Feb-95 136.804 97.540 07-Oct-96 150.605 139.748 27-Jul-98 387.893 298.190 27-Feb-95 130.751 97.393 14-Oct-96 151.332 140.093 03-Aug-98 392.736 285.596 06-Mar-95 130.508 95.659 21-Oct-96 143.584 140.931 10-Aug-98 390.073 277.765 13-Mar-95 129.782 93.568 28-Oct-96 148.426 140.626 17-Aug-98 376.755 271.913 20-Mar-95 128.571 93.934 04-Nov-96 146.005 138.288 24-Aug-98 361.743 270.314 27-Mar-95 125.182 93.546 11-Nov-96 147.458 142.042 31-Aug-98 314.286 258.494 03-Apr-95 127.119 93.794 18-Nov-96 151.090 145.120 07-Sep-98 295.400 256.017 10-Apr-95 127.361 96.172 25-Nov-96 159.564 148.267 14-Sep-98 282.809 245.893 17-Apr-95 131.961 96.722 02-Dec-96 166.828 149.211 21-Sep-98 198.547 214.720 24-Apr-95 135.593 97.202 09-Dec-96 167.312 148.417 28-Sep-98 244.552 230.604 01-May-95 145.521 100.012 16-Dec-96 164.891 146.566 05-Oct-98 213.317 197.281 08-May-95 147.942 100.864 23-Dec-96 169.007 151.065 12-Oct-98 234.867 214.014 15-May-95 148.426 102.181 30-Dec-96 169.492 154.207 19-Oct-98 254.237 223.955 22-May-95 151.332 101.251 06-Jan-97 169.249 155.301 26-Oct-98 242.131 229.645 29-May-95 152.058 101.434 13-Jan-97 178.692 155.282 02-Nov-98 262.470 245.165 05-Jun-95 152.300 103.028 20-Jan-97 184.746 160.247 16-Nov-98 287.651 251.883 12-Jun-95 153.269 102.762 27-Jan-97 180.872 162.352 20-Nov-98 325.424 264.013 19-Jun-95 157.627 103.109 03-Feb-97 182.567 160.518 27-Nov-98 307.022 270.143 26-Jun-95 160.291 103.958 10-Feb-97 180.872 165.340 04-Dec-98 307.022 254.031 03-Jul-95 161.017 103.387 17-Feb-97 192.252 174.130 11-Dec-98 297.579 254.821 10-Jul-95 191.041 108.440 24-Feb-97 198.789 174.492 18-Dec-98 294.189 265.923 17-Jul-95 197.094 109.404 03-Mar-97 207.506 175.146 25-Dec-98 306.780 280.372 24-Jul-95 196.368 109.473 10-Mar-97 214.770 183.162 01-Jan-99 305.085 282.223 31-Jul-95 184.746 108.983 17-Mar-97 205.811 179.223 08-Jan-99 346.831 293.187 07-Aug-95 181.840 109.154 24-Mar-97 195.400 170.141 15-Jan-99 323.353 277.093 14-Aug-95 187.167 108.947
56 28 SELECTED PRO FORMA CONSOLIDATED FIGURES FOR 1998 AFTER SHARE REDUCTION in millions of Dutch guilders Cash and cash equivalents 11,099 Current assets (excl. cash) 21,411 Non-current assets 26,189 ------ TOTAL 58,699 Current liabilities 19,626 Non-current liabilities 10,590 Other group equity 533 Stockholders' equity: Share capital (issued 339 million shares, par value 1 euro) 747 Share premium 3,615 Other reserves 23,588 ------ TOTAL 58,699
NEW ACCOUNTING STANDARD On June 15, 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). In compliance with this guideline, Philips will apply FAS 133 in the year starting January 1, 2000. This Statement requires that all derivative instruments are recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction. Philips is currently evaluating the full effects that the adoption of FAS 133 will have on results of operations and its financial position. QUANTITATIVE AND QUALITATIVE DISCLOSURES CONCERNING MARKET RISKS FINANCIAL RISK MANAGEMENT The Company is exposed to market risks, including the risk of changes in foreign exchange rates, interest rates and certain commodity prices. To manage these risks, the Company enters into various hedging transactions that have been authorized pursuant to its policies and procedures. The Company does not purchase or hold derivative financial instruments for trading purposes. The analysis below presents the sensitivity of the fair value of the Company's financial instruments and of earnings to certain hypothetical changes in foreign exchange rates and interest rates. Financial instruments consist of derivative financial instruments, derivative commodity instruments and other financial instruments. The value of commodity hedges is not material. The following overview of the Group's risk management activities contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those projected. FOREIGN CURRENCIES The Company's exposure to foreign exchange rates outside the euro block currencies relates principally to the US dollar. The local currency is used by most subsidiaries 57 29 as the functional currency to prepare their financial information. Exceptions are made for highly inflationary countries where the functional currency differs from the local currency. With regard to currency risks, it is the Company's policy to cover transaction exposures, including certain anticipated transaction exposures. For this purpose, the Company enters into forward foreign exchange and option contracts. Virtually all of these contracts will expire in 1999. Financing of subsidiaries is mostly done in the functional currency of the borrowing entity. Exceptions are made in the case of those subsidiaries for which a significant part of the business is done in a currency other than the functional currency or when required by law. For these entities, financing takes place in the main business currency, providing a natural offset against potential exposures in the business. If the financing currency is neither the functional currency nor the main currency of the business, the Company's exposure to foreign exchange rates is hedged against the functional currency where this is not restricted for regulatory reasons. The value of the Group's financial instruments is affected by changes in foreign currencies. An instantaneous 10% strengthening or weakening of the non-euro block currencies versus the euro block currencies from their levels at December 31, 1998, with all other variables held constant, would result in an estimated net change in the value of the Company's financial instruments of NLG 105 million. A substantial proportion of the exposures relates to derivative instruments which are meant to offset foreign exchange exposures in the business. Therefore earnings effects of these hedges will be offset over time by changes in the value of hedged business assets or liabilities. Furthermore, part of the financial instruments are held in the functional currency. INTEREST RATES At year-end 1998 the Company had a ratio of fixed-rate debt to outstanding debt of approximately 68%, compared to 66% one year earlier. A sensitivity analysis shows the following results. If the long-term interest rates were instantaneously to decrease by 1% from their level of December 31, 1998, with all other variables (including foreign exchange rates) held constant, the fair market value of the long-term debt would increase by NLG 210 million. This increase is based on the assumption that the 'putable' bonds will be repaid at their final maturity date. This assumption was made since the current long-term interest rates are clearly below the coupon rates of these bonds, which makes it unlikely that investors will require prepayment of these bonds on their respective put dates. If the short-term interest rates were instantaneously to decrease by 1% from their level of December 31, 1998, with all other variables (including foreign exchange rates) held constant, the annualized interest income on the net cash position would decrease by NLG 115 million. COMMODITIES The Company is a purchaser of certain base metals such as palladium, aluminum, copper, lead, nickel and zinc. The Company covers a limited part of the commodity price risk exposures by entering into 58 30 hedge transactions such as forward purchasing agreements. Almost all agreements outstanding at December 31, 1998, will expire in 1999. The hedge transactions outstanding as of December 31, 1998, are not material. EURO Philips started its preparations for the new European single currency at the end of 1994. The Board of Management established the Philips Euro Project Steering Committee, comprising representatives of the product divisions, European country organizations and corporate functions. At the beginning of 1997 a full-time Euro Project Director was appointed, who reports directly to the Chief Financial Officer. He chairs the Steering Committee and coordinates some 35 different working groups dealing with the preparations for the introduction of the euro within the Company. Philips is convinced that the European single currency will improve Europe's competitive position. The disappearance of currency fluctuations within this massive market could have a positive impact in terms of attracting inward investment. In spite of the increased competition to be expected as a result of the greater transparency of the market, Philips stands to gain from the introduction of a single European currency in the long term. The introduction of the euro will have an impact on the Company's business strategies: price transparency will increase and companies will compete in a much broader market, facilitated by new developments such as the Internet and e-commerce. Furthermore there will be a growing convergence in various labor-related fields. All of Philips' business managers have completed a business impact analysis to assess and quantify the business implications of the euro for each customer, product, country, currency, etc. At the start of the Economic and Monetary Union on January 1, 1999, Philips introduced the euro as its reporting currency. When the participating member states became known and the internal conversion rates were provisionally fixed in May 1998, the Company decided to discontinue hedging contracts only involving EMU currencies. Intercompany transactions, previously expressed in EMU currencies, will be converted into euros. The consolidated quarterly figures and annual report for 1999 will be published in euros, and the share price was converted into the new currency when most European stock exchanges made the transition on January 4, 1999. Under the proposals which will be submitted to the Annual General Meeting of Shareholders to amend the Company's Articles of Association, the new nominal value of a common share will be 1 euro. Regarding the technical preparations for the euro, Philips has defined a set of minimum requirements to be met. In order to be able to cope with these technical requirements, Philips had to adapt thousands of computer systems and applications. Because this was often combined with other IT projects, it is difficult to identify the cost associated with this project. The euro project is not Philips' largest IT project, but it still accounts for a substantial part of the total IT cost. 59 31 During the summer of 1998, Philips informed its customers and suppliers of its plans. No prohibition/no compulsion during the transition period means that no one can be forced to use the euro instead of EMU currencies. Philips is offering its customers the possibility of being invoiced in euros as and when required. Philips' suppliers have been requested to start invoicing the Company in euros as of January 1, 1999. MILLENNIUM The Millennium issue refers to business continuity risks in Philips' integral national and international business chains, including the supply base and customer base, caused by systems, products and equipment with date-sensitive components that may fail to recognize the year 2000. The Millennium program is coordinated and supervised on behalf of the Board of Management by the Corporate Millennium Office, which reports directly to the Chief Financial Officer. STATE OF READINESS Philips' Millennium program has been designed and developed from the business perspective, integrating progressively the internal and external risk factors in the integral business chains, which operate in many different national and regional environments. The program identifies seven interrelated Millennium impact areas: customer base; supply base; IT applications; IT infrastructure; facilities and services; corporate core processes; and countries and regions. The program prescribes a standard procedure comprising the following phases: 1. business impact analysis; 2. strategy definition and action planning; 3. execution (including remediation, testing and, where applicable, contingencies). All sectors and groups in the Company tailor the program as appropriate for the seven impact areas. Dedicated staff, supported by external solution and service providers, are active in all these sectors and groups worldwide. COSTS The Millennium program fits into Philips' ongoing effort to improve its IT structure and its business processes. A substantial part of the Millennium costs relates to the replacement and upgrading of systems, which will be beneficial to the future operations of the Company. The cost of addressing the Millennium issue is expected to total approximately NLG 600 million, of which NLG 350 million has already been expensed. The remaining costs will be expensed as incurred. A major portion of the total cost is associated with the modification and testing of software, the hiring of external solution providers, the accelerated implementation of new systems, and the replacement of non-compliant systems. RISKS Internal and external risk factors have been identified, relating to all Millennium impact areas and the relationships between them. The Company views the likelihood of disruption of business continuity as a result of internal risk factors as relatively small. However, due to the risks inherent in a number of external year 2000 issues, over which the Company has no control or for which no precedents exist, the Company is unable to determine at this time the likelihood of a material impact on the Company's performance. 60 32 Although Philips has taken what it believes to be reasonable, prudent measures to mitigate these risks through the implementation of the program, it can give no assurances that such measures will be sufficient to prevent a materially adverse impact on its operations, liquidity and financial condition. The Company expects that the program's progression will result in reduced uncertainty relating to the Company's year 2000 compliance and a reduced likelihood of interruptions to its operations. CONTINGENCIES The contingency policy considers internal and external risk factors, with the latter having clear priority. Based upon continuous information-gathering and qualitative analyses, contingency alternatives are being studied and developed, primarily for local risks in utility supply, banking, communication, transport and customs services. Philips' businesses are working to coordinate their respective contingency plans with key suppliers and customers and are specifically considering elements such as logistics, activity scheduling, maintenance and overhaul scheduling, and staff and holiday planning. The Company anticipates having contingency plans to minimize the external risks in place by the third quarter of 1999. More detailed information is given on pages 135 to 139. CORPORATE GOVERNANCE The Company has consistently improved its corporate governance over the past decade by increasing transparency and accountability to its shareholders through simplification of the corporate structure, by improving the supervision of the Company's policies and activities, and by adopting recommendations on best practices. The Supervisory Board has an Audit Committee, a Remuneration Committee and a Nomination and Selection Committee. It has adopted Rules of Procedure to consolidate its own governance rules. The profile for the Supervisory Board's composition and additional data on the individual members are given on page 68. A proposal will be submitted to the General Meeting of Shareholders to be held on March 25, 1999, to simplify the Company's Articles of Association. The suggested simplification follows the Company's policy of continuously improving its corporate governance, this time by making the Articles of Association more transparent and easier to read. The internal organization of the Philips Group has also been greatly improved by the further implementation of the Governance Model introduced in 1997. Last year, bottom-line accountability was increased, business controls at both Business Unit and Product Division levels were tightened, regional management was strengthened, and the role of country organizations was streamlined. In line with international business developments, the Company will continue to strengthen entrepreneurship and its commitment to corporate profit targets. An incentive stock option scheme for senior managers, introduced in the late 1980s and since refined, focuses management and staff continuously on the performance of the Group and, through specific targets, on the performance of its constituent business units and divisions. This scheme has proven to be an indispensable 61 33 instrument in the highly competitive global market for management. BUSINESS CONTROLS The Philips Policy on Business Controls is communicated to all levels of management. Key elements are: setting clear policies; setting clear directives; delegating tasks and responsibilities clearly; carrying out supervision; taking corrective action; and maintaining an adequate accounting system including an internal control system (internal accounting controls). The Company's internal control structure follows current thinking and practice in integrating management control over company operations, compliance with legal requirements and the reliability of financial reporting. It makes management responsible for implementing and maintaining effective business controls, including internal financial controls. The effectiveness of these controls is monitored by self-assessment, and accountability is enforced through the formal issuance of a Statement on Business Controls by each Business Unit, resulting, via a cascade process, in a statement at Product Division level. Audit Committees at Product Division level ensure adherence to the policy and take corrective action where necessary. They are also involved in determining the desired audit coverage. The entire process is reviewed on a regular basis by Corporate Internal Audit. Reports on the functioning of the process are sent to the Board of Management and the Audit Committee of the Supervisory Board. COMMUNICATION WITH SHAREHOLDERS Philips is continuously striving to improve relations with its shareholders. In line with the Anglo-American model, the Company has joined together with several other major Dutch companies, banks and the Amsterdam Exchanges to enable proxy solicitation in the Netherlands. A Shareholders' Communication Channel will be operational before the Annual General Meeting of Shareholders in 1999. However, proxy solicitation will not yet be possible at that time as it first requires an amendment to Dutch law. It is expected that proxy solicitation will be introduced in time for the General Meeting of Shareholders in the year 2000. In a broader context, we are constantly intensifying our contact with the financial community at large. BUSINESS PRINCIPLES In February 1998, we issued our General Business Principles. These govern our business decisions and actions throughout the world, applying equally to corporate actions and to the behavior of individual employees when on company business. They incorporate the values on which all Philips' activity is or should be based: business focus, integrity, speed, simplicity, quality, people and teamwork. The responsibility for compliance with the Principles rests first and foremost with the management of the business. A Corporate Review Committee supervises the practical implementation of the Principles, and Corporate Internal Audit is responsible for auditing the compliance procedure. In August 1998 the first set of additional directives was issued. 62 34 ENVIRONMENTAL POLICY Philips has restated its general objectives in the Global Environmental Policy 1998-2002 and defined additional targets in its EcoVision environmental program, focusing on green product development and manufacturing. Management believes that, handled imaginatively, the environment is a business opportunity. Philips is committed to taking environmental leadership and action and aims to become the leading eco-efficient company in electronics and lighting. Eco-efficiency is achieved by the delivery of competitively priced goods and services that satisfy human needs and bring quality of life, while reducing ecological impact and intensity of resource usage throughout the life cycle. Philips has defined eco-efficiency as a major challenge: it encourages Philips businesses to become more competitive, more innovative and more environmentally responsible. Some 35% of Philips' industrial sites already manage their environmental performance in accordance with ISO-14001, an internationally accepted environmental standard. The focus of environmental management based on ISO-14001 is not only on improving the environmental performance of manufacturing, but is also expanding towards products and services. Accordingly, ISO-14001 provides a basis for EcoDesign, environmentally conscious product design. Our EcoDesign program considers the environmental impact of a product during its entire life cycle and focuses on five areas to enhance environmental performance: weight, hazardous substances, energy consumption, packaging and recycling. Praising the Company's 'clear and articulated set of values, history of proven accomplishment, global outlook and commitment to sustainable development', the World Environment Center based in New York presented Philips with its 1998 Gold Medal Award for International Corporate Environmental Achievement. Philips also received the 1998 Climate Protection Award from the United States Environmental Protection Agency (US EPA) in recognition of its energy-reduction program, which has resulted in a 20% energy saving in relation to 1994. This is equivalent to a cost reduction of approximately NLG 140 million per year and an avoided CO2 emission of 704,000 tons per year -- equivalent to the absorption effect of 350 km2 of forest. EMPLOYEES The number of employees at year-end 1998 was 233,686, which represents a decrease of 18,582 compared to December 1997. This decrease was mostly due to changes in consolidations. The most significant new consolidations were Hosiden and Philips Display Corporation with 962 employees in April 1998, ATL Ultrasound in October 1998, which added 2,649 employees to the Company's headcount, and 645 employees from all other new consolidations. The most important deconsolidation was PCC/Lucent resulting in a headcount reduction of 8,568 in October 1998 and the deconsolidation of the Passive Components business group as at December 31, 1998, with 4,134 employees. Various other divestments resulted in a decrease in the number of employees by 3,376. When compared with the comparable position as of January 1, 1998, the workforce decreased by 6,760 employees. 63 35 The most important decreases related to Consumer Electronics (3,918), Lighting (2,725) and Domestic Appliances and Personal Care (1,149). On a comparable basis, headcount increased at Origin (1,484) and Components (858). During 1998 the number of employees in Latin America and Asia fell by 3,327 and 3,692, respectively, in connection with the economic downturn in these areas. The headcount in Europe remained virtually stable, whereas in North America it increased by 714. OUTLOOK Comparisons in the first two quarters will not be favorable; however we expect the second half of the year to show an improvement over the second half of 1998. Capital expenditures will be somewhat higher but will track depreciation charges; employment will be down slightly, reflecting streamlining of operations and improvements in productivity. We will continue to control cost; however, we will further spend to improve our brand and our IT infrastructure and to deal with the year 2000 issue. Our objectives remain unchanged: annually double-digit earnings growth and positive cash flow and for the longer term RONA at 24%. Eindhoven, February 9, 1999 Board of Management Group Management Committee 64 36 [Page 65 intentionally omitted] 37 BOARD OF MANAGEMENT COR BOONSTRA 1938, Dutch DUDLEY EUSTACE 1936, British President and Chairman Executive Vice-President and Vice- of the Board of Management and Chairman of the Board of Management and the Group Management Committee the Group Management Committee Member of the Board of Management and the Member of the Board of Management and the Group Group Management Committee since June 1994; Management Committee since October 1992; Chairman and President of the Company since Vice-Chairman since March 1997 October 1996 [photograph of Committee Member] [photograph of Committee Member] JAN HOMMEN 1943, Dutch ADRI BAAN 1942, Dutch Executive Vice-President Executive Vice-President and Chief Financial Officer Member of the Board of Management since May 1998; Member of the Board of Management and the member of the Group Management Committee Group Management Committee and Chief Financial since May 1996. Chairman of the Consumer Electronics Officer since March 1997 division since 1998 [photograph of Committee Member] [photograph of Committee Member] Y.C. LO 1939, Chinese ARTHUR VAN DER POEL 1948, Dutch Executive Vice-President Executive Vice-President Member of the Board of Management since May 1998; Member of the Board of Management since May 1998; member of the Group Management Committee since May member of the Group Management Committee since May 1996. Chairman of the Components division since 1996* 1996. Chairman of the Semiconductors division since 1996 [photograph of Committee Member] [photograph of Committee Member] * As of January 1, 1999 Y.C. Lo has relinquished his position as Chairman of the Components division JOHN WHYBROW 1947, British ROEL PIEPER 1956, Dutch Executive Vice-President Executive Vice-President Member of the Board of Management since May 1998; Member of the Board of Management and the Group member of the Group Management Committee since April Management Committee since May 1998 1996. Chairman of the Lighting division since 1995 [photograph of Committee Member] [photograph of Committee Member]
66 38 GROUP MANAGEMENT COMMITTEE The Group Management Committee is composed of the Board of Management and the following senior officers:* AD VEENHOF 1945, Dutch KEES BULTHUIS 1937, Dutch Member of the Group Management Committee since Member of the Group Management Committee January 1996 and Chairman of the Domestic Appliances since March 1997; responsible for establishing the and Personal Care division since 1996 Technology Management process [photograph of Committee Member] [photograph of Committee Member] HANS BARELLA 1943, Dutch FRED BOK 1940, Dutch Member of the Group Management Committee since Member of the Group Management Committee since March 1997 and Chairman of the Medical Systems April 1998 and Chairman of the Business Electronics division since 1997 division since 1998 [photograph of Committee Member] [photograph of Committee Member] JAN OOSTERVELD 1944, Dutch ARIE WESTERLAKEN 1946, Dutch Member of the Group Management Committee since Member of the Group Management Committee since May May 1998 and Senior Director of Corporate Strategy 1998. Secretary to the Board of Management since 1997 and since 1997 Chief Legal Officer since 1996 [photograph of Committee Member] [photograph of Committee Member] NICO BRUIJEL 1945, Dutch Member of the Group Management Committee since July 1998; responsible for Corporate Human Resource Management [photograph of Committee Member]
*As of January 1, 1999, Gerard Kleisterlee has been appointed Chairman of the Components division and member of the Group Management Committee. 67 39 Supervisory Board
F.A. MALJERS 1933, Dutch ** *** C.J. OORT 1928, Dutch * Chairman Member of the Supervisory Board since 1995; first term expires Member of the supervisory Board since 1993; second term in 1999 Former Treasurer General of the Dutch Ministry of expires in 2001 Former Chairman and Chief Executive Finance and currently Chairman of the Supervisory Boards of Officer of Unilever N.V. and currently Vice-Chairman of KLM Royal Dutch Airlines and the Robeco Group the Supervisory Board of KLM Royal Dutch Airlines and member of the Supervisory Board of SHV Holdings N.V. A. LEYSEN 1927, Belgian *** L. SCHWEITZER 1942, French Vice-Chairman and Secretary Member of the Supervisory Board since 1997; first term expires Member of the Supervisory Board since 1983; fourth term in 2001 Chairman and Chief Executive Officer of Renault and expires in 1999 Former Chairman and Chief Executive member of the Boards of Pechiney, Banque Nationale de Paris and Officer of the Agfa-Gevaert Group and currently Chairman Credit National of the Supervisory Board of the Agfa-Gevaert Group W. HILGER 1929, German * ** SIR RICHARD GREENBURY 1936, British Member of the Supervisory Board since 1990; third term Member of the Supervisory Board since 1998; first term expires expires in 2001 Former Chairman of the Board of Management in 2002 Chairman and Chief Executive Officer of Marks & Spencer of Hoechst A.G. and currently member of the Supervisory plc and former non-executive director of Lloyds TSB, ICI and Boards of Mannesman A.G., Victoria Versicherung A.G. and Zeneca Victoria Lebensversicherung A.G. L.C. VAN WACHEM 1931, Dutch ** W. DE KLEUVER 1936, Dutch * Member of the Supervisory Board since 1993; second term Member of the Supervisory Board since 1998; first term expires in 2001 Former Chairman of the Committee of expires in 2001 Former Executive Vice-President of Royal Managing Directors of the Royal Dutch/Shell Group and Philips Electronics currently Chairman of the Supervisory Board of Royal Dutch Petroleum Company
