THOMSON REUTERS STREETEVENTS TRANSCRIPT PHIA.AS - KONINKLIJKE PHILIPS ELECTRONICS NV FINANCIAL REPORTING RELATED MATTERS CONFERENCE CALL

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1 THOMSON REUTERS STREETEVENTS TRANSCRIPT PHIA.AS - KONINKLIJKE PHILIPS ELECTRONICS NV FINANCIAL REPORTING RELATED MATTERS CONFERENCE CALL EVENT DATE/TIME: DECEMBER 08, 2011 / 12:00PM GMT OVERVIEW: PHIA.AS provided an update on financial reporting related matters. 1

2 C O R P O R A T E P A R T I C I P A N TS Abhijit Bhattacharya Royal Philips Electronics - Head of IR Jan van Leeuwen Royal Philips Electronics - Group Controller Ron Wirahadiraksa Royal Philips Electronics - CFO C O N F E R E N C E C A L L P A R T I C I P A N T S Andreas Willi JPMorgan - Analyst William Mackie Berenberg Bank - Analyst P R E S E N T A T I O N Abhijit Bhattacharya - Royal Philips Electronics - Head of IR Good afternoon, ladies and gentlemen. Welcome to this conference call where we will give you an update on matters related to financial reporting, pensions, group management and services costs, and other financial matters for Royal Philips Electronics. In the previous years, we provided this update during the Capital Markets Day held in December. As of this year, we combined the Lighting and Consumer Lifestyle Capital Markets Day into one, which took place in September, and, hence, we are providing this update through this call. And also, I would like to clarify that our fourth quarter earnings announcement will take place on the 30th of January. As such, we will not provide any detail or take any questions that relate to our performance during the fourth quarter. And here, with Philips CFO, Ron Wirahadiraksa, and our Group Controller, Jan van Leeuwen. In a moment, Jan will take you through his presentation. After that, Ron will summarize the main points and provide his concluding remarks, and then, both Jan and Ron will be pleased to take your questions. Our press release and the accompanying information slide deck were published at 8.00 a.m. CET this morning. Both documents are now available for download from our investor relations website. We will also make available a full transcript of this conference call on the Investor Relations website by tomorrow morning, at the latest. With that, let me hand you over to Jan to start the proceedings for the day. Thank you, Abhijit. Good afternoon, and welcome to all of you. Let me quickly run you through the agenda of topics that I would like to address today. We will start with informing you about certain reclassifications that we'll do from 2012 onward and explain the rationale for making these changes. These will primarily relate to license income, warranty costs, and the amortization of intangibles. We will then give you an update on the goodwill review that we have performed and a position of the equity stakes that we currently hold. This will be followed by an update on pensions, where I will update you on the estimates for this year compared to what we have indicated in our last annual report. I will also give you an insight into the impact that the changeover to IAS19 will have on our earnings statement. We will then move on to group management and services, where I will first explain the composition of these costs and then give you our estimate for Finally, I will walk you through some interest -- some important dates for next year before handing over the floor to Ron for his concluding remarks. Starting with the change we will make in the allocation of IP royalty, or license income, as it is also commonly referred to. Our current policy is that license income is allocated to that sector which sells the product for which the royalties are received. For example, the royalty received on the sale of CD and DVD players are allocated to consumer lifestyle, since that is the sector through which these products are sold. The only exception to this rule was for royalties for certain products, which are no longer sold by the consumer lifestyle sector, but are still allocated to it. 2