Profile of the Supervisory Board The Supervisory Board will aim for an adequate spread of knowledge and experience among its members in relation to the global and multi-product character of the business of the Company. Consequently, the Board will aim for an adequate level of experience in financial, economic, social and legal aspects of international business and government and public administration. The Supervisory Board further aims to have available adequate experience within Philips by having one or two former Philips executives on the Supervisory Board. In the case of vacancies the Supervisory Board will ensure that when such persons are recommended for appointment these various qualifications are reflected sufficiently. Term of appointment Members of the Supervisory Board are appointed for a fixed term of four years. In principle, they may be re-elected for two additional terms of four years (for further information see page 140) * Member of the Audit Committee ** Member of the Remuneration Committee ***Member of the Nomination and Selection Committee 68 40 REPORT OF THE SUPERVISORY BOARD The Supervisory Board met six times in the course of 1998. Except in matters regarding the composition of the Supervisory Board, the Board of Management and the Group Management Committee, the members of the Board of Management and/or the Group Management Committee were present at our meetings to inform us on the course of business, important decisions and the strategy of the Philips Group. A number of important matters, such as the sale of PolyGram to Seagram, the tender offer for the shares in ATL, and the proposal to the shareholders regarding the share reduction program, were discussed at length. The Supervisory Board also held a separate meeting with regard to PolyGram. A two-day meeting was devoted to strategy. The Audit Committee met four times in the presence of the external auditor. On behalf of the Supervisory Board and in preparation for our decisions, this committee monitors the effectiveness of internal financial control systems and reviews internal audit programs and their findings. It also advises the Supervisory Board on the annual and half-yearly figures and discusses the scale and scope of the annual audit by the external auditor. Important findings and identified risks are examined thoroughly so that appropriate measures can be taken. The Remuneration Committee met twice. This committee is responsible for preparing resolutions regarding the remuneration of members of the Board of Management and the other members of the Group Management Committee. In addition, it advises the Supervisory Board with regard to the policy to be pursued. The Nomination and Selection Committee met for the first time in August 1998, in particular to discuss the filling of vacancies in the Board of Management and/or the Group Management Committee. COMPOSITION OF THE SUPERVISORY BOARD At the Annual General Meeting of Shareholders in 1999, Mr A. Leysen and Mr F.A. Maljers will retire from the Supervisory Board. Mr Leysen joined the Supervisory Board in 1983 and has been Vice-Chairman since 1984. He reaches the statutory age limit in this year. Mr. Maljers has expressed the wish to retire from the Supervisory Board, which he joined in 1993. He has been Chairman since 1994. We want to put on record our gratitude to the departing members for their contribution to the Company, made in an often turbulent period with a difficult business environment, and we wish them well for the future. In agreement with the Meeting of Priority Shareholders we will propose at the General Meeting of Shareholders to re-elect Mr C. Oort, whose present term ends at the 1999 Annual General Meeting of Shareholders, and to elect Mr J-M. Hessels to the Supervisory Board. Mr Hessels (57) is Chief Executive Officer of Vendex. He has 69 41 extensive international experience. The Supervisory Board has appointed Mr L. van Wachem as its Chairman as from the Annual General Meeting of Shareholders. COMPOSITION OF THE BOARD OF MANAGEMENT-GROUP MANAGEMENT COMMITTEE In the course of 1998, Messrs H. Bodt, W. de Kleuver and D.J. Dunn retired as members of the Board of Management and the Group Management Committee. We are most grateful to them for everything they did for the Company. Mr de Kleuver joined the Supervisory Board on August 1, 1998. Messrs A. Baan, D.J. Dunn, Y.C. Lo, A.P.M. van der Poel, J.W. Whybrow and R. Pieper were appointed members of the Board of Management, Messrs F. Bok (April 1, 1998), J. Oosterveld (May 1, 1998), A. Westerlaken (May 1, 1998) and N.J. Bruijel (July 1, 1998) were appointed members of the Group Management Committee. Mr M. Moakley retired as a member of the Group Management Committee on January 31, 1999, and Mr K. Bulthuis will do so on April 1, 1999. We wish to thank both gentlemen for all their efforts on behalf of the Company. As of April 1, 1999, Mr D.G. Eustace will relinquish his position as Vice-Chairman of the Board of Management and the Group Management Committee. Mr Eustace, who became Chief Financial Officer within the Board of Management in 1992, played an important role in regaining the confidence of our shareholders and financiers during the difficult period in the first half of the 1990s. We are greatly indebted to him for that. Mr Y.C. Lo will retire as a member of the Board of Management and the Group Management Committee and Executive Vice-President of the Company in the middle of 1999. We wish to express our sincere thanks for the outstanding manner in which he served the Company. FINANCIAL STATEMENTS The financial statements of Koninklijke Philips Electronics N.V. for 1998, as presented by the Board of Management, have been audited by KPMG Accountants N.V., independent public auditors. Their report appears on page 134. We approved these financial statements and recommend that you adopt them in accordance with the proposal of the Board of Management and likewise adopt the proposal to declare a dividend of NLG 2.20 per common share. Eindhoven, February 9, 1999 THE SUPERVISORY BOARD 70 42 [page 71 intentionally omitted] 43 ACCOUNTING PRINCIPLES The consolidated financial statements are prepared on a basis consistent with generally accepted accounting principles in the Netherlands (`Dutch GAAP'). Historical cost is used as the measurement basis unless otherwise indicated. CONSOLIDATION PRINCIPLES The consolidated financial statements include the accounts of Koninklijke Philips Electronics N.V. (`Royal Philips Electronics' or `the Company') and companies that are majority-owned or otherwise controlled. Minority interests are disclosed as share of other group equity in group income in the consolidated statement of income and as other group equity in the consolidated balance sheet. Intercompany transactions and balances have been eliminated. Investments in companies in which Royal Philips Electronics exerts significant influence, but does not control the financial and operating decisions, are accounted for by the equity method. Generally, significant influence is presumed to exist if at least 20% of the voting stock is owned. The Company's share of the net income of these companies is included in results relating to unconsolidated companies in the consolidated statement of income. Investments in companies in which Royal Philips Electronics does not exert significant influence are carried at cost or, if a long-term impairment exists, at lower net realizable value. FOREIGN CURRENCIES The financial statements of foreign operations are translated into the Dutch guilder, the Company's reporting currency. Assets and liabilities are translated using the exchange rates on the respective balance sheet dates. Income and expense items are translated based on the average rates of exchange for the periods involved. The resulting translation adjustments are charged or credited to stockholders' equity. Cumulative translation adjustments are recognized as income or expense upon disposal of foreign operations. The functional currency of foreign operations is generally the local currency, unless the primary economic environment requires the use of another currency. However, when foreign operations conduct business in economies considered to be highly inflationary, they record transactions in a designated functional currency (usually the US dollar) instead of their local currency. Gains and losses arising from the translation or settlement of foreign-denominated monetary assets and liabilities into the local currency are recognized in income in the period in which they arise. However, currency differences on intercompany loans which have the nature of a permanent investment are accounted for in stockholders' equity. 72 44 DERIVATIVE FINANCIAL INSTRUMENTS The Company uses derivative financial instruments principally in the management of its foreign currency risks. A derivative financial instrument is recognized by the Company on its balance sheet at the value of the consideration given or received for it. After initial recognition the Company measures derivatives at their fair value. Gains or losses arising from changes in the fair value of a derivative are recognized in the income statement for the period in which they arise to the extent they hedge an asset or liability that has been recognized on the balance sheet. Unrealized gains and losses relating to derivative financial instruments entered into as hedges of firm commitments are deferred until the hedged transactions have been reflected in the accounts. Deferred gains and losses on hedges of firm commitments are reported in the balance sheet as deferred income under stockholders' equity. CASH AND CASH EQUIVALENTS Cash and cash equivalents include all cash balances and short-term highly liquid investments that are readily convertible to known amounts of cash. They are stated at face value. RECEIVABLES Receivables are carried at face value, net of allowances for doubtful accounts. INVENTORIES Inventories are valued at the lower of cost or market value less advance payments on work in process. The cost of inventories comprises all costs of purchase, costs of conversion and other costs incurred bringing the inventories to their present location and condition. The costs of conversion of inventories include direct labor, fixed and variable production overheads, product development and process development costs, taking into account the stage of completion. The cost of inventories is determined using the first-in, first-out (FIFO) method. Provision is made for obsolescence. OTHER NON-CURRENT ASSETS Loans receivable are carried at face value, less a provision for doubtful accounts. Investments in companies (securities) with a restriction on the resale of these securities for a period of one year or more, are accounted for at cost, being the fair value upon receipt of the shares. These are presented as other non-current financial assets. 73 45 PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is carried at cost less accumulated depreciation. Assets manufactured by the Company include direct manufacturing costs, production overheads and interest charges incurred during the construction period. Government grants are deducted from the cost of the related asset. Depreciation is calculated using the straight-line method over the expected economic life of the asset. Depreciation of special tooling costs is based on the expected future economic benefit of these tools. In the event that an impairment in value of fixed assets occurs, the loss is charged to income. Gains and losses on the sale of property, plant and equipment are included in other business income. INTANGIBLE ASSETS Intangible assets include goodwill arising from acquisitions made after January 1, 1992. Goodwill is amortized using the straight-line method over its estimated economic life, not to exceed forty years. Certain acquired intangible assets other than goodwill (`in-process R&D') are expensed in the period of acquisition. Patents and trademarks acquired from third parties are capitalized and amortized over their remaining lifetime. If events or circumstances indicate that the carrying amount of intangible assets may not be recoverable, an impairment test is applied based upon an assessment of future cash flows to ensure that they are appropriately valued. Costs of research and development are expensed in the period in which they are incurred. PROVISIONS Provisions are recognized by the Company for liabilities and losses which have been incurred as of the balance sheet date and for which the amount is uncertain but can be reasonably estimated. Additionally, the Company records provisions for losses which are expected to be incurred in the future but which relate to contingencies that exist as of the balance sheet date. Provisions are stated at face value, with the exception of provisions for postretirement benefits (including pensions) and severance payments in certain countries where such payments are made in lieu of pension benefits; those provisions are stated at the present value of the future obligations. 74 46 DEBT AND OTHER LIABILITIES Debt and liabilities other than provisions are stated at face value. REVENUE RECOGNITION Sales are generally recognized at the time the product is delivered to the customer, net of sales taxes, customer discounts, rebates and similar charges. Service revenue is recognized over the contractual period or as services are rendered. Revenues from long-term contracts are recognized in accordance with the percentage of completion method. Provision for estimated contract losses, if any, is made in the period that such losses are determined. Royalty income is recognized on an accrual basis. Government grants other than those relating to assets, are recognized as income to the extent that it is more likely than not that these grants will be received. FINANCIAL INCOME AND EXPENSES Interest income and interest expense are recognized on an accrual basis. INCOME TAXES Income tax expense is based on pre-tax financial accounting income. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Measurement of deferred tax assets and liabilities is based upon the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets, including assets arising from loss carryforwards, are recognized if it is more likely than not that the asset will be realized. Deferred tax assets and liabilities are not discounted. Deferred tax liabilities for withholding taxes are only taken into consideration in situations where the income of subsidiaries is to be paid out as dividends in the near future. 75 47 BENEFIT ACCOUNTING The Company accounts for the cost of pension plans and postretirement benefits other than pensions substantially in accordance with SFAS No. 87 `Employers Accounting for Pensions' and SFAS No. 106 `Postretirement Benefits other than Pensions', respectively. Most of the Company's defined benefit plans are funded with plan assets that have been segregated and restricted in a trust to provide for the pension benefits to which the Company has committed itself. When plan assets have not been segregated by the Company or in such cases in which the Company is required to make additional pension payments, the Company recognizes a provision for such amounts. The costs related to defined benefit pension plans are in general terms the aggregate of the compensation cost of the benefits promised, interest cost resulting from deferred payment of those benefits and, in the case of plan assets segregated in a trust, the results on the amounts of the invested plan assets. The cost component of the pension benefit corresponding to each year of service is the actuarial present value of the benefit earned in that year. In principle the same amount of pension benefit is attributed to each year of service. If and to the extent that as of the beginning of the year, the present value of the projected benefit obligation differs from the market value of the plan assets or the existing pension provision, the difference is amortized over the average remaining service period of active employees. In the event, however, that at any date the accumulated benefit obligation calculated as the present value of the benefits attributed to employee service rendered prior to that date and based on current and past compensation levels would be higher than the market value of the plan assets or the existing level of the pension provision, the difference is immediately charged to income. In certain countries the Company also provides postretirement benefits other than pensions to various employees. The cost relating to such plans consists of the present value of the benefits attributed on equal basis to each year of service, and interest cost on the accumulated postretirement benefit obligation, which is a discounted amount. The transition obligation is being recognized through charges to earnings over a twenty-year period beginning in 1993 in the US and in 1995 for all other plans. STOCK-BASED COMPENSATION The Company accounts for stock-based compensation using the intrinsic value method in accordance with Dutch GAAP which is also in conformity with US Accounting Principles Board Opinion No. 25, `Accounting for Stock Issued to Employees'. The Company has adopted the pro forma disclosure requirements of SFAS No. 123, `Accounting for Stock-Based Compensation'. DISCONTINUED OPERATIONS Any gain or loss from disposal of a segment of a business (product sector), together with the results of these operations until the date of disposal, are reported separately as discontinued operations. The financial information of a discontinued segment of business is excluded from the respective captions in the consolidated financial statements and related notes. Comparative figures for prior periods are restated accordingly. 76 48 EXTRAORDINARY INCOME AND LOSSES Extraordinary items include income or losses arising from the disposal of a line of activity or closures of substantial production facilities within a segment of business as well as significant gains or losses arising from disposals of interests in unconsolidated companies. RISKS AND UNCERTAINTIES The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements in order to conform with generally accepted accounting principles. Changes in such estimates and assumptions may affect amounts reported in future periods. CASH FLOW STATEMENTS Cash flow statements have been prepared under the indirect method in accordance with Dutch GAAP, which is substantially similar to the requirements of SFAS No. 95 `Statement of Cash flows'. Cash flows in foreign currencies have been translated into Dutch guilders using the average rates of exchange for the periods involved. 77 49 CONSOLIDATED STATEMENTS OF INCOME OF THE PHILIPS GROUP in millions of Dutch guilders unless otherwise stated
1998 1997* 1996* ------- ------- ------- Sales 67,122 65,358 59,707 Direct cost of sales (53,155) (50,780) (47,574) ------- ------- ------- GROSS INCOME 13,967 14,578 12,133 Selling expenses (9,655) (8,950) (9,195) General and administrative expenses (2,495) (2,036) (1,774) Other business income 418 290 330 Restructuring charges (726) (105) (565) ------- ------- ------- L2 INCOME FROM OPERATIONS 1,509 3,777 929 L3 Financial income and expenses (686) (703) (890) ------- ------- ------- INCOME BEFORE TAXES 823 3,074 39 L4 Income taxes (91) (607) 15 ------- ------- ------- INCOME AFTER TAXES 732 2,467 54 L5 Results relating to unconsolidated companies 86 206 320 ------- ------- ------- Group income 818 2,673 374 L6 Share of other group equity in group income 374 39 (96) ------- ------- ------- INCOME FROM CONTINUING OPERATIONS 1,192 2,712 278 L1 DISCONTINUED OPERATIONS: Income from discontinued operations (less applicable income taxes of NLG 166, NLG 355 and NLG 244 million for 1998, 1997 and 1996, respectively) 462 579 445 Gain on disposal of discontinued operations (no tax effect) 10,675 - - L7 EXTRAORDINARY ITEMS - NET 1,010 2,442 (1,313) ------- ------- ------- L8 NET INCOME (LOSS) 13,339 5,733 (590)
78 50 EARNINGS PER SHARE
1998 1997* 1996* ---------- ----------- ---------- Weighted average number of common shares outstanding (after deduction of treasury stock) during the year 360,056,076 349,397,603 341,847,784 Basic earnings per common share in NLG: - - income from continuing operations 3.31 7.76 0.81 - - income from discontinued operations 1.28 1.66 1.30 - - gain on disposal of discontinued operations 29.65 -- -- - - extraordinary items - net 2.81 6.99 (3.84) - - net income (loss) 37.05 16.41 (1.73) Diluted earnings per common share in NLG: - - income from continuing operations 3.29 7.61 0.81 - - income from discontinued operations 1.27 1.63 1.30 - - gain on sale of discontinued operations 29.41 -- -- - - extraordinary items - net 2.78 6.85 (3.84) - - net income (loss) 36.75 16.09 (1.73) Dividend per common share in NLG 2.20** 2.00 1.60
The dilution effects on earnings per share are only taken into consideration if this does not result in an improvement in income per share or in a reduction in loss per share (year 1996). * Restated to reflect the sale of PolyGram N.V. and to present the Philips Group accounts on a continuing basis for all years presented. ** Subject to approval by the Annual General Meeting of Shareholders on March 25, 1999. 79 51 CONSOLIDATED BALANCE SHEETS OF THE PHILIPS GROUP AS OF DECEMBER 31 in millions of Dutch guilders unless otherwise stated The 1998 consolidated balance sheet includes a liability for the proposed dividend, which is subject to approval by the Annual General Meeting of Shareholders on March 25, 1999. ASSETS
1998 1997* ----- ----- CURRENT ASSETS 9 Cash and cash equivalents 14,441 3,079 10 Receivables: - Accounts receivable, net 9,566 10,399 - Other receivables 1,681 1,197 - Prepaid expenses 745 444 ------- ------ 11,992 12,040 11 Inventories 9,419 9,966 ------ ------ Total current assets 35,852 25,085 NON-CURRENT ASSETS 5 Unconsolidated companies: - Investments 2,104 2,469 - Loans 45 55 - Net assets of discontinued operations (PolyGram N.V.) - 3,265 ------- ------ 2,149 5,789 12 Other non-current financial assets 4,101 674 13 Non-current receivables: - Accounts receivable 630 176 - Other receivables 454 366 - Prepaid expenses 3,146 3,553 ------- ------ 4,230 4,095 14 Property, plant and equipment: - At cost 36,741 37,161 - Less: accumulated depreciation (22,253) (21,878) ------- ------ 14,488 15,283 15 Intangible assets 1,221 468 ------ ------ Total non-current assets 26,189 26,309 ------ ------ Total 62,041 51,394
* Restated to reflect the sale of PolyGram N.V. and to present the Philips Group accounts on a continuing basis for all years presented. 80 52 LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997* ------ ------ CURRENT LIABILITIES Accounts and notes payable: - Trade creditors 6,469 6,333 - Unconsolidated companies 27 67 ------ ------ 6,496 6,400 L16 Accrued liabilities 6,396 6,078 L17 Short-term provisions 2,128 2,066 L18 Other current liabilities 2,047 1,465 Dividend payable 794 716 L19 Short-term debt 1,765 1,810 ------ ------ Total current liabilities 19,626 18,535 Non-current liabilities L20 Long-term debt 6,140 7,072 L17 Long-term provisions 4,450 5,098 ------ ------ Total non-current liabilities 10,590 12,170 L21 Commitments and contingent liabilities Group equity L6 Other group equity 533 1,232 Stockholders' equity: Priority shares, par value NLG 5,000 per share: Authorized and issued 10 shares Preference shares, par value NLG 10 per share: Authorized 499,995,000 shares Issued - none - Common shares, par value NLG 10 per share: Authorized 500,000,000 shares - Issued 368,494,824 shares - (364,777,116 in 1997) 3,685 3,648 L22 Share premium 4,019 3,943 L22 Other reserves 23,588 11,866 ------ ------ 31,292 19,457 ------ ------ Total 62,041 51,394
81 53 CONSOLIDATED STATEMENTS OF CASH FLOWS OF THE PHILIPS GROUP in millions of Dutch guilders
1998 1997* 1996* ------- ------ ------ Cash flows from operating activities: NET INCOME (LOSS) 13,339 5,733 (590) Adjustments to reconcile net income to net cash provided by operating activities: Income from discontinued operations (462) (579) (445) Net gain on disposal of discontinued operations (10,675) - - Depreciation and amortization 4,164 3,520 3,405 Net gain on sale of investments (1,604) (3,070) (255) Decrease (increase) in working capital, net of effects from acquisitions and sales 600 1,137 (556) Decrease (increase) in non-current receivables 95 (341) (390) (Decrease) increase in provisions (390) (246) 833 Results relating to unconsolidated companies (68) - (283) Share of other group equity in group income (382) (100) 24 Other items 98 1,019 265 ------- ------ ------ NET CASH PROVIDED BY OPERATING ACTIVITIES 4,715 7,073 2,008 Cash flows from investing activities: Capital expenditures on property, plant and equipment (3,600) (3,585) (4,815) Proceeds from disposals of property, plant and equipment 527 496 354 Purchase of other non-current financial assets (149) (383) (258) Proceeds from other non-current financial assets 291 527 339 Purchase of businesses, net of cash acquired (1,910) (576) (794) Proceeds from sale of interests in businesses 1,666 3,621 1,128 ------- ------ ------ NET CASH (USED FOR) PROVIDED BY INVESTING ACTIVITIES (3,175) 100 (4,046) ------- ------ ------ CASH FLOWS (BEFORE FINANCING ACTIVITIES) 1,540 7,173 (2,038) Cash flows from financing activities: (Decrease) increase in short-term debt (164) (3,311) 1,478 Principal payments on long-term debt (1,245) (2,597) (1,855) Proceeds from issuance of long-term debt 427 886 2,560 Payments of conversion certificates - (33) - Effect of other financial transactions 252 - - Treasury stock transactions (345) (251) 77 Dividends paid (719) (557) (549) ------- ------ ------ NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (1,794) (5,863) 1,711 ------- ------ ------ CASH (USED FOR) PROVIDED BY CONTINUING OPERATIONS (254) 1,310 (327)
*Restated to reflect the sale of PolyGram N.V. and to present the Philips Group accounts on a continuing basis for all years presented. 82 54
CONSOLIDATED STATEMENTS OF CASH FLOWS OF THE PHILIPS GROUP (CONTINUED) 1998 1997* 1996* ------ ------ ------ CASH (USED FOR) PROVIDED BY CONTINUING OPERATIONS (254) 1,310 (327) Effect of changes in exchange rates and consolidations on cash positions 67 (89) (123) Net cash provided by (used for) discontinued operations 202 407 (65) Net cash from disposal of discontinued operations 11,347 -- -- Cash and cash equivalents at beginning of year 3,079 2,145 2,660 ------ ------ ------ CASH AND CASH EQUIVALENTS AT END OF YEAR 14,441 3,773 2,145 Of which: cash and cash equivalents discontinued operations -- 694 414 ------ ------ ------ CASH AND CASH EQUIVALENTS CONTINUING OPERATIONS 14,441 3,079 1,731 SUPPLEMENTAL DISCLOSURES TO CONSOLIDATED STATEMENTS OF CASH FLOWS: Decrease (increase) in working capital net of effects from acquisitions and sales: Increase in accounts receivable and prepaid expenses (292) (56) (1,798) (Increase) decrease in inventories (133) (394) 857 Increase in accounts payable and accrued expenses 1,025 1,587 385 ------ ------ ------ 600 1,137 (556) Net cash paid during the year for: Interest 536 748 767 Income taxes 440 340 313 Additional common stock issued upon conversion of long-term debt 56 143 8 Net gain on sale of investments: Cash proceeds from the sale of investments (property, plant and equipment and interests in companies) 2,492 4,644 1,827 Book value of these investments taking into account the effects of related goodwill and translation differences (888) (1,574) (1,572) ------ ------ ------ 1,604 3,070 255 Non-cash investing and financing information: Assets received in lieu of cash 3,742 82 -- Treasury stock transactions: Shares acquired (711) (781) (217) Shares sold 260 206 54 Exercise warrants/stock options 106 324 240
For a number of reasons, principally the effects of translation differences and consolidation changes, certain items in the statements of cash flows do not correspond to the differences between the balance sheet amounts for the respective items. 83 55 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY in millions of Dutch guilders, unless otherwise stated
number of shares* issued, share other total ------------------------- paid-up premium reserves outstanding issued capital BALANCE AS OF DECEMBER 31, 1995 341,756,174 345,062,054 3,451 3,474 7,130 14,055 Issued in exchange for: - - convertible debentures and on exercise of conversion certificates 190,569 2 6 8 - - stock options 1,422,330 14 29 43 - - warrants 5,804,609 58 139 197 Net loss for the year (590) (590) Dividend payable (555) (555) Treasury stock transactions (163) (163) Translation differences and other changes 961 961 ----------- ----- ----- ------ ------ BALANCE AS OF DECEMBER 31, 1996 347,080,144 352,479,562 3,525 3,648 6,783 13,956 Issued in exchange for: - - convertible debentures and on exercise of conversion certificates 1,544,714 15 79 94 - - stock options (42) (42) - - warrants 10,752,840 108 258 366 Net income for the year 5,733 5,733 Dividend payable (716) (716) Treasury stock transactions (493) (493) Translation differences and other changes 559 559 ----------- ----- ----- ------ ------ BALANCE AS OF DECEMBER 31, 1997 357,949,491 364,777,116 3,648 3,943 11,866 19,457 Issued in exchange for: - - convertible debentures and on exercise of conversion certificates 80,847 1 6 49 56 - - stock options (17) (17) - - warrants 3,636,861 36 87 123 Net income for the year 13,339 13,339 Dividend payable (794) (794) Treasury stock transactions (451) (451) Translation differences and other changes (421) (421) ----------- ----- ----- ------ ------ BALANCE AS OF DECEMBER 31, 1998 360,690,217 368,494,824 3,685 4,019 23,588 31,292
* par value NLG 10 per share 84 56 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF THE PHILIPS GROUP all amounts in millions of Dutch guilders unless otherwise stated INTRODUCTION The financial statements of Koninklijke Philips Electronics N.V. (the `Parent Company') are included in the statements of the Philips Group. The unconsolidated statements of income of Koninklijke Philips Electronics N.V. therefore reflect only the net after-tax income from affiliated companies and other income after taxes. The accompanying notes are an integral part of the consolidated financial statements. PRESENTATION BALANCE SHEET AND INCOME STATEMENT In 1997, the Company changed the format of its consolidated balance sheet presentation. The primary reason for the change was to accommodate the expectations of foreign, mainly US shareholders, who represent a large percentage of the shareholders in the Company. In light of this, the Company decided to present its consolidated balance sheet and income statement more in line with a presentation that is common practice in the United States. Under the new format, the order of presentation of assets and liabilities is based on the degree of liquidity. The most important change refers to certain items which in the previous format were included in current receivables and have been reclassified to long-term receivables under the new format, to better reflect the nature of the assets and to better present working capital and the proportion of current assets that is not current. The current balance sheet presentation is somewhat different from the one used under Dutch regulations. 1 ACQUISITIONS AND DIVESTITURES PolyGram On May 21, 1998, Philips, PolyGram N.V. (`PolyGram') and The Seagram Company Ltd. (`Seagram') announced that they had reached an agreement that Seagram would acquire all outstanding shares of PolyGram for a consideration of NLG 117 in cash for each PolyGram share or, at shareholders' election, a mixture of cash and Seagram shares based on an exchange ratio of 1.4012 Seagram shares for each PolyGram share. On June 22, 1998, the price was reduced to NLG 115 or a mixture of cash and Seagram shares based on an exchange ratio of 1.3772 Seagram shares for each PolyGram share. This reduction reflected the lower than expected financial results of PolyGram during the second quarter of 1998. Philips also agreed to hold the Seagram shares for at least two years from the closing of the transaction. 85 57 On December 10, 1998, Seagram acquired substantially all of the outstanding PolyGram shares. On that date, Philips received NLG 11,531 million in cash and 47,831,952 Seagram shares representing approximately 12% of the outstanding Seagram shares. The sale of PolyGram resulted in a gain of NLG 10,675 million, or NLG 29.65 per share, free of taxes. In order to gain insight into the Company's cash flows, earnings capacity and financial position, the information about discontinued operations has been segregated from the information about continuing operations. The financial information relating to PolyGram, being a separate product sector, has been excluded from the respective captions in the consolidated financial statements and related notes, and is reported separately up to the date of sale. Comparative information for prior periods has been restated by separating continued and discontinued operations retrospectively. Summarized financial information for PolyGram is as follows:
1998* 1997 1996 ------ ------ ------ Sales 10,617 11,095 9,488 Costs and expenses (9,734) (9,912) (8,605) INCOME FROM OPERATIONS 883 1,183 883 Financial income and expenses (57) (17) (8) INCOME BEFORE TAXES 826 1,166 875 Income taxes (166) (355) (244) INCOME AFTER TAXES 660 811 631 Results unconsolidated companies/share other group equity (198) (232) (186) NET INCOME (PHILIPS' SHARE) 462 579 445 Net cash provided by operating activities -- 645 630 Net cash used for investing activities -- (235) (456) Net cash used for financing activities -- (3) (239) Dec. 31, Dec. 31, 1997 1996 -------- -------- Current assets 6,580 5,229 TOTAL ASSETS 11,312 9,434 Current liabilities 5,451 4,442 TOTAL LIABILITIES 8,047 6,794 Net assets of discontinued operations 3,265 2,640
* Until December 10, 1998 Joint venture Philips/Lucent Effective September 27, 1998, Philips and Lucent Technologies terminated their joint venture, Philips Consumer Communications (PCC). Philips, which owned 60% of the venture, and Lucent, which owned 40%, each regained control of their originally contributed assets. The joint venture was formed on October 1, 1997. 86 58 The assets over which Philips regained control include its wireless business, which is mainly GSM, its wired business outside North America, and paging. Approximately 5,000 PCC employees returned to Philips, approximately 8,600 returned to Lucent. The 1998 income from operations incorporated losses related to the unwinding of the joint venture, including a write down of obsolete inventories (NLG 351 million), and the subsequent restructuring of the returned PCC activities (NLG 475 million). Summarized financial information for the PCC joint venture, included in Philips' consolidated financial statements, is as follows:
9 months 1998 3 months 1997 ------------- ------------- Sales 3,032 1,257 Loss from operations (770) (121) Loss before income taxes (771) (120) Net loss (483) (66) Net cash (used for) provided by operating activities (832) 133 Net cash used for investing activities (105) (69) Net cash provided by financing activities 870 116 Dec. 31, 1997 ------------- Current assets 1,930 TOTAL ASSETS 2,620 Current liabilities 1,202 TOTAL LIABILITIES 1,697 Net assets (Philips' share 1997) 923
Acquisition ATL Ultrasound ATL Ultrasound was acquired on October 2, 1998 for NLG 1,613 million in cash. ATL Ultrasound is a leading company in the high-performance ultrasound market. Included in the purchase price for ATL was goodwill paid for the amount of NLG 775 million, in-process R&D for the amount of NLG 401 million and NLG 115 million for patents and trademarks. Goodwill and patents and trademarks are capitalized under intangible assets and amortized over 12 years and 8 years respectively. In-process R&D represents the value assigned to research and development projects of ATL Ultrasound that were commenced but not yet completed at the date of acquisition and which, if unsuccessful, have no alternative future use in research and development activities or otherwise. In-process R&D was charged to expense at the date of acquisition. 87 59 2 INCOME FROM OPERATIONS Depreciation and amortization Included in direct cost of sales is depreciation of property, plant and equipment and amortization of intangible assets.
1998 1997 1996 ---- ---- ----- Depreciation of property, plant and equipment 3,412 3,143 3,024 Amortization of goodwill 119 189 205 Amortization of patents and trademarks 5 - - Amortization of other intangible assets 445 - 14
In 1998, additional depreciation costs relating to write-downs of property, plant and equipment of NLG 148 million resulting from the recognition of asset impairment were reported in the separate line item restructuring charges (1997: NLG 145 million, 1996: NLG 144 million). Amortization of goodwill relating to unconsolidated companies amounting to NLG 2 million (1997: NLG 18 million, 1996: NLG 14 million) was not included in costs of sales but was charged against results relating to unconsolidated companies. Amortization of other intangible assets is NLG 445 million, representing amortized in-process R&D paid as part of acquisitions in 1998. Research and development Expenditures for research and development activities amounted to NLG 4,513 million, representing 6.7% of sales (1997: NLG 4,057 million, 6.2% of sales, 1996: NLG 4,050 million, 6.8% of sales). These expenditures are included in direct cost of sales. Salaries and wages
1998 1997 1996 ---- ---- ---- Salaries and wages 15,156 15,173 14,778 Pension costs 415 622 647 Other social security and similar charges: Required by law 2,162 1,959 1,979 Voluntary 357 451 408 ------ ------ ------ TOTAL 18,090 18,205 17,812
88 60 Remuneration Board of Management and Supervisory Board Board of Management Remuneration and pension costs relating to the present members of the Board of Management amounted to NLG 25,808,000 (1997: NLG 17,328,000). The increase in these costs in 1998 is connected with the higher bonuses as a result of the profit level achieved in 1997 and the increase in the number of members of the Board of Management. The costs for former members of the Board of Management amounted to NLG 16,832,000 (1997: NLG 5,540,000). The increase in these costs is connected with the severance contracts of former members of the Board of Management concluded prior to 1998. In 1996, total remuneration and pension costs of present and former members of the Board of Management amounted to NLG 27,154,000. In 1998, members of the Board of Management were granted 385,900 stock options (1997: 331,300 stock options). At year-end 1998 the present members of the Board of Management held a total of 799,800 stock options at a weighted average exercise price of NLG 112.93 (for information on stock options, see note 23 to the financial statements). Supervisory Board The remuneration of present members of the Supervisory Board amounted to NLG 831,000 (1997: NLG 724,000, 1996: NLG 836,000); former members received no remuneration. The remuneration for individual members is NLG 90,000 and for the Chairman NLG 165,000. Additionally, with effect from 1998, the membership of committees of the Supervisory Board is compensated. At year-end 1998 present members of the Supervisory Board own directly and/or beneficially 5,354 shares (1997: 5,836 shares) in the Company's capital and 28,100 stock options acquired before the membership of the Supervisory Board; no options were traded at the stock exchange. Employees The average number of employees during 1998 was 252,680 (1997: 255,664, 1996: 259,628). The number of employees by category is summarized as follows:
1998 1997 1996 --------------------------- ------- ------- beginning end average average average of year* of year ** Production 145,247 131,551 146,249 150,616 152,029 Research & development 20,122 20,473 20,657 21,238 23,065 Other 64,781 63,436 64,494 63,478 68,232 ------- ------- ------- ------- ------- Permanent employees 230,150 215,460 231,400 235,332 243,326 Temporary employees 21,750 18,226 21,280 20,332 16,302 ------- ------- ------- ------- ------- TOTAL 251,900 233,686 252,680 255,664 259,628
* including changes in consolidations at January 1, 1998. ** (de)consolidation changes have not been taken into consideration in determining the average number of employees. The number of employees at year-end 1998 went down by 18,214 as compared to the beginning of the year. This includes a decrease of 11,454 relating to consolidation changes. 89 61 OTHER BUSINESS INCOME Other business income consists of amounts not directly related to the production and sale of products and services, including NLG 84 million relating to the net gain from the disposal of certain business interests which do not constitute separate lines of activities (1997: NLG 33 million, 1996: NLG 41 million). Other business income also includes gains of NLG 163 million from the sale of fixed assets (1997: NLG 93 million, 1996: NLG 54 million) and various smaller items. RESTRUCTURING CHARGES The provision for restructuring relates to the estimated costs of planned reorganizations that have been approved by the Board of Management and publicly announced, and which involve the realignment of certain parts of the industrial and commercial organization. When such reorganizations require discontinuance and/or closure of lines of activities, the anticipated costs of closure or discontinuance are included in total restructuring provisions. Of the provision for restructuring as of January 1, 1998 (NLG 718 million), an amount of NLG 355 million was utilized during 1998. An amount of NLG 57 million was released to income, principally relating to the Consumer Products (NLG 14 million), Semiconductors (NLG 12 million), Lighting (NLG 9 million) and Professional (NLG 17 million) sectors. To the remaining balance of prior-years provisions (NLG 306 million), an amount of NLG 766 million was charged to income for new restructuring programs. This charge included lay-off costs of NLG 274 million for planned workforce reduction of approximately 4,000 persons and involved the Lighting (NLG 31 million), Components (NLG 24 million), Consumer Products (NLG 168 million), Professional (NLG 14 million) and Semiconductors (NLG 37 million) sectors. Asset write-downs included in this restructuring charge totaled NLG 424 million, mainly relating to the Consumer Products, Professional and Components sectors. The write-down amount was based on the discounted cash flow method. Other restructuring charges totaled NLG 68 million, principally for the Lighting and Consumer Products sectors. In 1998, the net amount of additions and releases to income from operations came to NLG 726 million as compared to NLG 105 million in 1997. 90 62 Restructuring provision
1998 1997 ---- ---- The changes in the provision for restructuring are as follows: Balance as of January 1 718 1,422 Changes: Utilization relating to prior-year provisions: - write-down of assets (43) (135) - personnel costs (230) (419) - other costs (76) (241) - consolidation changes/translation differences (6) (4) ---- ---- (355) (799) Release of provisions against: - income from operations (40) (64) - extraordinary income (17) - ---- ---- Remaining prior-year provisions as of December 31 306 559 Additions charged against: - income from operations 766 169 - extraordinary income - 13 Utilization relating to current-year provisions: - write-down of assets (403) (10) - personnel costs (29) (12) - other costs (53) (6) - other movements 2 6 - translation differences (5) (1) ---- ---- (488) (23) ---- ---- BALANCE AS OF DECEMBER 31, 584 718
The remaining prior-year provisions at December 31, 1998 relate primarily to personnel lay-off costs. The Company expects to make cash expenditures of approximately NLG 0.5 billion in 1999 in connection with existing restructuring programs. 91 63 3 FINANCIAL INCOME AND EXPENSES
1998 1997 1996 ---- ---- ---- Interest income 169 163 174 Interest expense (705) (911) (941) ---- ---- ---- TOTAL INTEREST EXPENSE (NET) (536) (748) (767) Other income from non-current financial assets 87 158 34 Value adjustments of non-current financial assets (7) (9) (29) Interest on provisions for pensions (131) (129) (130) Foreign exchange differences (87) 27 11 Miscellaneous financing costs (12) (2) (9) ---- ---- ---- TOTAL (686) (703) (890)
Interest paid decreased due to lower average debt, which declined from NLG 12.7 billion in 1997 to NLG 9.0 billion in 1998. Other income from non-current financial assets in 1998 mainly related to the gain on the sale of equity investments, principally in Flextronics (NLG 59 million). The 1997 gain mainly reflects the profit on the sale of the shares in Viacom and Fluke (NLG 128 million). Foreign exchange differences primarily included increased hedging costs of hard currency loans to subsidiaries in emerging markets. Beginning in 1999, interest on provisions for pensions will be included in income from operations. 4 INCOME TAXES Tax on income from continuing operations amounted to NLG 91 million in 1998 (1997: NLG 607 million, 1996: NLG 15 million benefit). In 1998, there was a tax expense of NLG 211 million on extraordinary items compared to a NLG 31 million benefit in 1997 and a NLG 159 million benefit in 1996. 92 64 The components of income before income taxes are as follows:
1998 1997 1996 ---- ---- ---- Netherlands 728 482 (148) Foreign 95 2,592 187 ----- ----- ----- INCOME BEFORE INCOME TAXES 823 3,074 39 The components of income tax expense are as follows: Netherlands: Current taxes 2 (4) 23 Deferred taxes 198 162 (92) ----- ----- ----- 200 158 (69) Foreign: Current taxes 221 395 279 Deferred taxes (330) 54 (225) ----- ----- ----- (109) 449 54 ----- ----- ----- INCOME TAX EXPENSE (BENEFIT) FROM CONTINUING OPERATIONS 91 607 (15)
Philips' operations are subject to income taxes in various foreign jurisdictions with statutory income tax rates varying from 16.5% to 51% which cause a difference between the weighted average statutory income tax rate and the Netherlands' statutory income tax rate of 35%. A reconciliation of the weighted average statutory income tax rate as a percentage of income before taxes and the effective income tax rate is as follows:
1998 1997 1996 ---- ---- ---- Weighted average statutory income tax rate 30.7 34.5 19.5 Tax effect of: Utilization of previously unrecognized loss carryforwards (93.0) (14.5) (24.0) New loss carryforwards not recognized 57.4 5.2 63.3 Changes in the valuation allowance for other deferred tax assets 16.7 (2.3) (12.9) Exempt income and non-deductible expenses 18.1* 1.3 (7.4) Tax incentives and other (18.8) (1.5) (13.4) Effect of sale of PolyGram -- (3.0) (65.2) ---- ---- ---- Effective tax rate 11.1 19.7 (40.1)
* of which 17.8 write-off of in-process R&D (ATL). 93 65 Deferred tax assets and liabilities Deferred tax assets and deferred tax liabilities are as follows:
1998 1997 ------------------- ------------------- assets liabilities assets liabilities ------ ----------- ------ ----------- Intangible fixed assets 200 (20) 210 (20) Property, plant and equipment 640 (710) 680 (660) Inventories 200 (70) 150 (50) Receivables 190 (60) 210 (50) Provisions: - for pensions 280 (180) 280 (160) - restructuring 140 (10) 220 - - guarantees 30 - 90 - - other 1,000 (190) 720 (60) Other assets 140 (490) 200 (700) Other liabilities 250 (310) 470 (117) ------- --------- ------ ----------- Total deferred tax assets/liabilities 3,070 (2,040) 3,230 (1,817) ======= ========= ====== =========== Net deferred tax position 1,030 1,413 Tax loss carryforwards (including tax credit carryforwards) 4,535 4,449 Valuation allowances (4,766) (5,022) ------ ------ NET DEFERRED TAX ASSETS 799 840
At December 31, 1998, operating loss carryforwards expire as follows:
Total 1999 2000 2001 2002 2003 2004/2008 later unlimited - ----- ---- ---- ---- ---- ---- --------- ----- --------- 11,800 200 200 400 200 400 1,000 800 8,600
The Company also has tax credit carryforwards of NLG 267 million which are available to offset future tax, if any, and which expire as follows:
Total 1999 2000 2001 2002 2003 2004/2008 later unlimited - ----- ---- ---- ---- ---- ---- --------- ----- --------- 267 3 2 3 5 15 39 7 193
Classification of the deferred tax assets and liabilities takes place at a fiscal entity level as follows:
1998 1997 ------ ------ Deferred tax assets grouped under non-current receivables 1,057 1,088 Deferred tax liabilities grouped under provisions (258) (248)
94 66 Classification of the income tax payable and receivable is as follows:
1998 1997 ----- ----- Income tax receivable grouped under non-current receivables 80 219 Income tax receivable grouped under current receivables 298 173 Income tax payable grouped under current liabilities (458) (565)
The amount of the unrecognized deferred income tax liability for temporary differences, totaling NLG 620 million (1997: NLG 530 million), related to unremitted earnings in foreign group companies and unconsolidated companies which are considered to be essentially permanent. Under current Dutch tax law, no additional taxes are payable. However, in certain jurisdictions, withholding taxes would be payable. 5 RESULTS RELATING TO UNCONSOLIDATED COMPANIES These results principally include the Company's share in the net income of Taiwan Semiconductor Manufacturing Co., ASM Lithography and the losses from the ongoing development costs of digitized street maps incurred by Navigation Technologies Corporation. Included in 1997 and 1996 is the share in the losses of Grundig AG through June 1997. In 1998, an amount of NLG 16 million resulting from the sale of various companies was also included. In 1997, the gain on the sale of the Company's stake in Bang & Olufsen was included. In addition, a charge of NLG 2 million (1997: NLG 18 million, 1996: NLG 14 million), representing amortization of goodwill arising from the acquisition of unconsolidated companies, is included in the amount presented in the income statement, but not in equity in income presented in the following table. Investments in, and loans to unconsolidated companies The changes during 1998 are as follows:
total investments loans ----- ----------- ------ Balance as of January 1, 1998 2,524 2,469 55 Changes: Acquisitions/additions 471 291 180 Sales/redemptions (536) (497) (39) Equity in income 71 214 (143) Dividend declared (3) (3) - Changes in consolidations 222) (219) (3) Other (77) (77) _ Translation and exchange rate differences (79) (74) (5) ----- ----- ---- BALANCE AS OF DECEMBER 31, 1998 2,149 2,104 45
95 67 The investments in unconsolidated companies at December 31, 1998 includes NLG 25 million (1997: NLG 28 million) for companies accounted for under the cost method. The total book value of unconsolidated companies is summarized as follows:
1998 1997 ---- ---- Taiwan Semiconductor Manufacturing Co. 1,375 1,199 Philips Car Systems - 443 ASM Lithography 264 231 Conventional Passive Components 225 - Other 285 651 ----- ----- TOTAL 2,149 2,524
To reflect the disposition of PolyGram as a discontinued operation, the net asset value of PolyGram as of December 31, 1997 has been recorded under unconsolidated companies for an amount of NLG 3,265 million. In December 1998, PolyGram was sold to Seagram (see note 1). Under a preliminary agreement signed on September 27, 1998, Philips sold its Conventional Passive Components activities to an affiliate of Compass Partners International on January 14, 1999. Assets and liabilities were therefore no longer consolidated as of December 31, 1998. The net asset value of this business has been included under unconsolidated companies - investments - in the balance sheet. Sales and income over 1998 have been included in the consolidated Group accounts. The gain on the disposal will be recognized in 1999. The aggregate fair values of Philips' shareholding in TSMC and ASML, based on quoted market prices at December 31, 1998, were NLG 7.0 billion (1997: NLG 8.0 billion) and NLG 1.8 billion (1997: NLG 1.0 billion) respectively. In December 1997, Philips and Mannesmann VDO signed a contract for the sale of Philips Car Systems to Mannesmann. Car Systems' net assets were deconsolidated at year-end 1997 and recognized in the balance sheet under Unconsolidated companies for an amount of NLG 443 million. Under the contract, Mannesmann VDO paid NLG 1,013 million in the first quarter of 1998. Additional payments in 1998 were made for an amount of NLG 69 million and subsequent payments of NLG 295 million will be received for amounts of NLG 26 million in 1999 and NLG 269 million in the year 2000. Reference is made to note 7. 96 68 6 SHARE OF OTHER GROUP EQUITY IN GROUP INCOME The share of other group equity in group income principally includes the share of third parties in the net income (loss) of consolidated companies. Mainly due to the loss-giving situation in PCC, the share of other group equity in 1998 amounted to a profit of NLG 374 million. In the years prior to 1998 the compensation paid on conversion certificates and similar securities was also included. Other group equity Minority interests in consolidated companies, totaling NLG 533 million (1997: NLG 1,232 million), are valued on the basis of their interest in the underlying net asset value. 7 EXTRAORDINARY ITEMS - NET
1998 1997 1996 ---- ---- ---- Extraordinary gains 1,298 3,184 375 Extraordinary losses (77) (773) (1,847) Taxes (211) 31 159 ----- ----- ------ TOTAL 1,010 2,442 (1,313)
Extraordinary items contributed NLG 1,010 million to net income in 1998. The sale of Philips Car Systems to Mannesmann VDO resulted in a net gain of NLG 836 million whereas the sale of the Optoelectronics unit to Uniphase Corporation and various other items amounted to NLG 174 million. Accumulated translation differences relating to the disposed businesses reduced the gains on disposal by NLG 11 million (1997: NLG 12 million). Those translation differences were previously accounted for directly within stockholders' equity. In extraordinary losses of 1998 are included costs of NLG 34 million resulting from the early repayment of debt. The principal components of the NLG 3,184 million extraordinary gain reported in 1997 were the sale of a 5.4% shareholding in TSMC (NLG 1,979 million), the sale of 50% of UPC (NLG 491 million) and the sale of a portion of ASML (NLG 405 million). Other gains related to various divestitures. The principal components of the 1997 extraordinary losses were Grundig (NLG 487 million) and costs resulting from the early repayment of debt (NLG 96 million). Other losses related to various divestitures. In 1996, the extraordinary gain of NLG 375 million resulted from the flotation of part of Philips' shareholding in ASML. 97 69 The principal components of the 1996 extraordinary losses were the structural realignment of the Sound & Vision division, including the closure of substantial production facilities in Europe and the USA (NLG 800 million), and the first phase of the termination of the Grundig Unternehmensvertrag resulting in a charge of more than NLG 600 million. Other losses related to the Board's decision in 1996 to exit the media software business, the audio/video rental business, the divestiture of Data Communications and other Communication Systems operations. 8 EARNINGS PER SHARE The earnings per share data have been calculated in accordance with SFAS No. 128 `Earnings per Share'. The weighted average number of common shares outstanding during the respective years are:
1998 1997 1996 ---- ---- ---- WEIGHTED AVERAGE NUMBER OF SHARES 360,056,076 349,397,603 341,847,784 BASIC EPS COMPUTATION Income from continuing operations available to holders of common shares 1,192 2,712 278 Income from discontinued operations 462 579 445 Gain on sale of discontinued operations 10,675 - - Extraordinary items - net 1,010 2,442 (1,313) ----------- ----------- ----------- NET INCOME (LOSS) AVAILABLE TO HOLDERS OF COMMON SHARES 13,339 5,733 (590) DILUTED EPS COMPUTATION Income from continuing operations available to holders of common shares 1,192 2,712 278 Plus: Interest on assumed conversion of convertible debt, net of taxes 2 1 4 ----------- ----------- ----------- Income available to holders of common shares 1,194 2,713 282 Income from discontinued operations 462 579 445 Gain on sale of discontinued operations 10,675 - - Extraordinary items - net 1,010 2,442 (1,313) ----------- ----------- ----------- NET INCOME (LOSS) AVAILABLE TO HOLDERS OF COMMON SHARES PLUS EFFECT OF ASSUMED CONVERSIONS 13,341 5,734 (586) WEIGHTED AVERAGE NUMBER OF SHARES 360,056,076 349,397,603 341,847,784 Plus, shares applicable to: - options 2,010,923 3,406,612 1,299,081 - warrants - 2,630,931 6,371,195 - convertible debt 952,124 906,763 1,832,310 --------- --------- --------- Dilutive potential common shares 2,963,047 6,944,306 9,502,586 ----------- ----------- ----------- ADJUSTED WEIGHTED AVERAGE NUMBER OF SHARES 363,019,123 356,341,909 351,350,370
98 70 9 CASH AND CASH EQUIVALENTS Included in cash and cash equivalents are marketable securities of NLG 2 million (1997: NLG 22 million) with a market value of NLG 2 million (1997: NLG 35 million). Also included are time deposits with banks totaling NLG 268 million (1997: NLG 339 million) that are not freely available for withdrawal. 10 RECEIVABLES Trade accounts receivable include installment accounts receivable of NLG 4 million (1997: NLG 9 million) and receivables from unconsolidated companies, primarily representing trade balances, for an amount of NLG 146 million (1997: NLG 205 million). Discounted drafts of NLG 65 million (1997: NLG 103 million) have been deducted. Income tax receivable (current portion) for an amount of NLG 298 million (1997: NLG 173 million) is included under other receivables. The changes in the allowances for doubtful accounts and notes are as follows:
1998 1997 1996 ------ ------ ------ Balance as of January 1, 341 252 478 Additions charged to income 394 268 135 Deductions from allowances * (133) (131) (78) Other movements ** (191) (48) (283) ------ ------ ------ BALANCE AS OF DECEMBER 31, 411 341 252
[FN] * Write-offs for which allowances were provided. ** Including the effect of translation differences and consolidation changes. 11 INVENTORIES Inventories are summarized as follows:
1997 1996 ------ ------ Finished products 4,631 4,846 Work in process, materials, parts and supplies 4,788 5,120 ------ ------ TOTAL 9,419 9,966
Included in work in process, materials, parts and supplies is an amount of NLG 534 million (1997: NLG 364 million) of customer orders net of advance payments of NLG 242 million (1997: NLG 341 million). 99 71 12 OTHER NON-CURRENT FINANCIAL ASSETS The changes during 1998 are as follows:
other loans and restricted security non-current liquid total investments receivables assets ----- ----------- ----------- --------- Balance as of January 1, 1998 674 279 256 139 Changes: Acquisitions/additions 3,596 3,447 130 19 Sales/redemptions (232) (83) (149) - Value adjustments (9) (6) (3) - Translation and exchange differences (9) (2) (7) - Changes in consolidations 4 15 (11) - Other 77 77 - - ----- ----- ---- --- BALANCE AS OF DECEMBER 31, 1998 4,101 3,727 216 158 Accumulated total of write-downs included in the book value 19 8 11 -
Included in other non-current financial assets are securities that generate income unrelated to normal business operations. Other loans and non- current receivables are stated net of allowances for doubtful accounts of NLG 11 million (1997: NLG 2 million). Included in security investments are shares valued at NLG 198 million (1997: NLG 207 million) that are not available for trade or redemption. In connection with the sale of PolyGram to Seagram, Philips received 47,831,952 shares of Seagram whose fair value upon receipt on December 10, 1998 amounted to NLG 3,091 million and is recorded under security investments. Philips is restricted from selling this 12% shareholding until December 2000, a period of two years from the acquisition date. At year-end 1998, the market value of the Seagram shares that Philips holds amounted to NLG 3,399 million. In connection with the sale of Optoelectronics B.V. to Uniphase Corporation, Philips received 3,259,646 common shares and 100,000 preference shares of Uniphase Corporation, making Philips a 8.5% stockholder in Uniphase. Philips is restricted from selling these shares for a period of one year from the acquisition date. At December 31, 1998, they are recorded under security investments at their fair value upon receipt of NLG 356 million. At year-end 1998, the market value of the Uniphase shares that Philips holds amounted to NLG 427 million. 13 NON-CURRENT RECEIVABLES Included in non-current receivables are receivables with a remaining term of more than one year and the non-current portion of income taxes receivable for an amount of NLG 80 million (1997: NLG 219 million). Prepaid expenses in 1998 include prepaid pension costs of NLG 2,005 million (1997: NLG 2,121 million) and deferred tax assets of NLG 1,057 million (1997: NLG 1,088 million). 100 72 14 PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment decreased from NLG 15,283 million at year-end 1997 to NLG 14,488 million at year-end 1998. The changes during 1998 were as follows:
prepayments land machinery and no longer and and other construction productively total buildings installations equipment in progress employed ----- --------- ------------- --------- ------------ ------------ Balance as of January 1, 1998: Cost 37,161 7,555 21,663 6,215 1,632 96 Accumulated depreciation (21,878) (3,637) (13,508) (4,655) - (78) ------- ------ ------- ------ ----- ---- Book value 15,283 3,918 8,155 1,560 1,632 18 Changes in book value: Capital expenditures 3,600 403 2,399 799 (7) 6 Retirements and sales (464) (142) (247) (67) (4) (4) Depreciation (3,271) (306) (2,133) (829) (2) (1) Write-downs due to impairment (289) (18) (237) (34) - - Translation differences (402) (85) (226) (41) (49) (1) Changes in consolidations 31 114 (31) (23) (29) - ------- ------ ------- ------ ----- ---- Total changes (795) (34) (475) (195) (91) - Balance as of December 31, 1998: Cost 36,741 7,609 21,492 6,011 1,541 88 Accumulated depreciation (22,253) (3,725) (13,812) (4,646) - (70) ------- ------ ------- ------ ----- ---- BALANCE 14,488 3,884 7,680 1,365 1,541 18
Land is not depreciated. The difference between replacement cost and historical cost of property, plant and equipment at year-end is estimated at approximately NLG 2.1 billion. The expected service lives as of December 31, 1998 were as follows: Buildings from 14 to 50 years Machinery and installations from 5 to 10 years Other equipment from 3 to 5 years 101 73 15 INTANGIBLE ASSETS The changes during 1998 were as follows:
patents and other total goodwill trademarks intangibles ----- -------- ---------- ---------- Balance as of January 1, 1998: Acquisition cost 886 886 -- -- Accumulated amortization (418) (418) -- -- ----- ----- ----- ----- Book value 468 468 -- -- Changes in book value: Acquisitions 1,370 807 118 445 Amortization and write-downs (569) (119) (5) (445) Translation differences (48) (46) (2) -- ----- ----- ----- ----- Total changes 753 642 111 -- Balance as of December 31, 1998: Acquisition cost 1,996 1,885 111 -- Accumulated amortization (775) (775) -- -- ----- ----- ----- ----- BALANCE 1,221 1,110 111 --
Acquisitions under other intangibles represent the amount paid for in-process R&D as part of the acquisition of ATL Ultrasound and Active Impulse Systems, which amount was charged directly to the 1998 income statement. As part of these acquisitions, additionally an amount of NLG 118 million was paid for patents and trademarks and capitalized as an intangible asset. Furthermore, these acquisitions led to an increase in goodwill paid of NLG 783 million. The remaining goodwill paid arose from various smaller acquisitions. 16 ACCRUED LIABILITIES Accrued liabilities are summarized as follows:
1998 1997 ----- ----- Salaries and wages payable 860 1,100 Income tax payable 458 565 Accrued holiday rights 454 465 Accrued pension costs 365 -- Commissions, freight, interest and rent payable 685 673 Other transitory liabilities 3,574 3,275 ----- ----- TOTAL 6,396 6,078
102 74 17 PROVISIONS Provisions are summarized as follows:
1998 1997 ------ ------ Pensions: - defined benefit plans 2,336 2,074 - other pension obligations 206 557 - other postretirement benefits 648 626 Income taxes (see note 4) 258 248 Restructuring (see note 2) 584 718 Obligatory severance payments 429 440 Replacement and guarantees 870 818 Other provisions 1,247 1,683 ----- ----- TOTAL 6,578 7,164 Long-term 4,450 5,098 Short-term 2,128 2,066
Pensions and postretirement benefits other than pensions Employee pension plans have been established in many countries in accordance with the legal requirements, customs and the local situation in the countries involved. The majority of employees in Europe and North America are covered by defined benefit plans. The benefits provided by these plans are based primarily on years of service and employees' compensation near retirement. In addition to providing pension benefits, the Company provides other postretirement benefits, primarily retiree healthcare benefits, in certain countries. Provided is a table with a summary of the changes in the pension benefit obligations and defined pension plan assets for 1998 and 1997, and a reconciliation of the funded status of these plans to the amount recognized in the consolidated balance sheets. Also provided is a table with a summary of the changes in the unfunded accumulated postretirement benefit obligation for 1998 and 1997 and a reconciliation of the obligations to the amounts recognized in the consolidated balance sheets. 103 75
1998 1997 1998 1997 ---------------------- ------------------ Pension benefits Other benefits BENEFIT OBLIGATION Benefit obligation at beginning of year 36,200 31,000 993 906 Service cost 802 633 25 20 Interest cost 2,057 2,074 73 70 Plan participants' contribution 72 81 - - Actuarial (gains) and losses 699 3,377 167 (22) Plan amendments 7 95 - - Settlements (284) (8) - - Curtailments (6) (16) - - Changes in consolidations 717 (18) - - Benefits paid (1,759) (1,587) (75) (64) Exchange rate differences (639) 1,017 (48) 88 Miscellaneous 757 (448) 8 (5) ------ ------ ------ ---- BENEFIT OBLIGATION AT END OF YEAR 38,623 36,200 1,143 993 PLAN ASSETS Fair value of plan assets at beginning of year 40,400 35,500 - Actual return on plan assets 4,434 5,096 - Employee contributions 72 61 - Plan participants' contribution (88) 79 - Settlements (232) - - Changes in consolidation 354 (16) 35 Benefits paid (1,626) (1,453) - Exchange rate differences (709) 1,224 - Miscellaneous 637 (91) - ------ ------ ------ FAIR VALUE OF PLAN ASSETS AT END OF YEAR 43,242 40,400 35 Funded status 4,619 4,200 (1,108) (993) Unrecognized net transition (asset) obligation (821) (1,034) 387 431 Unrecognized prior service cost 377 464 6 - Unrecognized net (gain) loss (4,871) (3,583) 67 (64) ------ ------ ------ ---- NET BALANCES (696) 47 (648) (626) Classification of the net balances are as follows: - prepaid pension costs under non-current receivables 2,005 2,121 - accrued pension costs under accrued liabilities (365) - - provisions for pensions under provisions (2,336) (2,074) ------ ------ (696) 47
104 76 The weighted average assumptions underlying the pension computation at December 31 were:
1998 1997 ---- ---- Discount rate 5.4% 6.4% Rate of compensation increase 3.3% 3.5% Expected return on plan assets 6.4% 7.2%
Contributions are made by the Company, as necessary, to provide assets sufficient to meet the benefits payable to defined benefit pension plan participants. These contributions are determined based upon various factors, including legal and tax considerations as well as local customs. The Company funds certain defined benefit pension plans and other postretirement benefit plans as claims are incurred. The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for defined benefit pension plans with accumulated benefit obligations in excess of plan assets were NLG 1,224 million, NLG 1,147 million and NLG 971 million, respectively as of December 31, 1998 (1997: NLG 855 million, NLG 831 million and NLG 735 million, respectively). The components of net periodic pension cost related to major defined benefit plans, are as follows:
1998 1997 1996 ---- ---- ---- Service cost - benefits earned during the period 802 633 587 Interest cost on the projected benefit obligation 2,057 2,074 1,940 Expected return on plan assets (2,454) (2,196) (2,070) Net amortization of unrecognized net transition assets (207) (198) (191) Net actuarial gain recognized (124) (55) (15) Amortization of prior service cost 59 47 43 Settlement gain (57) - - Minimum pension liability loss 102 - - ------- ------- ------- NET PERIODIC PENSION COST 178 305 294
The Company also sponsors defined contribution and similar type plans for a significant number of salaried employees. The total cost with respect to these plans amounted to NLG 368 million in 1998 (1997: NLG 446 million, 1996: NLG 483 million). The components of the net periodic cost of postretirement benefits other than pensions are:
1998 1997 1996 ---- ---- ---- Service cost - benefits earned during the period 25 20 19 Interest cost on accumulated postretirement benefit obligation 73 70 62 Amortization of unrecognized transition obligation 30 32 29 Net actuarial gain recognized - (3) - ------- ------- ------- Net periodic cost 128 119 110
105 77 The accumulated postretirement benefit obligation was determined using a weighted average discount rate of 6.3% (1997: 7.1%) and a weighted average compensation increase, where applicable, of 4.25% (1997: 3.5%). For measurement purposes, the rate of increase in per capita health care costs is assumed to be on average 6.5% for 1999, reaching 5% by the year 2002. Health care cost trend assumptions have a significant effect on the amounts reported for other postretirement benefits. Increasing the assumed health care cost trend rate by 1 percentage point would increase the accumulated postretirement benefit obligation as of December 31, 1998 by approximately NLG 116 million and increase the net periodic postretirement benefit cost for 1998 by NLG 11 million. Conversely, decreasing the assumed health care cost trend by 1 percentage point would decrease the accumulated postretirement benefits as of December 31, 1998 by approximately NLG 99 million and decrease the net periodic postretirement benefit cost for 1998 by NLG 11 million. Obligatory severance payments The provision for obligatory severance payments covers commitments to pay to employees, or to relatives of deceased former employees, a lump sum in the case of retirement because of age, or in the case of death or dismissal of resignation of employees. Replacement and guarantees The provision for replacement and guarantees reflects the estimated costs of replacement and free-of-charge services that will be incurred by the Company with respect to products that have been sold. Other provisions Other provisions cover a wide range of risks and obligations. Included are provisions for expected losses on existing projects/orders for an amount of NLG 100 million (1997: NLG 120 million) and environmental provisions of NLG 356 million (1997: NLG 381 million). The changes in the provisions for obligatory severance payments, replacement and guarantees and other provisions are as follows: Balance as of January 1, 1998 2,941 Changes: - Additions 1,044 - Write-offs (1,439) ------ BALANCE AS OF DECEMBER 31, 1998 2,546
18 OTHER CURRENT LIABILITIES Other current liabilities are summarized as follows:
1998 1997 ----- ----- Advances received from customers on orders not covered by work in process 322 341 Other taxes including social security premiums payable 863 983 Other short-term liabilities 862 141 ----- ----- TOTAL 2,047 1,465
106 78 19 SHORT-TERM DEBT Included in short-term debt are outstanding short-term bank borrowings totaling NLG 1,440 million (1997: NLG 1,508 million) and other short-term loans totaling NLG 325 million (1997: NLG 302 million) which include the current portion of long-term debt totaling NLG 315 million (1997: NLG 241 million). The weighted average interest rate on the bank borrowings was 6.5% (1997: 6.5%, 1996: 5.9%). 20 LONG-TERM DEBT
range of average rate amount due in due after due after average interest rates of interest outstanding 1999 1999 2003 remaining --------------- ------------- ----------- ------- --------- --------- --------- term (in years) Convertible debentures 1.2 1.2 167 - 167 - 4.0 Other debentures 5.6 - 8.8 7.3 4,866 50 4,816 3,128 7.0 Private financing 3.0 - 8.5 4.0 27 13 14 1 1.7 Bank borrowings 2.0 - 8.4 6.8 756 143 613 109 3.1 Other long-term debt 5.4 - 7.0 5.9 639 109 530 134 4.2 ---- ------ ------ ------ ------ TOTAL 6.7 6,455 315 6,140 3,372 Corresponding data previous year 7.3 7,313 241 7,072 4,116
The following amounts of long-term debt as of December 31, 1998 are due in the next five years: 1999 315 2000 685 2001 1,117 2002 530 2003 436 ----- 3,083 Corresponding amount previous year 3,197
In 1998 and in 1997 certain debt was repaid prior to maturity resulting in a redemption premium which was charged against extraordinary items (see note 7). Approximately NLG 5.8 billion of the outstanding long-term debt is at fixed interest rates. In the Netherlands, Philips issues personnel debentures with a 5-year right of conversion, all of which are convertible into common shares of Royal Philips Electronics. These personnel debentures are available to all permanent employees and are purchased by them with their own funds. They are redeemable on demand but in practice are considered to be a form of long-term financing. The personnel debentures become non-convertible debentures at the end of the conversion period. At such time, they will be reported as other long-term debt. The right of conversion currently exists for all debentures. At December 31, 1998 an amount of NLG 167 million (1997: NLG 130 million) of personnel debentures was outstanding with an average conversion price of NLG 111.50 and an interest rate of 1.2%. The conversion price varies between NLG 51.60 and NLG 189.90, with various conversion periods ending between January 1, 1999 and December 31, 2003. 107 79 21 COMMITMENTS AND CONTINGENT LIABILITIES The total of long-term lease commitments amounted to NLG 1,388 million in 1998 (1997: NLG 1,722 million). These leases expire at various dates during the next 40 years. The payments which fall due in connection with these obligations during the coming five years are: 1999 313 2000 269 2001 171 2002 130 2003 113 The total amount of contingent liabilities was NLG 57 million (1997: NLG 95 million). Guarantees given with regard to unconsolidated companies and third parties amounted to NLG 801 million (1997: NLG 1,386 million). Royal Philips Electronics and certain of its group companies are involved as plaintiff or defendant in litigation relating to such matters as competition issues, commercial transactions, product liability, participations and environmental pollution. On the basis of information received to date, the Board of Management is of the opinion that this litigation should not materially affect Royal Philips Electronics' financial position and results of operations. Although the Company has taken what it believes are reasonable, prudent measures to mitigate the risks through the implementation of the Philips Millennium program, the Company can give no assurances that such measures will be sufficient to prevent a materially adverse impact on its operations, liquidity and financial condition. The Company expects that the program's progression will result in reduced uncertainty relating to the Company's Year 2000 compliance and a reduced likelihood of interruptions to its operations. 22 SHARE PREMIUM AND OTHER RESERVES Share premium Share premium is fully exempt from Dutch taxes upon distribution to shareholders. Warrants Warrants for the purchase of common shares of Royal Philips Electronics were issued in 1992 to the remaining shareholders in Superclub Holding & Finance S.A. with an exercise price of NLG 34.00. All remaining warrants expired on June 30, 1998. Option rights Certain officers of the Company have been granted stock options on shares of Royal Philips Electronics at original exercise prices equal to market prices of the shares at the date of grant (see note 23). 108 80 Other reserves In accordance with Dutch legislation, all other reserves are available for distribution to shareholders at December 31, 1998, without any restrictions. The repurchase and sale of shares of Royal Philips Electronics held as treasury stock are directly accounted for in stockholders' equity under other reserves. In order to reduce potential dilution effects, a total of 4,601,869 shares were acquired during 1998 at an average market price of NLG 154.43 per share and a total of 3,624,887 shares were sold at an average conversion price of NLG 74.97. There were 7,804,607 shares held by group companies as of December 31, 1998 (1997: 6,827,625 shares) acquired at an average price of NLG 147.58 per share. 23 STOCK-BASED COMPENSATION The Company has granted stock options on its common shares to certain officers and directors. The purpose of the stock option plans is to align the interest of management with the interest of shareholders by providing certain officers and other key employees with additional incentives to increase the Company's performance on a long-term basis, thereby increasing shareholder value. Under the Company's fixed option plans, options are granted at a price not less than the fair market value of the stock on the date of grant. Certain of these options were granted with a contractual life of five years and cliff vesting up to three years from the date of grant. The consideration for these options owed to the Company by the grantees is fixed at 7.5% of the exercise price. In 1998, the Company redesigned the stock option plans in line with guidelines from the fiscal authorities in the Netherlands. Also the Company no longer provides loans to employees to fund the exercise of options. The amount owed to the Company is lent to the grantee and is to be repaid upon exercise. Other options granted under the Company's fixed option plans have a ten-year contractual life and vest within three years from the date of grant. Prior to 1998, options were granted under the Company's variable plans at a price equal to the market value of the stock on the date of grant, subject to the achievement of certain financial objectives during multi-year performance cycles. The options vest within three years after the end of the performance cycle and have a ten-year term. Exercise of all options is restricted by the Company's rules on insider trading. USD-denominated stock options are granted to employees in the US only. 109 81 The pro forma net income, calculated as if the fair value of the options granted to officers and directors would have been considered as compensation costs is as follows:
1998 1997 1996 ------ ----- ----- Net income (loss), as reported 13,339 5,733 (590) Pro forma net income (loss) 13,298 5,724 (621) Basic earnings per share as reported 37.05 16.41 (1.73) Pro forma basic earnings per share 36.93 16.38 (1.82)
This pro forma net income may not be representative of that to be expected in future years. The fair value of the Company's 1998, 1997 and 1996 option grants was estimated using a Black-Sholes option pricing model and the following assumptions: FIXED OPTION PLANS
1998 1998 1997 1996 ------ ------------------------ (USD denominated) (NLG denominated) Risk-free interest rate 5.30% 4.16% 3.87% 4.80% Expected dividend yield 1.40% 1.40% 1.50% 2.00% Expected option life 5 yrs. 3 yrs. 3 yrs. 3 yrs. Expected stock price volatility 34% 36% 29% 25% VARIABLE OPTION PLANS (USD denominated) Risk-free interest rate 6.30% 5.75% Expected dividend yield 1.50% 2.00% Expected option life 4 yrs. 5 yrs. Expected stock price volatility 30% 29%
These assumptions were used for these calculations only and do not necessarily represent an indication of management's expectations of future development. 110 82 The following table summarizes information about the stock options outstanding at December 31, 1998: Fixed option plans
options outstanding options exercisable -------------------------------------------- ----------------------------- number exercise weighted number weighted outstanding price per average exercisable average at Dec. 31, share remaining at Dec. 31, price per 1998 (price in NLG) contractual 1998 share life (years) (price in NLG) 1994 130,100 50.00 0.2 130,100 50.00 1995 316,800 55.60 1.2 316,800 55.60 1996 719,000 58.30- 66.40 2.2 719,000 66.13 1997 1,361,400 81.00-171.30 3.3 - 1998 1,316,900 102.00-185.30 4.2 - (price in USD) 1998 621,150 51.75-94.37 9.3 - --------- --------- 4,465,350 1,165,900 Variable plans (price in USD) (price in USD) 1991-1992 42,454 11.81-21.38 2.0 42,254 12.82 1993-1994 182,250 11.00-27.56 4.0 182,250 11.66 1995-1997 976,480 30.00-56.81 6.0 236,866 31.41 --------- --------- 1,201,184 461,370
111 83 A summary of the status of the Company's stock option plans as of December 31, 1998, 1997 and 1996 and changes during the years then ended is presented below: Fixed option plans
1998 1997 1996 ------------------------ --------------------- ------------------------ shares weighted shares weighted shares weighted average average average exercise exercise exercise price price price in NLG in NLG in NLG Outstanding at the beginning of the year 5,290,500 68.77 6,805,600 54.95 6,889,800 43.35 Granted 1,316,900 143.64 1,376,400 96.98 2,031,400 66.21 Exercised (2,763,200) 57.70 (2,891,500) 49.70 (2,115,600) 27.99 Forfeited - - - ---------- ---------- ---------- Outstanding at the end of the year 3,844,200 102.37 5,290,500 68.77 6,805,600 54.95 Weighted average fair value of options granted during the year in NLG 34.32 18.57 10.23 price in USD Outstanding at the beginning of the year - Granted 626,900 71.61 Exercised - Forfeited (5,750) 73.34 ------- Outstanding at the end of the year 621,150 69.34 Weighted average fair value of options granted during the year in USD 24.50
Variable plans
shares weighted shares weighted shares weighted average average average exercise exercise exercise price price price in USD in USD in USD Outstanding at the beginning of the year 1,819,038 26.32 2,367,051 23.32 2,421,897 21.61 Granted - 32,440 40.26 154,022 36.15 Exercised (399,860) 18.94 (532,351) 12.74 (197,207) 12.97 Forfeited (217,994) 31.65 (48,102) 38.19 (11,661) 12.92 --------- --------- --------- Outstanding at the end of the year 1,201,184 27.80 1,819,038 26.32 2,367,051 23.32 Weighted average fair value of options granted during the year in USD - 11.87 10.83
112 84 24 FINANCIAL INSTRUMENTS AND RISK MANAGEMENT Concentrations of credit risk Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. The Company does not have significant exposure to any individual customer or counterparty. To reduce exposure to credit risk, the Company performs ongoing credit evaluations of the financial condition of its customers but generally does not require collateral. The Company invests available cash and cash equivalents with various banks. The Company is exposed to credit-related losses in the event of non-performance by counterparties with respect to derivative financial instruments. However, given their high credit ratings, management does not expect any counterparties to fail to meet their obligations. Fair value of financial assets and liabilities The estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methods. The estimates presented are not necessarily indicative of the amounts that the Company could realize in a current market exchange or the value that ultimately will be realized by the Company upon maturity or disposition. Additionally, because of the variety of valuation techniques permitted under SFAS No. 107, comparability of fair values between entities may not be meaningful. The use of different market assumptions and/or estimation methods may have a material effect on the estimated fair value amounts.