3 We will correct this, going forward, and from 2012 onward, there will be no exceptions in any sector. If this was done for the year 2011, the impact would be that approximately EUR220 million of revenue and EUR180 million of EBITA, which is currently reported on the consumer lifestyle, would be reclassified to GM&S. The next reclassification relates to warranty cost. Currently, Philips reports its costs of standard warranty as part of selling expenses. We will change this in 2012 and report these costs as part of cost of sales. The rationale for this is that the costs of warranty are an integral part of the sales of goods and services and are therefore better reflected in cost of sales. The reclassification impact of this, for the previous two years, as well as the first nine months of this year, is clearly presented in the slide. On the next slide, you can see that we will also reclassify the change on account of amortization of intangibles related to brand names and customer lists. Currently, all intangibles are booked as part of cost of sales, and this refinement will ensure that the aforementioned intangibles, which support the sales process, are better reflected as part of selling expenses. Again, the reclassification impact for this change is clearly represented in the slide. Next, we move on to the goodwill review. I am happy to report that we do not expect any impairment for acquisitions, as no impairment triggers have been identified. This applies, obviously, to the fourth quarter. The next slides disclose the position of the equity interests of Philips. In the table we have provided details of equity interests above EUR25 million in value. The value of the equity interests, as at the end of 2010, was EUR473 million compared to the value of EUR326 million, as per the end of the third quarter of this year. The decline of EUR147 million is mainly due to the sale of TCL shares that was in our books for EUR63 million and to the decline of the stock prices of Innolux Display Corporation and Shenyang Neusoft Corporation of EUR63 million and EUR 20 million, respectively. Now, moving to pensions has been a volatile year for pensions. The first half of 2011 was positive for our plans, with interest curves and stock markets going up. However, in Q3, adverse markets, on the back of the concerns for sovereign backed debt solutions in the Eurozone and in the US negatively impacted most of the plans. Q4 showed continued lower interest rates, as well as pressure on equity markets. Our Netherlands plan decided not to provide indexation increases for The Netherlands plan is in a regulatory deficit since September, and a recovery plan has been filed in November. The 2010 recovery plan of our UK plan is making good progress. The UK trustees sold 12 million of the 42 million NXP shares and realized GBP194 million of gain. The value of the remaining stake is GBP320 million, as of the 30th of November. The current IFRS balance sheet position, as of November, 2011, reflects these movements. The unrecognized IFRS surplus of the Netherlands plan further declined. This is due to lower discount rates, leading to higher liabilities and higher spreads on the investments in government bonds and lower equity markets leading to lower asset values. The funded position of the other major plans is more or less on the same level as at the end of Let us now move to pension cost and cash flows. Slide 13 shows the expected movement in pension costs and pension cash flow in 2011 and We have added the expected numbers for 2011, as disclosed in the 2010 annual report. Pension cost is stable, around the EUR200 million level, excluding one-off gains, which was a EUR15 million curtailment gain from the UK in the first quarter. The reason for this is that lower discount rates have resulted in higher service cost and lower interest costs, which, on balance, is a wash. Pension cash flow consists of contributions for defined benefit and defined contribution plans, as well as benefit payments for unfunded plans and healthcare claims in retiree medical plans. Pension cash flow is not much affected by the movements on the financial markets. This is due to the effect of, a) defined contribution and benefit payments are not linked to market movements, and b) defined benefit contributions are only limited impacted by deficits. Contributions for deficits are generally smooth over a longer period of time. At this point, it is important to mention that the numbers for 2012 will be finalized in January on the basis of the funded position and market levels as at the 31st of December of this year. Moving on to the next slide -- that is slide 14, we would like to give you some insight on the impact of IAS19 on Philips. This year the final version of the revised version of IAS19 has been published. Once endorsed by the European Commission, this revised standard will be applied as of the first of January of the year First of all, there is the abolition of the so-called corridor method for deferral of actuarial gains and losses. This new rule is not relevant to Philips, as Philips already applies immediate recognition of actuarial gains and losses via equity. The main impact on our P&L is due to the elimination of expected return on assets, or EROA, and the introduction of the net interest method. 3