December 31, 1998 December 31, 1997 --------------------- --------------------- carrying estimated carrying estimated amount fair value amount fair value Assets: Cash and cash equivalents 14,441 14,441 3,079 3,092 Accounts receivable - current 11,312 11,312 11,699 11,699 Other financial assets 4,101 4,494 674 674 Accounts receivable - non-current 1,084 1,084 542 542 Liabilities: Accounts payable (6,496) (6,496) (6,400) (6,400) Debt (7,905) (8,380) (8,882) (9,282) Currency exchange agreements (net) (29) (29) (8) (8)
The following methods and assumptions were used to estimate the fair value of financial instruments: Cash, accounts receivable and accounts payable The carrying amounts approximate fair value because of the short maturity of those instruments. 113 85 Cash equivalents The fair value is based on the estimated aggregate market value. Other financial assets For other financial assets, fair value is based upon the estimated market prices or, because they bear interest, at current market rates. The fair value of equity investments is based on quoted market prices. Debt and conversion certificates The fair value is estimated on the basis of the quoted market prices for certain issues, or on the basis of discounted cash flow analyses based upon Philips' incremental borrowing rates for similar types of borrowing arrangements with comparable terms and maturities. Currency exchange agreements The fair value is the amount that the Company would receive or pay to terminate the exchange agreements, considering currency exchange rates and remaining maturities. 114 86 25 APPLICATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN THE UNITED STATES OF AMERICA The accounting policies followed in the preparation of the consolidated financial statements differ in some respects from those generally accepted in the United States of America. To determine net income and stockholders' equity in accordance with generally accepted accounting principles in the United States of America (US GAAP), Philips has applied the following accounting principles: - Under Dutch GAAP, goodwill arising from acquisitions prior to 1992 was charged directly to stockholders' equity. According to US GAAP, goodwill arising from acquisitions, including those prior to 1992, is capitalized and amortized over its useful life up to a maximum period of 40 years. As a result of the sale of PolyGram, goodwill has been fully amortized and charged to the gain on disposal in 1998 income under US GAAP. - Philips reported a charge to income from operations of NLG 726 million for restructurings in its 1998 financial statements. A portion of this restructuring, NLG 89 million (NLG 51 million net of taxes), was not communicated to employees until early 1999 and, accordingly, will be recorded under US GAAP as a charge in 1999. An identical restructuring charge for Grundig was recorded in 1995 under Dutch GAAP for an amount of NLG 262 million, which under US GAAP was reflected in the 1996 accounts. Until 1997 the Company had an obligation under certain put options given to other shareholders in Grundig. For the purposes of US GAAP this liability was recorded in 1995, whereas under Dutch GAAP it was accrued in 1996. Philips settled this obligation. - In 1998, Philips reported a charge to net income of NLG 74 million (1997: NLG 139 million) relating to a higher accumulated benefit obligation compared to the market value of the plan assets or the existing level of the pension provision in two of the Company's pension plans. For US GAAP purposes, this amount is capitalized as an intangible asset for this additional minimum liability, or directly charged to comprehensive income. - In July 1995, Philips contributed its net assets of cable networks, with a book value of approximately NLG 200 million, to UPC, a newly established joint venture in which Philips had acquired a 50% interest. Under Dutch GAAP, this transfer resulted in a gain of NLG 127 million relating to the partial disposal of its interest in these assets to the other joint venture party (UIH). For US GAAP purposes, this gain was not considered realized because the consideration received by Philips principally consisted of equity and notes issued by UPC and equity in UIH, instead of cash. In 1997, Philips sold its 50% interest in this joint venture, the gain of NLG 127 million on this transaction was recognized under US GAAP in 1997. - Under Dutch GAAP's historical cost convention, Philips generally considers the functional currency of entities in a highly inflationary economy to be the US dollar. Under US GAAP, the functional currency would be the reporting currency. The difference between the use of the US dollar as the functional currency instead of the reporting currency is not material. 115 87 - Under Dutch GAAP, securities available for sale are valued at the lower of cost or net realizable value. Under US GAAP they are valued at market price, unless such shares are restricted by contract for a period of one year or more. Under US GAAP, unrealized holding gains or losses will be credited or charged to stockholders' equity. - Under US GAAP, it is not appropriate to record a liability for dividends/distribution to shareholders subject to approval of the Annual General Meeting of Shareholders. - Under Dutch GAAP, majority-owned entities are consolidated. Under US GAAP, consolidation of majority-owned entities is not permitted if minority interest holders have the right to participate in operating decisions of the entity. Although Philips owned 60% of Philips Consumer Communications under US GAAP the venture with Lucent Technologies could not be consolidated but should have been accounted for under the equity method. For the effect of the consolidation, reference is made to note 1. - Under Dutch GAAP, catalogues of recorded music, music publishing rights, film rights and theatrical rights belonging to PolyGram, which company was sold in 1998, were written down if and to the extent that the present value of the expected income generated by the acquired catalogues falls below their book value. Under US GAAP they were initially amortized over a maximum period of 30 years. As a result of the sale of PolyGram, the cumulative amortization has been credited to the gain on disposal in 1998 income under US GAAP. - According to US GAAP, divestments which cannot be regarded as discontinued segments of business must be included in income from continuing operations. Under Dutch GAAP, certain material transactions such as disposals of lines of activities, including closures of substantial production facilities, have been accounted for as extraordinary items, which under US GAAP would be recorded in income from operations. - Under Dutch GAAP, funding of NavTech activities is accounted for as results relating to unconsolidated companies (1998: NLG 134 million, 1997: NLG 210 million, 1996: NLG 66 million) whereas under US GAAP these amounts have to be included in income from operations as research and development costs. 116 88 Reconciliation of net income according to Dutch GAAP versus US GAAP
1998 1997 1996 ----- ----- ------ Income from continuing operations as per the consolidated statements of income 1,192 2,712 278 Reclassification extraordinary items under Dutch GAAP 1,044 2,538 (1,313) Adjustments to US GAAP: - amortization of goodwill from acquisitions prior to 1992 - (21) (50) - reversal of provisions for restructuring (net) 51 - (262) - liabilities relating to Grundig put options - - 127 - additional minimum liabilities under SFAS No. 87 (net) 74 139 - - reversal of gain on UPC transaction - 127 - - pension cost relating to the acquisition of PENAC - (16) (13) - other items (15) (15) (21) ------ ----- ------ INCOME FROM CONTINUING OPERATIONS IN ACCORDANCE WITH US GAAP 2,346 5,464 (1,254) Income from discontinued operations 462 513 388 Gain on disposal of discontinued operations 10,316 - - Extraordinary items (34) (96) - ------ ----- ------ NET INCOME IN ACCORDANCE WITH US GAAP 13,090 5,881 (866) Basic earnings per common share in NLG: - income (loss) from continuing operations 6.52 15.64 (3.67) - income from discontinued operations 1.28 1.46 1.14 - gain on disposal of discontinued operations 28.65 - - - extraordinary items (0.09) (0.27) - - net income (loss) 36.36 16.83 (2.53) Diluted earnings per common share in NLG: - income (loss) from continuing operations 6.46 15.34 (3.67) - income from discontinued operations 1.27 1.44 1.14 - gain on disposal of discontinued operations 28.42 - - - extraordinary items (0.09) (0.27) - - net income (loss) 36.06 16.51 (2.53)
117 89 In addition to the reconciliation of net income in accordance with Dutch GAAP versus US GAAP, the disclosure of `Comprehensive Income' is required to be reported under US GAAP, commencing in 1998. Comprehensive income is defined as all changes in equity of a business enterprise during a period, except investments by, and distributions to equity owners. Accordingly, comprehensive income consists of net income and other items that are reflected in stockholders' equity on the balance sheet and have been excluded from the income statement. Such items of other comprehensive income include foreign currency translation adjustments, gains and losses on currency transactions qualifying for hedge treatment, certain pension liability-related losses not yet recorded as pension costs and unrealized holding gains and losses on securities available for sale. Comprehensive income statement
1998 1997 1996 ------- ------- ------ Net income in accordance with US GAAP 13,090 5,881 (866) Other comprehensive income (net of taxes): - translation differences (335) 646 1,076 less: reclassification for translation losses included in net income (93) (85) (124) - deferred foreign exchange results 34 - - - minimum pension liability charge (108) - - - holding gain on securities available for sale 71 (140) (101) ------- ------- ------ COMPREHENSIVE INCOME IN ACCORDANCE WITH US GAAP 12,659 6,302 (15)
Reconciliation of stockholders' equity according to Dutch GAAP versus US GAAP
1998 1997 ------ ------ Stockholders' equity as per consolidated balance sheets 31,292 19,457 Equity adjustments that affect net income: Intangible assets - goodwill (Polygram) - 758 Intangible assets - catalogues of recorded music - (399) Reversal of provisions for restructuring 51 - Intangible assets relating to additional liabilities under SFAS No. 87 105 139 Adjustment highly inflationary countries, mainly to property, plant and equipment 49 64 Equity adjustments not affecting net income under US GAAP: Holding gain on securities available for sale 71 - Dividend payable subject to approval of the Annual General Meeting of Shareholders 794 716 ------ ------ STOCKHOLDERS' EQUITY IN ACCORDANCE WITH US GAAP 32,362 20,735 Translation differences as included in stockholders' equity (3,108) (2,773)
118 90 26 INFORMATION RELATING TO PRODUCT SECTORS AND GEOGRAPHIC AREAS SEGMENT REPORTING In 1998, the Company changed its product sector reporting to comply with the new requirements of Statement of Financial Accounting Standard No. 131, issued by the Financial Accounting Standards Board of the USA. As a consequence, the Philips activities are now grouped together into seven product sectors and reported separately: Lighting, Consumer Products, Components, Semiconductors, Professional, Origin, Miscellaneous. LIGHTING Philips is a leader in the world lighting market. A wide variety of applications are served by a full range of incandescent and halogen lamps, automotive lamps, high-intensity gas-discharge and special lamps, QL induction lamps, fixtures, ballasts, lighting electronics and batteries. CONSUMER PRODUCTS This sector comprises the divisions Consumer Electronics and Domestic Appliances and Personal Care. Moreover, the revenues from license agreements are included in this sector. Consumer Electronics This division markets a wide range of consumer products in the following areas: video products (TV, VCR, tuners, remote controls), audio (audio systems, portable products, speaker systems, CD-Recordable), PC peripherals (monitors, PC add-ons), personal communication (mobile phones, corded/cordless phones) and new digital products (DVD, Flat TV, Internet TV, mobile computing products such as Velo, Nino). Domestic Appliances and Personal Care This division markets a wide range of products in the following areas: home comfort (vacuum cleaners, steam irons, etc.), kitchen appliances (food processors, mixers, coffee makers, etc.) and personal care (shavers, depilators, hair dryers, etc.). COMPONENTS Philips Components is a major supplier of components and subsystems, with a wide range of products, such as picture tubes (both for TV and Monitors), liquid crystal displays (LCDs), passive components, magnetic products and modules for optical storage. SEMICONDUCTORS Philips Semiconductors is a leading supplier of integrated circuits (ICs) and discrete semiconductors for application in consumer, telecommunication, multimedia and automotive electronics. 119 91 PROFESSIONAL This sector comprises the divisions Medical Systems and Business Electronics. Medical Systems Philips is among the top three makers of systems for diagnostic imaging, based on x-ray, magnetic resonance and ultrasound technologies. It also provides consultancy services, information management, training and technical services to its customers in the healthcare sector. Business Electronics This division focuses on the business-to-business sector. Main product areas are digital video-communication systems, broadband network equipment, business communication systems, communication and security systems, and fax equipment. The division is a major supplier of electronic manufacturing equipment to the semiconductor industry. It also deals with infrastructural and industrial projects. ORIGIN Origin is a global IT service company delivering systems and a full range of services that facilitate total business solutions for clients. It is represented in more than 30 countries. Philips holds a majority interest of 88% in Origin B.V. MISCELLANEOUS This sector comprises not only various ancillary businesses including Philips Plastics and Metalware Factories and Philips Machinefabrieken but also various (remaining) activities that have been sold, discontinued, phased out or deconsolidated in earlier years, such as Grundig, Philips Media, Philips Car Systems, Super Club and ASM Lithography. UNALLOCATED The sector Unallocated includes general and administrative expenses in the corporate center and the national organizations. The costs of basic research and patents are included in the Miscellaneous sector. All years presented have been restated for comparability reasons and reflect the performance of continuing operations, i.e. excluding PolyGram, which also ceased to be a separate product sector. For a description of various product divisions included in the product sectors, reference is made to the relevant section in this report. 120 92 Sales to third parties by product sector and by geographic area are shown in the following tables. Sales to third parties by geographic area represent the total proceeds from products and services supplied to third parties in the geographic area concerned. The sales growth rates are also presented on a comparable basis, adjusted for the effects of changes in consolidations and exchange rate movements. The sales volumes of the various business activities and the associated income from operations by product sector and by geographic area are set forth in the following tables. Segment revenues include sales to third parties (`sales') as well as sales of products and services between the product sectors (`intersegment sales'). Included in segment revenues by geographic area is the total revenue from worldwide sales to third parties by companies located within that geographic area, as well as the total value of sales to consolidated companies in other geographic areas (`interregional sales'). The transfer prices charged for all intersegment (including interregional) sales are based on the arm's length principle as set forth in internationally accepted transfer pricing policies and guidelines. Grundig was deconsolidated as of December 31, 1996. However its results of operations were consolidated for the year then ended. Group sales for 1996 included NLG 3.7 billion relating to Grundig. Car Systems was deconsolidated as of December 31, 1997. However its results of operations were consolidated for the year then ended. Group sales for 1997 and 1996 included NLG 1.7 billion and NLG 1.5 billion respectively relating to Car Systems. Both divested activities have now been included in the Miscellaneous sector. The Consumer Products sector includes 3 months of operations of the PCC/Lucent joint venture in 1997 and 9 months in the current reporting year 1998. For further details reference is made to note 1. 121 93 Sales and sales growth and number of employees by product sector
1998 --------------------------------------------------------------------------------------- sales (to % growth number of third parties) -------------------- employees nominal comparable -------- ---------- Lighting 9,813 (2) 1 48,997 Consumer Products 27,485 9 7 51,643 Components 8,404 4 5 42,613 Semiconductors 7,079 2 5 26,583 Professional 9,961 5 7 24,646 Origin 2,333 25 24 16,948 Miscellaneous 2,047 (45) 6 15,150 Unallocated 7,106 ------- ------- TOTAL 67,122 3 6 233,686
1997 --------------------------------------------------------------------------------------- Lighting 10,024 13 5 51,727 Consumer Products 25,265 19 7 66,046 Components 8,075 27 5 46,131 Semiconductors 6,928 24 14 26,916 Professional 9,478 12 11 21,208 Origin 1,865 30 21 15,464 Miscellaneous 3,723 (52) 6 17,109 Unallocated 7,667 ------- ------- Total 65,358 9 8 252,268
1996 --------------------------------------------------------------------------------------- Lighting 8,869 6 3 49,879 Consumer Products 21,223 11 8 61,113 Components 6,336 17 13 41,995 Semiconductors 5,589 6 1 25,833 Professional 8,458 12 8 24,271 Origin 1,436 407 70 13,341 Miscellaneous 7,796 (19) 2 25,607 Unallocated 7,920 ------- ------- Total 59,707 7 6 249,959
122 94 Sales and sales growth and number of employees by main countries.
1998 --------------------------------------------------------------------------------------- sales (to % growth number of third parties) -------------------- employees nominal comparable -------- ---------- Netherlands 3,642 14 22 44,476 United States 15,786 11 6 25,178 Germany 6,119 (2) 4 14,181 France 4,611 (4) 4 12,228 United Kingdom 4,256 9 12 8,801 Other countries 32,708 (1) 5 128,822 ------ ------- TOTAL 67,122 3 6 233,686
1997 --------------------------------------------------------------------------------------- Netherlands 3,191 (1) 4 46,032 United States 14,159 26 8 30,407 Germany 6,258 (22) 1 15,448 France 4,796 (4) 8 14,779 United Kingdom 3,911 11 2 9,963 Other countries 33,043 15 11 135,639 ------ ------- Total 65,358 9 8 252,268
1996 --------------------------------------------------------------------------------------- Netherlands 3,211 18 5 45,836 United States 11,206 2 2 27,519 Germany 8,039 - - 17,101 France 4,980 - 4 16,663 United Kingdom 3,511 10 9 10,807 Other countries 28,760 12 11 132,033 ------ ------- Total 59,707 7 6 249,959
123 95
Product sectors 1998 ---------------------------------------------- income as % of income segment (loss) from segment (loss) from revenues operations revenues operations* Lighting 9,925 1,311 13.2 1,366 Consumer Products 28,120 (613) (2.2) (118) Components 11,590 98 0.8 200 Semiconductors 8,732 1,687 19.3 1,720 Professional 10,245 (122) (1.2) (72) Origin 3,645 130 3.6 130 Miscellaneous 2,507 (102) (4.1) (104) Unallocated (880) (887) ------ ------ ------ TOTAL 74,764 1,509 2,235 INTERSEGMENT SALES (7,642) ------ SALES 67,122 INCOME FROM OPERATIONS AS A % OF SALES 2.2 3.3
1997 ---------------------------------------------- Lighting 10,141 1,151 11.3 1,239 Consumer Products 26,871 738 2.7 754 Components 11,237 562 5.0 560 Semiconductors 8,359 1,700 20.3 1,731 Professional 9,816 456 4.6 452 Origin 2,918 -- -- -- Miscellaneous 4,632 30 0.6 (3) Unallocated (860) (851) ------ ------ ------ Total 73,974 3,777 3,882 Intersegment sales (8,616) ------ Sales 65,358 Income from operations as a % of sales 5.8 5.9
1996 ---------------------------------------------- Lighting 8,980 702 7.8 795 Consumer Products 22,991 421 1.8 463 Components 9,582 696 7.3 787 Semiconductors 6,753 800 11.8 800 Professional 8,698 40 0.5 55 Origin 2,425 (160) (6.6) (64) Miscellaneous 9,068 (722) (8.0) (589) Unallocated (848) (753) ------ ------ ------ Total 68,497 929 1,494 Intersegment sales (8,790) ------ Sales 59,707 Income from operations as a % of sales 1.6 2.5
* Excluding restructuring 124 96 Geographic Areas
1998 ----------------------------------------------- segment income as % of income revenues (loss) from segment (loss) from operations revenues operations* Netherlands 27,015 982 3.6 1,018 Europe excl. Netherlands 36,206 1,405 3.9 1,534 USA and Canada 18,891 (1,042) (5.5) (639) Latin America 4,436 (451) (10.2) (443) Africa 278 (2) (0.7) (2) Asia 22,065 632 2.9 782 Australia and New Zealand 923 (15) (1.6) (15) ------- ------ ----- TOTAL 109,814 1,509 2,235 INTERREGIONAL SALES (42,692) ------- SALES 67,122 INCOME FROM OPERATIONS AS A % OF SALES 2.2 3.3
1997 ----------------------------------------------- Netherlands 23,424 837 3.6 878 Europe excl. Netherlands 34,887 1,515 4.3 1,574 USA and Canada 16,846 23 0.1 2 Latin America 4,637 (122) (2.6) (122) Africa 250 7 2.8 7 Asia 23,807 1,548 6.5 1,574 Australia and New Zealand 1,316 (31) (2.4) (31) ------- ------ ----- Total 105,167 3,777 3,882 Interregional sales (39,809) ------- Sales 65,358 Income from operations as a % of sales 5.8 5.9
1996 ----------------------------------------------- Netherlands 20,259 220 1.1 447 Europe excl. Netherlands 34,323 (442) (1.3) (268) USA and Canada 12,577 (206) (1.6) (54) Latin America 4,329 241 5.6 253 Africa 275 6 2.2 6 Asia 18,484 1,075 5.8 1,075 Australia and New Zealand 1,194 35 2.9 35 ------- ------ ----- Total 91,441 929 1,494 Interregional sales (31,734) ------- Sales 59,707 Income from operations as a % of sales 1.6 2.5
*Excluding restructuring 125 97 Product sectors
1998 ------------------------------------------------------------------ total net (in)tangible capital depreciation assets operating fixed assets expenditures capital Lighting 5,746 3,887 2,631 420 382 Consumer Products 9,586 3,721 1,811 838 733 Components 6,858 4,563 4,111 659 788 Semiconductors 6,845 4,199 3,492 962 1,002 Professional 6,193 3,034 1,663 194 170 Origin 1,260 324 405 152 140 Miscellaneous 2,251 1,121 889 205 233 Unallocated 23,302 467 707 170 112 ------ ------ ------ ----- ----- TOTAL 62,041 21,316 15,709 3,600 3,560
1997 ------------------------------------------------------------------ Lighting 6,001 4,008 2,732 476 412 Consumer Products 11,205 5,364 2,207 629 742 Components 6,932 4,884 4,308 881 612 Semiconductors 6,911 4,342 3,627 798 812 Professional 4,823 1,942 865 272 217 Origin 1,085 277 445 138 129 Miscellaneous 2,419 594 832 282 235 Unallocated 8,753 751 735 109 129 ------ ------ ------ ----- ----- Total 48,129 22,162 15,751 3,585 3,288 Discontinued operations 3,265 ------ Total 51,394
1996 ------------------------------------------------------------------ Lighting 5,946 4,118 2,715 657 345 Consumer Products 9,614 4,983 2,029 779 718 Components 5,791 4,179 3,640 1,051 632 Semiconductors 6,771 4,437 3,756 1,284 639 Professional 4,975 2,039 932 277 186 Origin 948 209 366 170 143 Miscellaneous 4,081 1,015 1,204 446 407 Unallocated 7,512 441 654 151 98 ------ ------ ------ ----- ----- Total 45,638 21,421 15,296 4,815 3,168 Discontinued operations 2,640 ------ Total 48,278
126 98 Main countries
1998 -------------------------------------------------------------------- total net (in)tangible capital depreciation asset operating fixed assets expenditures capital Netherlands 26,143 6,123 3,598 891 755 United States 7,752 3,388 2,572 341 417 Germany 3,384 1,475 1,539 316 552 France 2,491 348 903 167 285 United Kingdom 1,999 1,111 656 133 141 Other countries 20,272 8,871 6,441 1,752 1,410 ------ ------ ------ ------ ------ TOTAL 62,041 21,316 15,709 3,600 3,560 1997 --------------------------------------------------------------- ---- Netherlands 10,826 6,518 3,720 583 765 United States 8,067 3,003 2,265 304 398 Germany 4,040 1,508 1,546 344 356 France 3,019 884 1,121 309 325 United Kingdom 2,000 1,148 747 161 125 Other countries 20,177 9,101 6,352 1,884 1,319 ------ ------ ------ ------ ------ Total 48,129 22,162 15,751 3,585 3,288 Discontinued operations 3,265 ------ Total 51,394 1996 -------------------------------------------------------------------- Netherlands 11,746 6,611 3,948 1,273 790 United States 5,709 2,447 1,879 531 412 Germany 4,274 1,065 1,687 547 510 France 3,260 1,128 1,301 409 281 United Kingdom 2,017 1,013 716 232 95 Other countries 18,632 9,157 5,765 1,823 1,080 ------ ------ ------ ------ ------- Total 45,638 21,421 15,296 4,815 3,168 Discontinued operations 2,640 ------ Total 48,278
127 99 [Pages 128 to 134 intentionally omitted] 100 SUBSEQUENT EVENT On September 27, 1998, Philips signed a preliminary agreement with an affiliate of Compass Partners International to sell its conventional (non-ceramic) Passive Components business group. The transaction was concluded on January 14, 1999 and resulted in a gain of NLG 0.3 billion, while the relating cash proceeds of NLG 0.8 billion were received in January 1999. PROPOSED DISTRIBUTION OF INCOME OF ROYAL PHILIPS ELECTRONICS Pursuant to article 39 of the Articles of Association, NLG 12,545 million of the income for the financial year 1998 shall be retained by way of reserve. A proposal will be submitted to the General Meeting of Shareholders to declare a dividend of NLG 2.20 per common share from the remaining portion of NLG 794 million. PROPOSED SHARE REDUCTION PROGRAM As part of the share reduction program and apart from the dividend proposal, a proposal will be submitted to the General Meeting of Shareholders to convert part of the surplus paid-in capital into nominal share capital and subsequently to reduce the nominal share capital by distributing a cash amount of NLG 3.3 billion or NLG 9.07 per common share to all Philips' shareholders. This program will be combined with redenomination of the share capital to a par value of 1 euro and is expected to be effected mid-1999. INFORMATION ON THE MILLENNIUM PROGRAM In 1996, Philips established the Philips Millennium Program to address year 2000 issues. These issues relate to business continuity risks in Philips' integral national and international business chains, including the supply base and customer base, caused by systems, products and equipment containing date-sensitive components failing to recognize the year 2000. The Corporate Millennium Office, which is headed by a senior executive who reports directly to the Chief Financial Officer, is responsible for supervising the program. The Corporate Millennium Office monitors the program's headway and regularly provides progress reports to the Board of Management. State of readiness The program has been designed and developed from the business perspective, integrating progressively the internal and external risk factors in the integral business chains, which operate in many different national and regional environments. The program identifies seven interrelated Millennium impact areas: customer base; supply base; IT applications; IT infrastructure; facilities and services; corporate core processes; and countries and regions. The program prescribes a standard procedure comprising the following phases: 1. business impact analysis; 2. strategy definition and action planning; and 3. execution (including remediation, testing and, where applicable, contingencies). All sectors and groups in the Company, such as the businesses, countries and regions and corporate departments, tailor the program as appropriate for these seven impact areas. Dedicated staff, supported by external solution and service providers, are active worldwide. The status of the program in each impact area is summarized below. 135 101 - - Customer base. This impact area consists of Philips' past and present customers. Product compliance has been confirmed by the business for up to 90% of all products. The rest will be confirmed before July 1, 1999. With regard to the processes linking Philips' businesses with their key customers, phase 1 has been completed. Phases 2 and 3, which mainly focus on contingencies and joint activities, will be finalized before September 1, 1999. - - Supply base. This impact area consists of Philips' past and present suppliers. The product compliance issue focuses, at this stage, on IT equipment and manufacturing equipment. Overall, product compliance is approximately 70%-assured, often on the basis of additional in-house testing. The remainder will be finalized by July 1, 1999. With regard to the processes linking Philips' businesses with their key suppliers, phase 1 has been completed. Phases 2 and 3, which mainly focus on contingencies and joint activities, will be finalized before September 1, 1999. - - IT applications and IT infrastructure. These impact areas include application software, as well as hardware and system software. Phases 1 and 2 have been finalized in these areas. Phase 3 was approximately 60% complete by the end of 1998. The remaining phase 3 work will be done during the first half of 1999. Final testing is based upon time-travel-testing on Millennium- compliant test platforms, supported by Origin and external IT suppliers. - - Facilities and services. This impact area consists of buildings, sites and plants, and their internal and external environments. Phase 1 has been finalized; phase 2 is 70% ready; phase 3 is 40% ready. All remaining actions will be completed by July 1, 1999. This impact area also comprises shop-floor equipment and processes. Phase 1 has been finalized; phase 2 is 70% ready; phase 3 is 50% ready. All remaining actions will be completed by July 1, 1999. - - Corporate core processes. This impact area relates to the corporate core processes which are standardized worldwide, e.g. Control, Treasury, Management Development, Audit, etc. Phases 1 and 2 are 80% complete. Phase 3, which mainly focuses on local external risks such as banking services and communications, is 50% ready. All remaining actions, including contingencies, will be finalized before August 1, 1999. - - Countries and regions. In accordance with the allocation of tasks and responsibilities under the Company's governance model, this impact area focuses on minimizing local external risks, e.g. utilities, transportation, customs services, facilities services, communications and banking services. Phase 1 will be completed by March 1, 1999. Phases 2 and 3 will be completed before September 1, 1999. Costs The costs associated with the program are congruent with Philips' ongoing efforts to improve its IT systems and business processes and will provide future benefits to its operations. The Company estimates that the total cost of addressing the year 2000 issues will be approximately NLG 600 million. Major expenditures include the modification and testing of software (NLG 200 million), the hiring of external solution providers (NLG 25 million), the accelerated implementation of new systems (NLG 75 million), the replacement of non-compliant systems (NLG 250 million) and other non-IT costs (NLG 50 million). Since the program's inception in 1996 through the end of 1998, the Company has spent approximately NLG 350 million. The Company expects to incur further expenses totaling approximately NLG 250 million. Certain costs related to contingencies and joint 136 102 activities with third parties (including suppliers and customers), which will be incurred after 2000, can be estimated only towards the end of 1999 and are therefore not included in the above amounts. Philips undertakes a review of costs and expenditures related to the program on a quarterly basis. As further reviews are made, and because cost forecasts are predicated on assumptions of future events (many of which are outside the control of management), estimates of the program's costs may change. Although at present the Company does not expect the impact of year 2000 costs to have a material effect on the results of operations, actual results could be adversely impacted if the estimated costs rise by significant amounts. Risks Although the Company has dedicated significant resources to minimize year 2000 risks, the program's goal of complete year 2000 compliance may not be fully achieved. Any failure to correct all year 2000 problems may result in the interruption or cessation of normal business operations. Such a disruption of business continuity could arise due to a number of factors - (i) loss or corruption of data within Philips' internal information systems, (ii) operational failure of Philips' hardware and (iii) development of health, environmental and safety issues arising in connection with Philips' facilities - and could adversely affect the Company's results, liquidity or financial condition. Nevertheless, the Company views the likelihood of disruption of business continuity as a result of such internal risk factors as relatively small. However, due to the risks inherent in a number of external year 2000 issues, over which the Company has no control or for which no precedents exist, the Company is unable to determine at this time the likelihood of a material impact on its performance. One such issue is that the Company may have either inaccurately assessed or been unable to assess all external risk factors, including the degree of third parties' year 2000 preparedness. Since the beginning of 1998, Philips has been striving to minimize its exposure in this area by obtaining, where possible, assurances from third parties (including customers, suppliers and governmental agencies) of their Millennium readiness and by developing joint actions and contingencies were applicable. However, because Philips is neither able nor allowed to perform detailed reviews of all such third parties, it cannot determine with accuracy the level of their year 2000 readiness. Because the Company is reliant on these parties for the provision of water, energy, banking services, communication services, transportation, customs services, parts and raw materials, as well as other products and services, Philips' operations may be adversely impacted if year 2000 problems prevent these parties from being able to provide such items and services. Furthermore, it is predicted that year 2000 readiness issues will result in a significant amount of litigation. For example, Philips may become involved in third-party claims due to a material interruption or failure of any of its services or products resulting from year 2000 problems. While the outcome and impact of such litigation is impossible to predict due to its unprecedented nature, it may have a materially adverse effect on the Company. Finally, Philips' products may contain undetected year 2000 problems, and the Company cannot give assurances as to the absence of any such defects. 137 103 Although the Company has taken what it believes are reasonable, prudent measures to mitigate these risks through the implementation of the program, the Company can give no assurances that such measures will be sufficient to prevent a materially adverse impact on its operations, liquidity and financial condition. The Company expects that the program's progression will result in reduced uncertainty relating to the Company's year 2000 compliance and a reduced likelihood of interruptions to its operations. Contingencies The Company's contingency policy is designed to alleviate the potential harm that could result from both internal and external risks. Because the Company believes that external risks could exert a more damaging impact on business performance than internal risks, the contingency policy focuses on the former. The Company is in the process of gathering information and qualitatively analyzing these facts to develop a contingency plan to address such risks as the cessation or interruption of utilities, banking, communication, transportation and customs services. Philips' businesses are working to coordinate their respective contingency plans with key suppliers and customers and are specifically considering such elements as logistics, activity scheduling, maintenance and overhaul scheduling, and staff and holiday planning. The Company anticipates having contingency plans to minimize the external risks in place by the third quarter of 1999. With regard to the internal risks, the contingency plans being prepared include an optimized activity schedule for the millennium roll-over, the presence of dedicated support teams on all sites, and the availability of alternative means of communication. Cautionary statement The Company has made forward-looking statements regarding the program. These statements include: (i) the Company's expectations about when it will be year 2000 compliant; (ii) the Company's expectations about the impact of the year 2000 problem on its ability to continue to operate on and after January 1, 2000; (iii) the readiness of its suppliers; (iv) the costs associated with the program; and (v) a discussion of worst-case scenarios. The Company has described many of the risks associated with the above forward-looking statements. However, there are many factors that could cause actual results to differ materially from those stated in the forward-looking statements. This is especially the case because many aspects of the program are outside its control, such as the performance of many thousands of third-party suppliers and of customers and users. As a global company, Philips operates in many different countries; however, the year 2000 problem is not being addressed to the same extent everywhere. As a result, there may be unforeseen problems in different parts of the world. All of these factors make it impossible for the Company to ensure it will be able to resolve all year 2000 problems in a timely manner to prevent them having a materially adverse effect on its operations or business or exposing the Company to third-party liability. 138 104 CORPORATE GOVERNANCE OF THE PHILIPS GROUP General Koninklijke Philips Electronics N.V. (the 'Company') is the parent company of the Philips Group. Its shares are listed on the Amsterdam Exchanges, the New York Stock Exchange, the London Stock Exchange and several other stock exchanges. The management of the Company is entrusted to the Board of Management under the supervision of the Supervisory Board. The activities of the Philips Group are organized in product divisions, which are responsible for the worldwide business policy. Philips has more than 225 production sites in over 25 countries and sales and service outlets in some 150 countries. It delivers products, systems and services in the fields of lighting, consumer electronics and communications, domestic appliances and personal care, components, semiconductors, medical systems, business electronics and information technology. The Company's activities are grouped in seven sectors: Lighting, Consumer Products, Components, Semiconductors, Professional, Origin and Miscellaneous. The statutory list of all subsidiaries and affiliated companies, prepared in accordance with the relevant legal requirements (The Netherlands Civil Code, Book 2, Articles 379 and 414), forms part of the notes to the financial statements and is deposited at the office of the Commercial Register in Eindhoven, the Netherlands (file no. 1910). In their reports to shareholders, both the Board of Management and the Supervisory Board referred to the progress made in recent years in improving the governance of the Company and the Philips Group, in particular in respect of the supervisory function, the rights of shareholders and transparency. These improvements were in response to developments in the international capital markets, such as the United States, where its shares have been traded since 1962 and listed on the New York Stock Exchange since 1987. Philips also generally endorses the recommendations of the Committee of the Amsterdam Exchanges of October 1997 on best practices in corporate governance. Board of Management and Supervisory Board The Board of Management is responsible for the effective management of the business. It is required to keep the Supervisory Board informed of developments, to consult it on important matters and to submit certain important decisions to it for its prior approval. The Board of Management consists of at least three members (currently eight), who are elected for an indefinite period by the General Meeting of Shareholders. The President is appointed by the General Meeting of Shareholders. Members of the Board of Management may be suspended by the Supervisory Board and the General Meeting of Shareholders and dismissed by the latter. The remuneration of the members of the Board of Management is determined by the Supervisory Board upon a proposal from the President and on the advice of the Remuneration Committee of the Supervisory Board. The Supervisory Board is independent of the Board of Management and is responsible for supervising both the policies of the Board of Management and the general direction of the Group's business. It is also required to advise the Board of Management. The Supervisory Board consists of at least five members (currently eight). They elect a Chairman, Vice-Chairman and Secretary from their midst. The Board has three permanent 139 105 committees: an Audit Committee, a Remuneration Committee and a Nomination and Selection Committee. These committees advise the plenary Supervisory Board. Members of the Supervisory Board are appointed by the General Meeting of Shareholders for fixed terms of four years, and may be re-elected for two additional four-year terms. In exceptional cases, however, the Supervisory Board and the Meeting of Priority Shareholders may deviate from this rule. At the latest, members retire upon reaching the age of 72. Members of the Supervisory Board may be suspended or dismissed by the General Meeting of Shareholders. Their remuneration is fixed by the General Meeting of Shareholders. The appointment of the members of the Board of Management and the Supervisory Board by the General Meeting of Shareholders is upon a binding recommendation from the Supervisory Board and the Meeting of Priority Shareholders. However, this binding recommendation may be overruled by a resolution of the General Meeting of Shareholders taken by a majority of at least 2/3 of the votes cast and representing more than half of the issued share capital. Group Management Committee The Group Management Committee consists of the members of the Board of Management, certain Chairmen of product divisions and certain key officers. Members other than members of the Board of Management are appointed by the Supervisory Board. The task of the Group Management Committee, the highest consultative body within Philips, is to ensure that business issues and practices are shared across the Company and to define and implement common policies. General Meeting of Shareholders A General Meeting of Shareholders is held at least once a year to discuss and resolve on the report of the Board of Management, the financial statements, the report of the Supervisory Board, any proposal concerning dividends or other distributions, and any other matters proposed by the Board of Management or the Supervisory Board. This meeting is held in Eindhoven, Amsterdam, Rotterdam or The Hague no later than six months after the end of the financial year. Meetings are convened by public notice and mailed to registered shareholders. Extraordinary General Meetings may be convened by the Supervisory Board or the Board of Management if necessary or if requested by the Meeting of Priority Shareholders or shareholders representing at least 10% of the outstanding capital. The agenda of the General Meeting is drawn up by the Board of Management and the Supervisory Board. Requests from shareholders for items to be included on the agenda will be honored, provided that such requests are made to the Board of Management and the Supervisory Board by shareholders representing at least 1% of the Company's outstanding capital at least 60 days before a General Meeting of Shareholders and provided that the Board of Management and the Supervisory Board are of the opinion that such requests are not detrimental to the serious interests of Philips. The main powers of the General Meeting of Shareholders are to appoint, suspend and dismiss members of the Board of Management and the Supervisory Board, to adopt the financial statements and to discharge the Board of Management and the Supervisory Board 140 106 from responsibility for performing their respective duties for the previous financial year, to adopt amendments to the Articles of Association and proposals to dissolve or liquidate the Company, to issue shares or rights to shares, to restrict or pass pre-emptive rights of shareholders and to repurchase or cancel outstanding shares. Following common practice, the Company each year requests limited authorization to issue (rights to) shares, to pass pre-emptive rights and to repurchase shares. Meeting of Priority Shareholders and the Dr. A.F. Philips-Stichting There are ten priority shares. Eight are held by the Dr. A.F. Philips-Stichting, with Mr F.J. Philips and Mr H.A.C. van Riemsdijk each holding one. The self-electing Board of the Dr. A.F. Philips-Stichting consists of the Chairman and the Vice-Chairman and Secretary of the Supervisory Board, any further members of the Supervisory Board, and the President of the Company. At present, the Board consists of Mr F.A. Maljers, Mr A. Leysen, Mr L.C. van Wachem, Mr C.J. Oort and Mr C. Boonstra. A Meeting of Priority Shareholders is held at least once a year, at least thirty days before the General Meeting of Shareholders. Approval of the Meeting of Priority Shareholders is required for resolutions of the General Meeting of Shareholders regarding the issue of shares or rights to shares, the cancellation of shares, amendments to the Articles of Association, and the liquidation of the Company. Acting in agreement with the Supervisory Board, the Meeting also makes a binding recommendation to the General Meeting of Shareholders for the appointment of members of the Board of Management and the Supervisory Board. Meeting of Holders of Preference Shares and the Stichting Preferente Aandelen Philips The authorized share capital of the Company consists of ten priority shares, 500,000,000 ordinary shares and 499,995,000 preference shares. No preference shares have been issued. However, the Stichting Preferente Aandelen Philips ('the Foundation') has been granted the right to acquire preference shares in the Company should a third party ever seem likely to gain a controlling interest in the Company. The Foundation may exercise this right for as many preference shares as there are common shares in the Company outstanding at that time. The object of the Foundation is to represent the interests of the Company, the enterprises maintained by the Company and its affiliated companies within the Philips Group, such that the interests of Philips, those enterprises and all parties involved with them are safeguarded as effectively as possible, and that they are afforded maximum protection against influences which, in conflict with those interests, may undermine the autonomy and identity of Philips and those enterprises, and also to do anything related to the above ends or conducive to them. The members of the self-electing Board of the Foundation are Messrs J.R. Glasz, H.B. van Liemt, W.E. Scherpenhuijsen Rom, F.A. Maljers and C. Boonstra. As Chairman of the Supervisory Board and the Board of Management respectively, Messrs Maljers and Boonstra are members of the Board ex officio. Mr Boonstra is not entitled to vote. The Board of Management of the Company and the Board of the Stichting Preferente Aandelen Philips declare that they are jointly of the opinion that the Stichting Preferente Aandelen Philips is independent of the Company as required by the Listing Requirements of the Amsterdam Exchanges N.V. (AEX). 141 107 [Page 142 to back cover intentionally omitted] EX-99.III 4 ARTICLES OF ASSOCIATION 1 III ARTICLES OF ASSOCIATION ARTICLES OF ASSOCIATION OF KONINKLIJKE PHILIPS ELECTRONICS N.V. (formerly named Philips Electronics N.V.) as last amended by notarial deed executed on April 1, 1998, pursuant to the resolution of the General Meeting of Shareholders held on March 16, 1998. Translation of the original and authentic Dutch text. 2 NAME AND SEAT Article 1 1. The name of the Company is: Koninklijke Philips Electronics N.V. 2. The Company is authorized to act as `Royal Philips Electronics'. 3. Its registered office is situated in Eindhoven. OBJECTS Article 2 The objects of the Company are to establish, participate in, administer and finance companies or enterprises engaged in the manufacture and trading of electrical, electronic, mechanical or chemical products, the development and exploitation of technical and other expertise, including software, or engaged in other fields, and to do everything pertaining thereto or connected therewith, including to perform or have performed industrial and commercial activities, to exercise or have exercised control over the quality of the products and services, to perform or have performed service and maintenance on all such products, all this in the widest sense, as may also be conducive to the proper continuity of the collectivity of business undertakings, in the Netherlands and abroad, which are carried on by the Company and the companies in which it directly or indirectly participates. SHARE CAPITAL, SHARES, SHARE CERTIFICATES AND SHARE REGISTER Article 3 1. The share capital of the Company is ten billion guilders ((Function). 