4 In summary, this means that pension costs will no longer include a credit for investment returns based on long-term expected returns on assets. Instead, there will be a net interest cost based on the recognized net funded status of each plan. If a plan has a deficit, the net interest will be a cost. If a plan is in surplus, a net interest credit will only be allowed if that surplus is recognized. In addition to these changes, IAS19R, or revised, also requires companies to provide additional disclosures about their pension plans. This refers to the type of benefits, details on funding arrangements, and the maturity profile of plans, and so. The impact of IAS19R on the income statement is reflected in slide 15, which provides an illustrative example, in particular, on EBITA, by comparing interest cost, under the current standard and under the revised standard. As you can see the service cost is not affected by the changes in the standard. We illustrate how, under the current method, interest cost and credit for expected return on assets are incorporated in the pension cost as part of EBITA. The net balance of these two components is a credit, due to the fact that the expected return on assets is normally higher than the interest cost. Under the revised standard, the interest cost and EROA are replaced by the net interest method. This means that the discount rate is applied on the net funded position of each plan. In case of an unrecognized surplus, the net interest is zero. In the illustrative example, it is shown that for 2011 the net interest credit of EUR120 million, which is the difference between the EROA and the interest cost under the current method, is replaced by a net interest cost of EUR97 million under the new method. The difference between the two is EUR217 million of extra cost. The net interest cost will be reported as part of financial income and expense, while the service cost will remain in EBITA. With that, let me turn to the outlook for Group Management and Services for the year. As you will recall, GM&S is composed of four buckets, the first being Philips Corporate Technologies, including corporate research and intellectual property and standards. The second bucket consists of the corporate center and country and regional overheads. The third consists of pensions and postretirement benefit costs, mostly related to former Philips employees. The final bucket consists of our global service units, corporate investments, new venture integration, Philips design, and it needs to be said that service unit costs are charged out on a zero budget basis. For the full year, we expect the adjusted EBITA of group management and services to be around EUR380 million, which is a negative number. It's a cost. This amount includes EUR75 million of so-called stranded costs relative to the divestment of television as well as some EUR25 million of extra costs for the Accelerate! program. Now let me finish by announcing the publication dates in the year 2012 to you. On the 30th of January, our fourth quarterly and annual results for the year 2011 will be published. On the 23rd of February, we will issue the annual report for On April 23, we will publish our first quarterly results The annual meeting of shareholders will be held on April 26. On the 23rd of July, we will publish the second quarterly and semiannual results, and finally, on the 22nd of October, we will publish the third quarterly results of And with that, let me hand you over to Ron for his summary and concluding Ron Wirahadiraksa - Royal Philips Electronics - CFO Thank you, Jan. Good afternoon, everyone. Welcome. I'd like to make only a few summary points today. First, I'm pleased to inform you that we appointed Paul Verhagen as the CFO of Philips lighting, effective January 1, As you know, I was the interim CFO of lighting for the last few months, and I'm happy that Paul will shortly be taking over the role from me. Paul is the current CFO of consumer lifestyle and was closely involved in the finalization of the TV deal. Hence, we didn't announce his move earlier, so he could complete the important task he had at hand. Paul will be succeeded as the CFO of consumer lifestyle by our current Group Controller, Jan van Leeuwen, who you have just heard elaborately on this call. Regarding the TV joint venture, as we mentioned in our announcements, we will report a pretax charge of approximately EUR 270 million in the fourth quarter. This is in addition to approximately EUR 110 million that we already charged in previous quarters. We remain on track to close the deal at the end of the first quarter of There were a few reports in the market that raised the issue of the joint venture falling through, due to the MAC, material adverse clause. I would like to clarify, though, that the MAC clause is a standard clause in most M&A contracts. The MAC clause for the TV joint venture relates to major adverse changes, which are internal to Philips and, therefore, not related to the market development. To make it abundantly clear, changes in the market conditions will not prevent the formation of the JV with our partner, TPV. 4

5 With that, let me summarize briefly a few important points that Jan made in his presentation, starting with the policy of the allocation of IP royalty. As said, IP license revenues for products no longer sold by Philips will be reported as part of GM&S results, starting in It is important to note that when we presented our 2013 midterm targets in Q2 of this year, consumer lifestyle metrics were presented excluding unrelated license income. This change will ensure that from 2012 onward, we report our performance on the same basis at which the midterm target was set, so there are no changes to our forecast in this. In addition, the reclassification of warranty costs and amortization of intangibles will start, as you heard, from Our tests indicate that we do not have any goodwill impairments to be taken for the remainder of Our latest expectation for GM&S results for this year are expected to be largely in line with our guidance, which is a negative EBITA, before restructuring, of EUR280 million. Added to this comes approximately EUR75 million of stranded costs related to the TV business and about EUR25 million in cost as part of the earlier reported annual investments necessary to deliver on our EUR800 million cost savings plan. This accounts, therefore, to a total of approximately EUR380 million for 2011 for GM&S. For 2012, we have yet to finalize the implications of all the allocations of the additional Accelerate! related investments and cost savings. We plan to provide you with this detail when we announce our Q4 results. In terms of pensions, our balance sheet position is expected to be in line with last year pension costs are expected to be in line with Pension cash costs are expected to decrease by EUR10 million in 2012 compared to Due to the change to IAS19R and as Jan explained, we would have an estimated negative impact on EBITA of around EUR120 million in This is to give you a dimension on what the impact would have been. This was taken account -- into account when determining our midterm 2013 target so also, there, no changes are necessary on this target. Before taking your questions, I would like to mention that I am particularly encouraged by the progress we are making on our change and performance program, Accelerate! We see a high level of engagement throughout the organization, and we are investing a lot of quality time and efforts in gearing our organization for the future. Many work streams are making great progress, and a few projects are moving into execution phase. With that, let me now open the line to your questions, which Jan and I will be happy to answer. Thank you. Q U E S T I O N A N D A N S W E R Thank you, sir. ( Instructions) And your first question comes from Andreas Willi from JPMorgan. Please proceed with your question. Good afternoon, gentlemen. My main question relates to dividend policy. May sound strange, but when you said dividends going forward, that now, that basically, we look at the earnings impact. You kind of reduced earnings by a relatively substantial amount, considering the reported number out of 13. Is your dividend policy relating to reported earnings or the underlying cash earnings, which don't really change, due to the pension accounting rule changes? And the follow-up question will be on the pension deficit. What discount rates have you used, compared to the relatively high, around 5%, you had at the end of 2010? Thank you. Ron Wirahadiraksa - Royal Philips Electronics - CFO Well, thank you for the question. This is Ron. Our dividend policy basically is 40% to 50% of payout on recurring net income. Our aim is to sustainably grow our dividend over time. So, on your specific question, this will be on underlying cash. And for the question on the discount rates, I would ask Jan to give you the answer. 5