10,000,000,000), divided into ten priority shares of five thousand guilders ((Function). 5,000) each, in these articles of association henceforth referred to as "priority shares", five hundred million ordinary shares of ten guilders ((Function). 10) each, in these articles of association henceforth referred to as "ordinary shares", and four hundred and ninety-nine million, nine hundred and ninety-five thousand preference shares of ten guilders ((Function). 10) each, in these articles of association henceforth referred to as "preference shares". 2. Unless otherwise stated, the term "shares" in these articles shall refer equally to priority, ordinary and preference shares. Article 4 1. The Board of Management shall have the power to issue ordinary shares if and insofar as the Board of Management has been designated by the general meeting of shareholders as the authorized body for this purpose. Such a designation shall only take place for a specific period of no more than five years and may not be extended by more than five years on each occasion. The Board of Management requires the approval of the Supervisory Board and of the meeting of priority shareholders for such an issue. 2. If a designation as referred to in the first paragraph is not in force, the general meeting of shareholders shall have the power, upon the proposal of the Board of Management -which proposal must be approved by the Supervisory Board and by the meeting of priority shareholders - to resolve to issue ordinary shares. 2 3 3. In the event of an ordinary share issue in return for a cash consideration, holders of ordinary shares shall have a pre-emption right in proportion to the number of ordinary shares which they own. The Board of Management shall have the power to restrict or exclude the pre-emption right accruing to these shareholders, if and insofar as the Board of Management has also been designated by the general meeting of shareholders for this purpose as the authorized body for the period of such designation. The provisions in the second and third sentences of the first paragraph shall apply accordingly. 4. If a designation as referred to in the third paragraph is not in force, the general meeting of shareholders shall have the power, upon the proposal of the Board of Management - which proposal must be approved by the Supervisory Board and by the meeting of priority shareholders - to restrict or exclude the pre-emption right accruing to shareholders. 5. A resolution of the general meeting of shareholders in accordance with the third or fourth paragraph of this article requires a majority of at least two-thirds of the votes cast if less than half of the issued share capital is represented at the meeting. 6. The Board of Management shall have the power, subject to the approval of the Supervisory Board and the meeting of priority shareholders, to issue preference shares to a maximum of the amount for preference shares referred to in article 3. It shall be empowered to do so up to 12 April 1996. Paragraph 1 and 2 of this article shall apply accordingly to the issue of preference shares after 12 April 1996. 7. In order for resolutions of the general meeting of shareholders to issue shares or to designate the Board of Management, as referred to in paragraphs 1, 2 and 6, to be valid, a prior or simultaneous resolution granting approval is required from each group of holders of shares of the same type whose rights are affected by the issue. 8. The preceding paragraphs of this article shall apply accordingly mutatis mutandis to the granting of rights to take shares, but shall not apply to the issue of shares to someone who exercises a previously acquired right to take shares. The Board of Management shall have the power to issue such shares. 9. The issue price shall not be fixed below par, subject to deviations which the law permits in this respect. The ordinary and priority shares shall be fully paid up when they are taken. At least a quarter of the nominal amount shall be paid on preference shares when they are taken. Further payment on the preference shares shall be made within one month after the Board of Management, subject to the approval of the Supervisory Board and the meeting of priority shareholders, has made a corresponding request in writing to the shareholders concerned. Article 5 1. Any acquisition by the Company of shares in its capital which are not fully paid up shall be null and void. 2. The Company may acquire, for valuable consideration, ordinary shares in its own share capital if and insofar as: a. its shareholders' equity less the purchase price of the ordinary shares is not less than is laid down in the relevant statutory provisions; b. the nominal amount of the shares in its capital which the Company acquires, holds or holds as pledgee, or which are held by a subsidiary, is not more than one-tenth of the issued share capital; and c. the general meeting of shareholders has authorized the Board of Management to acquire such shares, which authorization may be given for no more than 18 months on each occasion. 3 4 Shares thus acquired may again be disposed of. The Board of Management shall not acquire shares in the Company's own share capital as referred to above -if an authorization as referred to above is in force - or dispose of such shares without the approval of the Supervisory Board. 3. The Board of Management shall have the power, without the authorization referred to in paragraph 2 but with the approval of the Supervisory Board, to acquire on behalf of the Company shares in its own share capital as referred to above in order to transfer the shares to employees of the Company or of a group company, in pursuance of a rule applying to them. 4. No voting right attaches to own shares referred to above. These shares shall not rank for the purpose of determining any majority or for deciding whether a specific proportion of the issued share capital is represented at a general meeting of shareholders. 5. Upon the proposal of the Board of Management - which proposal must have the prior approval of the Supervisory Board and the meeting of priority shareholders - the general meeting of shareholders shall have the power to resolve, having regard to the provisions of section 99, Book 2 of the Netherlands Civil Code, to reduce the issued share capital: - by a cancellation of ordinary shares acquired by the Company in its own share capital; - by a reduction of the nominal amount of the shares by amendment of the articles of association, with partial repayment on those shares; - by a cancellation of preference shares, with repayment on the said preference shares; or - by a release from the obligation to make further payment on the preference shares upon implementation of a resolution to reduce the nominal amount of such shares. It shall be indicated in this resolution whether and, if so, to what extent this relates to ordinary shares, to all or only to certain preference shares or - insofar as this is permitted - to all shares, and rules shall be drawn up for the implementation of the resolution. A partial repayment or release from the obligation to make further payment must be made proportionally to all shares concerned. Article 6 1. Priority shares and preference shares shall be registered. 2. Ordinary shares shall, at the option of the shareholders, be either in bearer or registered form. They shall be in bearer form unless the shareholder, either expressly or implicitly, indicates that he desires a registered share. 3. Where a share belongs to more than one person in any form of joint ownership, or where limited rights in rem attach to any share, the Company is entitled to require those concerned to designate in writing one person to exercise the rights attached to the share. 4. The expression "shareholder", as used in these articles, shall, if the ownership of a share is vested in more than one person, mean the joint holders of such share, without prejudice, however, to the provisions of paragraph 3 of this article. The expression "person", as used in these articles, shall include a body corporate. 5. Share certificates for bearer shares: - shall be available - should the Board of Management so decide - in the form of a main part with a simplified dividend sheet; share certificates of this type are referred to in these articles as Type B share certificates. The dividend sheet of a Type B share certificate shall be issued by the Company only to a depositary to be designated by the shareholder. The designated depositary shall have been admitted as such by the Board of Management and have given an undertaking to the Company (a) not to surrender the dividend sheets except to other depositaries admitted by the Board of Management or to the Company 4 5 and (b) to arrange for the custody of the dividend sheets to be administered by an institution authorized to that effect by the Board of Management. 6. Share certificates of Type B shall be available in denominations of one share, five shares, ten shares, one hundred shares, and further in denominations of such higher numbers of shares as the Board of Management may determine. 7. Registered shares shall be available: - in the form of an entry in the share register without issue of a share certificate; shares of this type are referred to in these articles as Type I shares; - and - should the Board of Management so decide - in the form of an entry in the share register with issue of a certificate, which certificate shall consist of a main part without dividend sheet; shares of this type and share certificates of this type for ordinary shares are referred to in these articles as Type II shares and share certificates. 8. The Board of Management can decide that the registration of Type I shares may only take place for one or more quantities of shares -which quantities are to be specified by the said Board - at the same time. 9. Type II share certificates shall be available in such denominations as the Board of Management shall determine. 10. All share certificates shall be signed by two members of the Board of Management; the signatures may be effected by printed facsimile. Furthermore, Type II share certificates shall, and all other share certificates may, be countersigned by one or more persons designated by the Board of Management for that purpose. 11. All share certificates shall be identified by numbers and/or letters. 12. The expression "share certificate", as used in these articles, shall include a share certificate in respect of more than one share. Article 7 1. In respect of registered shares a register shall be kept by or on behalf of the Company, which register shall be regularly updated and, at the discretion of the Board of Management, may, in whole or in part, be maintained in more than one copy and at more than one place. At least one copy will be maintained at the office of the Company. 2. Each shareholder's name, his address, the number and type of the shares registered in his name, as well as the amounts paid thereon and such further data as the Board of Management shall deem desirable, whether at the request of a shareholder or not, shall be entered in the register. 3. The form and the contents of the share register shall be determined by the Board of Management with due regard to the provisions of paragraphs 1 and 2 of this article. The Board of Management may determine that the records shall vary as to their form and contents according to whether they relate to Type I shares or to Type II shares. 4. Upon request, a shareholder shall be given free of charge a declaration of what is stated in the register with regard to the shares registered in his name. 5. The provisions of the preceding paragraphs shall apply accordingly to those who hold a right of usufruct or a pledge on one or more registered shares, with the proviso that also the other data required by law must be entered in the register. 5 6 Article 8 1. Upon a written request from a person entitled to such certificates, missing or damaged ordinary share certificates, or parts thereof, may be replaced by new certificates, or by duplicates bearing the same numbers and/or letters, provided that the applicant proves his title and, in so far as applicable, his loss to the satisfaction of the Board of Management, and further subject to such conditions as the Board of Management may deem fit. 2. In appropriate cases, at its own discretion, the Board of Management may stipulate that the identifying numbers and/or letters of missing documents be published three times, at intervals of at least one month, in at least three newspapers to be indicated by the Board of Management, announcing the application made; in such a case new certificates or duplicates may not be issued until six months have expired since the last publication, always provided that the original documents have not been produced and shown to the Board of Management before that time. 3. The issue of new certificates or duplicates shall render the original document invalid. 4. The issue of new certificates or duplicates for bearer shares may in appropriate cases, at the discretion of the Board of Management, be published in newspapers to be indicated by the Board of Management. Article 9 1. Subject to the provisions of article 6, the holder of a Type B share certificate may, after surrendering the share certificate to the Company, upon his request and at his option, either: - have one or more Type I shares entered in the share register for the same nominal amount; or - obtain one or more Type II share certificates for the same nominal amount. 2. Subject to the provisions of article 6, the holder of an entry in the share register for one or more Type I shares may, upon his request and at his option, obtain, either: - one or more Type II share certificates for the same nominal amount; or - one or more Type B share certificates for the same nominal amount. 3. Subject to the provisions of article 6, the holder of a Type II share certificate registered in his name may, after surrendering the share certificate to the Company, upon his request and at his option, either: - have one or more Type I shares entered in the share register for the same nominal amount; or - obtain one or more Type B share certificates for the same nominal amount. 4. The holder of one or more bearer or registered share certificates may, after surrendering the share certificates to the Company, upon his request and at his option obtain one or more bearer share certificates or one or more registered share certificates of the same class, of the same type, and for the same nominal amount, each for as many shares as he requests, subject however to the provisions of article 6, paragraphs 6 and 9 and article 49, paragraph 2. 5. A request as referred to in this article shall, if the Board of Management so requires, be made on a form obtainable from the Company free of charge, which shall be signed by the applicant. 6 7 Article 10 1. The transfer of a registered share shall be effected either by service upon the Company of the instrument of transfer or by written acknowledgement of the transfer by the Company, subject however to the provisions of the following paragraphs of this article. In the case of preference shares which have not been paid up in full, the acknowledgement may only be made if there is an instrument of transfer with an officially recorded, or otherwise fixed, date. When preference shares which have not been paid up in full are transferred, the date of transfer shall be entered in the register. 2. Priority shares may be transferred in the manner provided by article 11. 3. A transfer of registered ordinary shares requires the consent of the Board of Management, except where paragraph 4 of this article is applicable. The consent of the Board of Management may be given subject to such terms and conditions as the Board may consider advisable or necessary. The applicant shall always be entitled to require that said consent be given subject to the condition that the transfer shall be made to such person as the Board of Management may designate. 4. The consent of the Board of Management shall not be required: a. in cases where a Type I share is transferred, if an instrument of transfer, signed by both parties to the transfer, on a form to be supplied by the Company free of charge, has been surrendered to the Company; b. in cases where a Type II share certificate is outstanding for the share if the share certificate has been surrendered to the Company, provided that the instrument printed on the back of the share certificate has been duly completed and signed by or on behalf of the transferor, or a separate instrument in substantially the same form has been surrendered together with the share certificate. 5. Where a transfer of a Type II share is effected by service of an instrument of transfer upon the Company, the Company shall, at the discretion of the Board of Management, either endorse the transfer on the share certificate or cancel the share certificate and issue to the transferee one or more new share certificates registered in his name to the same nominal amount. 6. The Company's written acknowledgement of a transfer of a Type II share shall, at the discretion of the Board of Management, be effected either by endorsement of the transfer on the share certificate or by the issue to the transferee of one or more new share certificates registered in his name to the same nominal amount. 7. The provisions of the preceding paragraphs of this article shall apply mutatis mutandis to the allotment of registered shares in the event of a judicial partition of any community of property or interests, the transfer of a registered share as a consequence of a judgement execution and the creation of limited rights in rem on a registered share. 8. The submission of requests and the surrender of documents referred to in articles 6 to 10 inclusive shall be made at a place to be indicated by the Board of Management. Different places may be indicated for the different classes and types of shares and share certificates. 9. The Company is authorized to charge amounts to be determined by the Board of Management to those persons who request any services to be carried out pursuant to articles 6 to 10 inclusive. 7 8 PRIORITY SHARES Article 11 1. A priority share may only be transferred to a nominee nominated by the meeting of priority shareholders, and upon payment of the nominal value of such share, with interest at the rate of four per cent per annum - or such lower rate as the legal interest rate will be at the beginning of the relevant financial year - as from the beginning of the current financial year until the date of the transfer. 2. A holder of a priority share wishing to transfer such share shall notify the Board of Management of such intention by registered letter. The Board of Management shall as soon as possible bring the contents of such notification to the notice of the Chairman of the Supervisory Board and of the holders of priority shares. In that event the Chairman of the Supervisory Board shall convene a meeting of priority shareholders, which shall be held within a month after receipt of the notification referred to above and which shall propose a nominee. 3. However, the holder of a priority share who, by registered letter addressed to the Board of Management, has requested the proposal of a nominee in accordance with the provisions of the preceding paragraph shall be free to transfer the share offered by him, if after a period of three months after receipt of such notification the meeting of priority shareholders has not proposed a nominee or no nominee has agreed to acquire the share. 4. In the event of transfer of any priority share upon the death of the holder thereof or for any other reason, those who acquire the share shall, by registered letter addressed to the Board of Management, offer such share for transfer to a nominee to be proposed by the meeting of priority shareholders. In that event the provisions of paragraphs 2 and 3 of this article shall apply mutatis mutandis. In such a case the Company shall be irrevocably authorized on behalf of the successor or successors in title to effect the transfer to such nominee and to receive the payments on his or their behalf. Until the transfer of the priority share has taken place in the prescribed manner and is entered in the priority share register, no vote may be cast in respect of such priority share at the meeting of priority shareholders. 5. The provisions of paragraph 4 of this article shall apply mutatis mutandis to a holder of priority shares who has been adjudicated bankrupt or granted a moratorium of payments or placed in the care of a guardian, or is unable for any other reason to dispose freely of his property. 6. The transfer of a priority share shall be entered in the priority share register. BOARD OF MANAGEMENT Article 12 1. The Company shall be managed by a Board of Management, consisting of at least three members, under the supervision of a Supervisory Board. The Chairman of the Board of Management shall be President of the Company. The other members shall be Executive Vice-Presidents 1 of the Company. With due observance of the minimum of three, the number of members shall be decided by the meeting of priority shareholders in consultation with the Supervisory Board. 2. Members of the Board of Management, as well as the Chairman of the Board of ____________ 1. In the original Dutch version of these articles of association the term "Vice-President" is used. 8 9 Management and President of the Company, shall be appointed by the general meeting of shareholders from a binding list of two or more nominees for each vacancy to be filled, drawn up by the meeting of priority shareholders in agreement with the Supervisory Board. Votes in respect of persons who have not been so nominated shall be invalid. 3. The list of nominees shall be deposited for inspection by shareholders at the office of the Company and at a bank at Amsterdam to be specified in the notice convening the general meeting at which the appointments are to be made, as from the date of serving the said notice until the close of that meeting. 4. The list of nominees referred to in the second paragraph of this article may be deprived of its binding character by a resolution adopted at a general meeting of shareholders by a majority of at least two-thirds of the votes cast, representing more than one half of the issued share capital. In that event a new binding list shall be submitted to a subsequent general meeting of shareholders, with due observance of the provisions of the preceding paragraphs of this article. Should such a second list also be deprived of its binding character in the manner provided for in the first sentence, the general meeting of shareholders shall be free to appoint. 5. Should the number of members of the Board of Management fall below three, the powers of the Board of Management shall remain intact. In such a case a general meeting of shareholders shall be held at the earliest opportunity to fill the vacancies on the Board of Management. 6. Without prejudice to the provisions of paragraph 2 of this article, a proposal to make appointments to the Board of Management may only be placed on the agenda of the general meeting of shareholders by the Board of Management and only in consultation with the meeting of priority shareholders and the Supervisory Board. Article 13 1. Members of the Board of Management may be suspended or removed by the general meeting of shareholders. A resolution to suspend or remove a member of the Board of Management, other than a resolution proposed by the Board of Management, the Supervisory Board or the meeting of priority shareholders, may only be adopted by a majority of at least two-thirds of the votes cast, representing more than half of the issued share capital. The provisions of section 120, paragraph 3, Book 2 of the Netherlands Civil Code shall not apply. 2. The members of the Board of Management may be suspended from office by the Supervisory Board either collectively or individually. Within three months of such suspension a general meeting of shareholders shall be held to decide whether the suspension shall be cancelled or upheld. The person so suspended shall be entitled to be heard at the meeting. Article 14 1. Two members of the Board of Management may jointly represent the Company at law and otherwise. 2. The Board of Management may authorize each of its members separately to represent the Company within the limits defined in the authorization. Article 15 1. The Board of Management shall have the power to enter into contracts as specified in section 94, paragraph 1, Book 2 of the Netherlands Civil Code. 2. The Board of Management may grant powers of attorney to persons, whether or not in 9 10 the service of the Company, to represent the Company and may thereby determine the scope of such powers of attorney and the titles of such persons. Article 16 The Board of Management shall draw up Standing Orders, regulating, inter alia, the mode of convening its meetings and the internal procedure at such meetings. Article 17 1. Without prejudice to the provisions made elsewhere in these articles, resolutions of the Board of Management concerning the following matters shall be subject to the approval of the Supervisory Board: a. issue of shares in the Company, restricting or excluding the pre-emption right in the event of an issue of shares, acquisition of shares in the capital of the Company and the disposal of shares thus acquired; issue of debentures chargeable to the Company; b. cooperation in the issue of certificates of shares in the Company; c. application for quotation or for withdrawal of the quotation of the securities referred to under a. and b. in the price list of any stock exchange; d. long-term cooperation, directly or indirectly, with another company or body corporate, and the discontinuation of such cooperation, if the said cooperation or discontinuation thereof is of fundamental significance; e. taking a direct or indirect participation in the share capital of another company, the value of which is at least equal to the amount of one quarter of the issued share capital plus the reserves of the Company, as shown by its balance sheet and explanatory notes, and any fundamental change in the scale of such participation; f. any investment involving expenditure equal to at least one quarter of the issued share capital plus the reserves of the Company, as shown by its balance sheet and explanatory notes; g. a proposal to amend the articles of association; h. a proposal to dissolve the Company or for a legal merger of the Company; i. a petition for bankruptcy or for a moratorium of payments; j. a proposal to reduce the issued share capital; 2. The Supervisory Board may grant the approvals required in accordance with this article either for a specific legal act, or for a group of such legal acts. Article 18 1. In the event of the absence or inability to act of one or more members of the Board of Management, the remaining members shall temporarily be charged with the entire management. 2. In the event of the absence or inability to act of all members of the Board of Management save one, the remaining member shall temporarily be charged with the entire management. 10 11 3. In the event of the absence or inability to act of all members of the Board of Management, the Supervisory Board shall temporarily be charged with the management. In this event the Supervisory Board may temporarily entrust one or more persons to be designated by this Board, from among its members or otherwise, with the management of the Company. Article 19 The remuneration and other terms of employment of the members of the Board of Management shall be fixed by the Supervisory Board upon the proposal of the President of the Company. SUPERVISORY BOARD Article 20 1. The Supervisory Board shall be responsible for supervising the policy pursued by the Board of Management and the general course of affairs in the group of companies within the Netherlands and abroad, of which the Company forms part. The Supervisory Board shall assist the Board of Management with advice relating to the general policy aspects connected with the activities of the Company and of the group of companies associated with it. 2. The Board of Management shall provide the Supervisory Board in due time with such information as the Supervisory Board needs for the performance of its duties. Article 21 1. The members of the Supervisory Board shall be appointed and may be removed by the general meeting of shareholders. The Supervisory Board shall consist of at least five members. With due observance of this minimum, the number of members shall be decided by the general meeting of shareholders on the proposal of the meeting of priority shareholders, which proposal shall be submitted to the general meeting of shareholders in consultation with the Supervisory Board. 2. Members of the Supervisory Board shall be appointed by the general meeting of shareholders from a binding list of two or more nominees for each vacancy to be filled, drawn up by the Supervisory Board in agreement with the meeting of priority shareholders. A list of nominees shall be deposited for inspection by shareholders at the office of the Company and at a bank in Amsterdam to be specified in the notice convening the general meeting on whose agenda the proposed appointment has been placed, as from the date on which the said notice is served until the close of that meeting. Without prejudice to the provisions of the first sentence, a proposal to appoint a member of the Supervisory Board may only be placed on the agenda of the general meeting by the Supervisory Board yet only in consultation with the Board of Management and the meeting of priority shareholders. 3. The list of nominees referred to in the second paragraph of this article may be deprived of its binding character by a resolution adopted at a general meeting of shareholders by a majority of at least two-thirds of the votes cast, representing more than one half of the issued share capital. In that event, a new binding list shall be submitted to a subsequent general meeting of shareholders with due observance of the provisions of the preceding paragraphs of this article. Should such a second list also be deprived of its binding character in the manner provided for in the first sentence, the general meeting of shareholders shall then be free to appoint. 4. Upon the appointment of members of the Supervisory Board, the particulars as referred 11 12 to in section 142, paragraph 3, Book 2 of the Netherlands Civil Code shall be made available for prior inspection. 5. Neither persons who have reached, or who in the course of the current financial year will reach, the age of 72, nor employees of the Company or of a body corporate at least half of whose shares are held directly or indirectly by the Company for its own account are eligible for appointment as members of the Supervisory Board. For these purposes the term "employees" shall not include persons who carry out for a body corporate as aforesaid a supervisory or advisory function or a function comparable thereto. 