6 The discount rate that we've used for our accurate calculations are the high quality corporate bond rates. Different for different countries. Most important country being the Netherlands, where that rate is currently at 4.5%. Just for your information, Bloomberg AA aggregate full curve ticker code C667 is the most dominant one used. Thank you very much. Thank you. Thank you. Our next question comes from William Mackie from Berenberg Bank. Please go ahead with your question. William Mackie - Berenberg Bank - Analyst Yes. Thank you for taking the question, and good afternoon. I'd like to go back to the intellectual property and the restatement. At this stage, you've highlighted the position of the IP transfer to GM&S for Perhaps, as a reference, could you give, initially, some expectation of how you see that progressing in '12 and perhaps, historically, how that developed in 2009 and '10? That would be the first question. And the second relates to warranties. When I look at the figures that you've presented, just so I understand how the business has been developing, I can see there's been a decline in warranty provisions of about over 20% over that three year period. I mean, can you give us a sense, from a business of your scale, and now, how you see risk developing across product development and geographies, what sort of normalized rate of warranties we should expect? Well, as to the first question, we do not guide on future expectations of royalty income for the group, and to date, we will not deviate from that policy. Secondly, on the warranty cost, indeed, we've seen a favorable trend of cost of non-quality being managed improvedly. However, on that individual cost category, we cannot give any future guidance either. So I'll have to -- I'm afraid I'll have to flatly disappoint you on the responses to your question. Abhijit Bhattacharya - Royal Philips Electronics - Head of IR Will, this is Abhijit. Maybe, just a clarification in terms of the license revenue going forward, there is no change in what we have said earlier, where we had guided, that for consumer lifestyle, there would be a decline on license revenue to the tune of EUR 60 million in the next four years. So that remains, but as Jan said, we don't have a specific guidance for 2012 because that is something which is very fluid, and we don't want to go into that at this moment. William Mackie - Berenberg Bank - Analyst Great. Thank you for the clarification to hear the restatement on guidance. Thanks. Thank you. ( Instructions). 6

7 Okay. Thank you, Mr. Wirahadiraksa and Mr. van Leeuwen. There are no further questions. Please continue. And I do apologize. We do have a follow-up question from Andreas Willi from JPMorgan. Please proceed. Yes. Just a question on the pension impact -- the EUR 217 million you mentioned. Assume that's a pretax number. Is there going to be any tax impact on that? So, how does it affect the tax rate? Thank you. It is indeed a pretax number, I can confirm. However, the tax effect, relative to that number, is a composite tax effect on which, at this moment, I can give you no explicit guidance. But it's generally a tax deductible cost. Absolutely. Yes. Yes. Thank you very much. Thanks, sir. There appears to be no questions at this time. Please continue. Ron Wirahadiraksa - Royal Philips Electronics - CFO All right. Well, thank you, everyone. I hope this call was informative. Thank you for the good questions, and we'll look forward to see you at our next IR event. Thank you, and have a nice day. 7

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