6. A member of the Supervisory Board shall retire at the end of the next general meeting of shareholders held after a period of four years following his appointment. Should a member of the Supervisory Board reach the age of 72 in any financial year, he shall retire at the end of the ordinary general meeting of shareholders held in that financial year. 7. After having held office for the first period of four years, members of the Supervisory Board are eligible for re-election only twice for a full period of four years. In specific cases the Supervisory Board and the meeting of priority shareholders may resolve to deviate from this provision. 8. The Supervisory Board may establish a rotation schedule. 9. A resolution to suspend or remove a member of the Supervisory Board, other than a resolution proposed by the Supervisory Board or the meeting of priority shareholders, may only be adopted by a majority of at least two-thirds of the votes cast, representing more than half of the issued share capital. The provisions of section 120, paragraph 3, Book 2 of the Netherlands Civil Code shall not apply. Article 22 1. The members of the Supervisory Board shall appoint from their number a Chairman, a Vice-Chairman and a Secretary. 2. The Supervisory Board may appoint one of its members to be a Delegate Member. Without prejudice to the duties and responsibilities of the Supervisory Board and of its members, the Delegate Member shall, on behalf of the Supervisory Board, maintain more frequent contact with the Board of Management with regard to the general course of affairs within the scope of article 20 of these articles of association. In so doing, the Delegate Member of the Supervisory Board shall assist the Board of Management with advice. 3. Without prejudice to the duty and responsibility of the Supervisory Board as such, the latter body may resolve to have certain tasks performed and certain powers exercised by a commission from their number. Such a resolution shall specify the chairman and the secretary thereof and in what manner and how frequently such commission shall render account to the Supervisory Board as such. Article 23 1. The Supervisory Board may adopt resolutions by absolute majority of the votes cast at a meeting attended by at least one-third of its members. The Supervisory Board may adopt resolutions in writing provided that the proposals for such resolutions have been sent in writing to all members and no member is opposed to this method of adopting a resolution, and provided that in such a case more than half of the members declare themselves in favour of the proposals. 12 13 2. Minutes shall be kept of the proceedings of the Supervisory Board, which in any case shall include the resolutions adopted by the meeting. In the event that the resolutions are adopted outside a meeting, as referred to in the preceding paragraph, the resolutions so adopted shall be recorded in writing by the Secretary. Such record shall be signed by the Chairman and the Secretary. 3. A certificate signed by two members to the effect that the Supervisory Board has adopted a particular resolution shall constitute evidence of such a resolution in dealings with third parties. 4. The members of the Board of Management shall, if so invited by the Supervisory Board, attend the meetings of the Supervisory Board. Article 24 1. Upon a proposal made by the Supervisory Board, the general meeting of shareholders shall determine the remuneration of the members of the Supervisory Board, which shall consist of a fixed yearly amount. 2. The Supervisory Board may grant an additional remuneration to be borne by the Company to its Chairman, to a Delegate Member or to members who pursuant to a resolution of the Supervisory Board have been designated to perform certain functions or activities of the Supervisory Board. GENERAL MEETINGS OF SHAREHOLDERS Article 25 1. The ordinary general meeting of shareholders shall be held each year not later than 30 June. 2. At this general meeting: a. the Board of Management shall present a written report on the course of affairs in the Company and in the group of companies in the Netherlands and abroad of which the Company forms part and on the conduct of its affairs and the general management of the Philips group during the past financial year and the Supervisory Board shall report on the annual accounts; b. the annual accounts shall be submitted for consideration and, if approved, shall be adopted and the dividend declared in the manner laid down in article 41; c. proposals placed on the agenda by the Supervisory Board, the meeting of priority shareholders, the Board of Management or shareholders in accordance with the provisions of these articles shall be considered and decided upon; d. vacancies to be filled in the Board of Management and/or the Supervisory Board shall be filled in accordance with the provisions of these articles. The provisions of a. and b. are without prejudice to the option of the general meeting of shareholders to resolve, by virtue of special circumstances, to extend by a maximum of six months the date by which the annual accounts and the annual report and associated documents must be drawn up and submitted to the general meeting of shareholders. Article 26 1. Extraordinary general meetings of shareholders shall be held as often as deemed necessary by the Supervisory Board or the Board of Management, and must be held if the meeting of priority shareholders or one or more shareholders jointly representing at least one-tenth of the issued share capital make a written request to that effect to the Supervisory Board and the Board of Management, specifying in detail the business to 13 14 be dealt with. 2. If the Board of Management fails to comply with a request as referred to in the preceding paragraph in such a manner that the general meeting of shareholders can be held within six weeks after the request, the persons making the request may be authorized by the President of the District Court at 's-Hertogenbosch to convene the meeting themselves. 3. The meeting shall not adopt resolutions on matters other than those which have been placed on the agenda in accordance with the provisions of article 28, paragraph 2. Article 27 1. General meetings of shareholders shall be held, at the option of the Board of Management, at Eindhoven, at Amsterdam, at The Hague or at Rotterdam; the notice convening the meeting shall inform the shareholders accordingly. 2. The notice convening a general meeting shall be published in the form of an advertisement which in the Netherlands shall be inserted in at least a national daily newspaper, and abroad in at least one daily newspaper appearing in each of those countries where, on the application of the Company, the Company's shares have been admitted for official quotation. In addition, holders of registered shares shall be notified by letter that the meeting is being convened. 3. The notice convening the meeting shall be issued by the Board of Management or, in the case envisaged at the end of the preceding article, by the shareholders therein specified, subject to the relevant provisions of section 111, Book 2 of the Netherlands Civil Code. Article 28 1. The notice convening the meeting referred to in the preceding article shall be issued no later than on the fifteenth day prior to the meeting. 2. Without prejudice to what is provided in this respect elsewhere in these articles, the agenda shall contain such business as may be placed thereon by the Board of Management, the Supervisory Board or the meeting of priority shareholders; and furthermore such business as one or more shareholders, representing at least one-tenth of the issued share capital, have requested the Board of Management to place on the agenda, at least four weeks before the date on which the meeting is convened. The meeting shall not adopt resolutions on matters other than those which have been placed on the agenda. 3. Without prejudice to the provisions of sections 99 and 123, Book 2 of the Netherlands Civil Code, the notice convening the meeting shall either mention the business on the agenda or state that the agenda is open to inspection by shareholders at the office of the Company and at a specified bank at Amsterdam. Article 29 1. General meetings of shareholders shall be presided over by the Chairman of the Supervisory Board or by any other person nominated by the Supervisory Board. The Chairman may restrict the time for which shareholders may speak, if he considers this to be desirable with a view to the orderly conduct of the meeting. 14 15 2. The resolutions adopted at a general meeting of shareholders shall be recorded by a civil law notary. Such record shall be co-signed by the chairman of the meeting. The latter shall ensure that a summary account is made of the business transacted at the meeting. Article 30 1. All shareholders are entitled, without prejudice to the provisions of article 6, paragraph 3, to attend the general meeting of shareholders, to address the meeting and, subject to the provisions of paragraph 7, to vote. 2. In order to exercise the rights mentioned in the first paragraph of this article, the holders of shares for which a Type B share certificate is outstanding shall deposit their share certificates prior to the meeting at the office of the Company or at one of the banks or other establishments to be indicated in the notice, at least one of which shall be a depositary as mentioned in article 6, paragraph 5, situated at Amsterdam. The notice shall also mention the last day on which this can be done. The deposit shall be made in return for a card of admission to the meeting. 3. In order to exercise the rights mentioned in the first paragraph of this article, the holders of registered ordinary shares shall notify the Company in writing of their intention to do so no later than on the day and at the place mentioned in the notice convening the meeting, and also - insofar as Type II ordinary shares are concerned - stating the identifying number of the ordinary share certificate. They may only exercise the said rights at the meeting for the ordinary shares registered in their name both on the day referred to above and on the day of the meeting. 4. In order to exercise the rights mentioned in the first paragraph of this article, the holders of preference shares shall notify the Company in writing of their intention to do so no later than on the day prior to the meeting. They may exercise the said rights at the meeting only for the shares registered in their name on the day of the meeting. 5. The Company shall send a card of admission to the meeting to holders of registered shares who have notified the Company of their intention in accordance with the provisions of the two preceding paragraphs. 6. If the right to vote is vested in a usufructuary or pledgee, the latter person shall be entitled to vote and not the shareholder. The provisions of the preceding paragraphs shall apply accordingly to usufructuaries and pledgees in whom the right to vote is vested. Usufructuaries and pledgees in whom the right to vote is not vested shall not enjoy the rights conferred by law on holders of share certificates issued with the cooperation of the Company. Article 31 Shareholders, usufructuaries and pledgees who are entitled to attend a general meeting may be represented by proxies with written authority. Without prejudice to the provisions of article 30, the written authorization must be deposited not later than at the time and at the place indicated in article 30. Article 32 1. Unless otherwise stated in these articles, resolutions shall be adopted by absolute majority of votes. Blank and invalid votes shall not be counted. The chairman shall decide on the method of voting and on the possibility of voting by acclamation. 15 16 2. Where the voting concerns appointments, further polls shall, if necessary, be taken until one of the nominees has obtained an absolute majority. In the event of an equality of votes, the nominee who is placed first in the nomination shall be appointed. The further poll or polls may, at the chairman's discretion, be taken at a subsequent meeting. 3. Except as provided in paragraph 2 above, in the event of an equality of votes the relevant proposal shall be deemed to have been rejected. Article 33 1. Each shareholder shall be entitled to a number of votes equal to the number of times the amount of ten guilders is comprised in the total nominal value of the shares for which he exercises his rights at a general meeting of shareholders. 2. Valid votes may be cast in respect of shares belonging to persons who, by virtue of the resolution to be adopted, would obtain any claim against the Company other than in their capacity as shareholder, or who would thereby be relieved of any obligation towards the Company. Article 34 1. Separate meetings of holders of preference shares shall be held as often as a resolution of the meeting of holders of preference shares is required by statutory provisions or these articles of association, and further as often as the Board of Management, the Supervisory Board or the meeting of priority shareholders deems this necessary, and must be held if one or more holders of preference shares representing at least one-tenth of the capital issued in the form of preference shares make a written request to that effect to the Board of Management, specifying in detail the business to be dealt with. 2. A meeting of holders of preference shares shall be convened no later than on the fifteenth day prior to the meeting by a letter addressed to the persons entitled to attend this meeting. 3. Meetings of holders of preference shares shall be held at Eindhoven, at Amsterdam, at The Hague or at Rotterdam. The notice convening the meeting shall inform the holders of preference shares in respect thereof. Articles 29 to 33 inclusive shall apply accordingly to meetings of holders of preference shares. 4. At a meeting of holders of preference shares at which the whole of the capital issued in the form of preference shares is represented, valid resolutions may be adopted, provided that the vote is unanimous, even if the provisions governing the place of the meeting, the manner in which it is convened, the period of notice and the specification in the notice of the business to be dealt with have not been observed. Article 35 Separate meetings of holders of ordinary shares shall be held as often as a resolution of the meeting of holders of ordinary shares is required by statutory provisions or these articles of association. The provisions of articles 26 to 33 inclusive shall apply accordingly to such a meeting. 16 17 MEETINGS OF PRIORITY SHAREHOLDERS Article 36 1. The ordinary meeting of priority shareholders shall be held each year not later than thirty days prior to the ordinary general meeting of shareholders. 2. Extraordinary meetings of priority shareholders shall be held as often as deemed necessary by the Board of Management, and must be held if holders of priority shares representing at least two-fifths of the issued priority share capital make a written request to that effect to the Board of Management, specifying in detail the business to be dealt with. 3. If the meeting is not convened within fourteen days after a request made by priority shareholders in accordance with the preceding paragraph, those shareholders shall be entitled to convene the meeting themselves. Article 37 1. Meetings of priority shareholders shall be held at a place to be indicated by the Chairman of the Board of Management. 2. Meetings shall be convened by notice to every holder of a priority share. A meeting shall not be deemed to be invalid by reason of a notice not having been received or not received in due time, unless it cannot be shown that the notice was in fact dispatched. 3. The notices shall be issued by the Chairman of the Board of Management or, in the case provided in the last paragraph of the preceding article, by the priority shareholders referred to therein. 4. Notices shall be served at least eight days prior to the meeting. 5. A meeting at which three-fifths of the priority share capital is represented shall be exempted from all periods of notice and formalities concerning the convening of the meeting. 6. The meeting of priority shareholders may adopt resolutions in writing provided that the proposals for such resolutions have been sent in writing to all holders of priority shares and no holder is opposed to this method of adopting a resolution. 7. A certificate signed by the holder(s) of at least half of the priority shares to the effect that the meeting of priority shareholders has adopted a particular resolution shall constitute evidence of such a resolution in dealings with third parties. Article 38 The provisions of articles 29, 31 (first sentence) and 32 regarding the chairmanship of the meetings, minutes, representation by proxies, the adoption of resolutions, the method of voting and an equality of votes shall apply accordingly, always provided that no persons may attend as proxies who are not acceptable as such to the meeting of priority shareholders. ANNUAL ACCOUNTS, REPORT OF THE BOARD OF MANAGEMENT AND DISTRIBUTIONS Article 39 1. The financial year shall be identical with the calendar year. 2. Without prejudice to the provisions of article 25, paragraph 2, the Board of Management shall, within four months after the close of each financial year, submit to the Supervisory Board annual accounts consisting of a balance sheet as at 31 December of the preceding year and a profit and loss account in respect of the financial 17 18 year then ended, with the explanatory notes thereto. 3. With the approval of the Supervisory Board and the meeting of priority shareholders, the Board of Management shall have the power to determine what portion of the profit -the positive balance of the profit and loss account - shall be retained by way of reserve, with due regard to the statutory provisions relating to the obligatory reserves and after the provisions of paragraphs 1, 2 and 3 of article 41 have been complied with. 4. The Supervisory Board shall cause the annual accounts to be examined by a registered accountant designated for that purpose by the general meeting of shareholders and shall report to the general meeting of shareholders on the annual accounts. If the general meeting of shareholders does not designate such a registered accountant, the Supervisory Board, and in default thereof, the Board of Management, shall have the power to do so. Such a designation may be made for an indefinite period. 5. Copies of the annual accounts which have been drawn up, of the report of the Supervisory Board, of the report of the Board of Management and of the information to be added in pursuance of the law shall be deposited for inspection by shareholders at the office of the Company and at a bank at Amsterdam to be specified in the notice convening the general meeting of shareholders, as from the day on which the said notice is served until the close of that meeting. Article 40 Adoption by the general meeting of shareholders of the annual accounts, as referred to in article 39 and without any express reservation made by the general meeting of shareholders, shall have the effect of fully discharging the Board of Management and the Supervisory Board from liability for the performance of their respective duties in the financial year concerned. Article 41 1. From the profit shown in the annual accounts adopted by the general meeting of shareholders, the percentage mentioned below of the amount required to be paid from time to time in the course of the financial year concerned on the preference shares shall, if possible, first be distributed on those shares. The dividend on the preference shares shall only be distributed for the number of days that such shares were actually outstanding in the financial year concerned. 2. The percentage referred to in paragraph 1 shall be equal to the average value of the contango rates ("prolongatiekoersen") weighted according to the number of days for which these rates prevailed - during the financial year for which the distribution is made, plus 1%. Contango rate shall be understood to mean the contango rate shown in the Official List published by the Vereniging voor de Effectenhandel (Stock Exchange Association) at Amsterdam. 3. If the profit for a financial year is declared and one or more preference shares have been withdrawn or preference shares have been fully repaid in that financial year, those persons who according to the register referred to in article 7 were holders of preference shares at the time of the said withdrawal or repayment shall have an inalienable right to a distribution of profit as described below. The profit which, if possible, shall be distributed to the said persons shall be equal to the amount of the distribution to which they would have been entitled under the provisions of paragraph 1 if they had still been holders of the aforementioned preference shares at the time when the profit was declared, this being calculated on the basis of the period for which they were holders of preference shares in the said financial year, a part of a month being counted as a full month. With regard to an alteration to the provisions of this paragraph, the proviso referred to in section 122, Book 2 of the Netherlands Civil Code is made. 4. From the profit that remains after the application of paragraphs 1 to 3 inclusive, an 18 19 amount of two hundred guilders (f 200) shall first be distributed on every priority share. The profit that remains thereafter shall be at the disposal of the general meeting of shareholders, which is empowered to withhold distribution in whole or in part or to make a distribution in whole or in part to holders of ordinary shares in proportion to their holdings of ordinary shares. 5. The Company may make distributions to shareholders and other persons entitled to distributable profit only in so far as its shareholders' equity interest is greater than the amount of the called and paid-up portion of the capital plus the legally required reserves. Article 42 1. Upon the proposal of the Board of Management, which proposal shall have received the prior approval of the Supervisory Board and of the meeting of priority shareholders, the general meeting of shareholders shall be entitled to resolve to make distributions charged to the "other reserves" shown in the annual accounts or charged to "share premium account". 2. Upon the proposal of the Board of Management, which proposal shall have received the prior approval of the Supervisory Board and of the meeting of priority shareholders, the general meeting of shareholders shall be entitled to make distributions to shareholders under article 41, article 42, paragraph 1, and article 43 in the form of the issue of shares. Article 43 At its own discretion and having regard to the statutory provisions relating thereto, the Board of Management, with the prior approval of the Supervisory Board and of the meeting of priority shareholders, may distribute one or more interim dividends on the shares before the annual accounts for any financial year have been approved and adopted at a general meeting. Article 44 1. Distributions under articles 41, 42 and 43, hereinafter referred to as "Distributions", shall be payable as from a date to be determined by the Board of Management. The date of payment set in respect of Type I shares may differ from the date of payment set in respect of shares for which Type II share certificates are outstanding. 2. "Distributions" shall be made payable at a place or places to be determined by the Board of Management. 3. The Board of Management may determine the method of payment in respect of cash "Distributions" on Type I shares. 4. Cash "Distributions" in respect of shares for which Type II share certificates are outstanding shall, if such distributions are made payable only outside the Netherlands, be paid in the currency of the country concerned, converted at the rate of exchange on the Amsterdam Stock Exchange at the close of business on a date to be fixed and announced by the Board of Management. This date may not be set earlier than the day before the date on which the distribution is declared and not later than the date which has been fixed for the shares concerned in accordance with the provisions of paragraph 5. If and insofar as on the first day on which a distribution is payable, the Company is unable, in consequence of government action or other exceptional circumstances beyond its control, to make payment at the place designated outside the Netherlands or in the relevant foreign currency, the Board of Management may in that event designate one or more places in the Netherlands instead. In that event the provisions of the first sentence of this paragraph shall no longer apply. 19 20 5. With regard to the provisions of article 6, paragraph 3 and article 7, the person entitled to any distribution on registered shares shall be the person in whose name the share is registered - or, in the case of limited rights in rem, the person whose right appears well-founded - at the date to be determined for that purpose by the Board of Management in respect of the "Distribution" for each of the different types of shares. 6. A person entitled to a "Distribution" on a share for which a Type B share certificate is outstanding shall, in order to exercise his right to such "Distribution", arrange for the dividend sheet appertaining to that share to be in the safe-keeping of a depositary as mentioned in article 6, paragraph 5, at such a time as shall be specified by the Board of Management. In respect of "Distributions" referred to herein, the Company shall have discharged its liability to the persons entitled thereto by making these "Distributions" available in compliance with certain instructions to be issued by the institution referred to in article 6, paragraph 5. 7. Notices relating to "Distributions", and to the dates and places referred to in the preceding paragraphs of this article, shall in the Netherlands be given in at least one national daily newspaper, and abroad in at least one daily newspaper appearing in each of those countries where, on the application of the Company, the Company's shares have been admitted for official quotation, and further in such manner as the Board of Management may deem desirable. 8. Rights of payment of "Distributions" in cash shall lapse if such "Distributions" are not claimed within five years following the day after the date on which they were made available. 9. In the case of a "Distribution" in shares, any shares not claimed within a period to be determined by the Board of Management shall be sold for the account of the persons entitled to the distribution who failed to claim the shares. The net proceeds of such sale shall thereafter be held at the disposal of the above persons in proportion to their entitlement; the right to the proceeds shall lapse, however, if the proceeds are not claimed within five years following the day after the date on which the "Distribution" in shares was made payable. 10. In the case of a "Distribution" in the form of shares on registered shares, those shares shall be added to the share register. A Type II share certificate for a nominal amount equal to the number of shares added to the register shall be issued to holders of Type II shares. 11. The Board of Management may, for reasons which it considers sufficient, and subject to such conditions as it may consider necessary, rule that the provisions of paragraphs 6 and 7 of this article shall not apply. 12. The provisions of paragraphs 5 to 8 inclusive and paragraph 12 shall apply accordingly in respect of any other distribution, including pre-emption subscription rights in the event of a share issue. AMENDMENT OF ARTICLES OF ASSOCIATION AND DISSOLUTION Article 45 1. A resolution to amend the articles of association or to dissolve the Company shall be valid only provided that: a. the consent of the Supervisory Board and of the meeting of priority shareholders has been or will be obtained; 20 21 b. the consent of the meeting of priority shareholders is given at a meeting at which more than half the issued priority share capital is represented and by at least three-fourth of the votes cast; if this requirement is not complied with, a further meeting shall be held within four weeks thereof, at which, irrespective of the share capital represented, the resolution can be adopted by at least three-fourth of the votes cast; c. the full proposals have been deposited for inspection by shareholders at the office of the Company and at a bank at Amsterdam specified in the notice convening the general meeting of shareholders, as from the day on which the said notice is served until the close of that meeting; d. the resolution is adopted at a general meeting of shareholders at which more than half of the issued share capital is represented and by at least three-fourth of the votes cast; if the requisite share capital is not represented at a meeting called for that purpose, a further meeting shall be convened, to be held within four weeks of the first meeting, at which, irrespective of the share capital represented, the resolution can be adopted by at least three-fourth of the votes cast. 2. Where a resolution as referred to in the preceding paragraph of this article is submitted by the Board of Management, the general meeting of shareholders may, notwithstanding the provisions of paragraph 1 d., resolve by absolute majority of votes to amend the articles of association or to dissolve the Company. Article 46 1. Should the Company be dissolved, the liquidation shall be effected by the Board of Management, unless otherwise decided by the general meeting of shareholders with the approval of the meeting of priority shareholders. 2. In adopting a resolution to dissolve the Company, the general meeting of shareholders may approve the payment of a remuneration to the liquidators. 3. After completion of the liquidation, the liquidators shall render account in accordance with the provisions of Book 2 of the Netherlands Civil Code. Article 47 1. After all liabilities have been settled, including those incident to the liquidation, a distribution shall, if possible, first be made on every preference share to the amount paid thereon. From the amount that remains, a distribution shall, if possible, first be made on every priority share to the nominal amount thereof. The residue thereafter shall be distributed on the ordinary shares. 2. Any amounts payable to shareholders or due to creditors which are not claimed within six months after the last distribution was made payable, shall be deposited with the Public Administrator of Unclaimed Debts. Article 48 To the extent applicable, the provisions of these articles shall remain in force during the liquidation. *** 21 22 CERTIFICATE OF ENGLISH TRANSLATION Pursuant to Rule 306 of Regulation S-T, the registrant certifies that the exhibit in Item 19. (b), III. Articles of Association, as amended, dated as of April 1, 1998, is a fair and accurate English translation. KONINKLIJKE PHILIPS ELECTRONICS N.V. (Registrant) BY /s/ A. Westerlaken _____________________ A.Westerlaken General Secretary Date: March 22, 1998 22 -----END PRIVACY-ENHANCED MESSAGE-----