Koninklijke Philips NV (PHG) 2017 Q2 法說會逐字稿

Welcome to the Royal Philips Second Quarter 2017 Results Conference Call on Monday, the 24th of July, 2017. During the introduction, hosted by Mr. Frans van Houten, CEO; and Mr. Abhijit Bhattacharya, CFO, (Operator Instructions) Please note that this call will be recorded and is available via webcast on the website of Royal Philips.

I will now hand the conference over to Mr. Pim Preesman, Head of Investor Relations. Please go ahead, sir.

Thank you. Good morning, ladies and gentlemen, and welcome to Philips' Second Quarter 2017 Results Conference Call. I'm here with our CEO, Frans van Houten; and our CFO, Abhijit Bhattacharya.

On today's call, Frans will take you through our strategic and financial highlights for the period. Abhijit will then provide more detail on financial performance and market dynamics. After that, we will take your questions.

Our press release and the related information slide deck were published at 7 a.m. this morning. Both documents are now available for download from our Investor Relations website. A full transcript of this conference call will be made available by end of today on our Investor Relations website.

Before I turn over the call to Frans, I would like to remind you of an accounting update regarding Philips' Lighting. Following a sell-down on April 25, 2017, Philips' shareholding in Philips Lighting was 41.16% of the issued and outstanding share capital by end of the second quarter, and results continue to be consolidated under IFRS. Our loss of control is highly probable within 1 year due to further sell-downs. Philips Lighting is presented as a discontinued operation in the financial statements of Philips as of the second quarter of 2017. Discontinued operations treatment means that profit and loss of the Lighting business is reported into discontinued operations. And for the balance sheet, the assets and liabilities of the business are reported on the lines assets held for sale and liabilities held for sales, respectively. Cash flows are reported in the line cash flow from discontinued operations. We've also published a reporting update to reflect the treatment of Lighting as discontinued operations. This document is also available for download from our Investor Relations website.

The combined Lumileds and Automotive lighting businesses continue to be reported under discontinued operations, including the deal results following the completion of the sale of an 80.1% stake on June 30, 2017. In the third quarter, the remaining 19.9% stake will be reported as an available-for-sale financial asset. Finally, as mentioned in the press release, adjusted EBITA is defined as income from operations excluding amortization of acquired intangible assets, impairment of goodwill and other intangible assets, restructuring charges, acquisition-related cost and other significant items.

With that, I would like to hand over the call to Frans.

Yes. Thank you, Pim, and thank you all for joining us here today. Philips' performance in the second quarter of 2017 was solid with a 4% comparable sales growth, driven by Western Europe, North America and China, and a strong 8% increase in our order intake. We achieved further operational improvements, resulting in a 90 basis point increase in the adjusted EBITA margin.

After covering some of the key results in the second quarter, I will share with you some recent highlights of our exciting HealthTech journey, but let me first start with our results.

Our second quarter results demonstrate our progress in creating value. Philips' comparable sales growth of 4%, which was led by the Personal Health segment, which showed a continued strong 6% growth in the quarter, while Diagnosis & Treatment and Connected Care & Health Informatics grew by 3% and 1%, respectively. We were able to further expand our backlog with a comparable order intake growth of 7% in Diagnosis & Treatment, with all businesses contributing. And in the Connected Care & Health Informatics businesses, the comparable order intake increased by 8%. Geographically, our 4% comparable sales growth in mature geographies was driven by 8% growth in Western Europe. North America recorded 4% growth, partly offset by a 7% decline in other mature geographies. In growth geographies, sales increased by 3% on a nominal and comparable basis, driven by high single-digit growth in China and Latin America.

Moving to profitability. Adjusted EBITA was 10.2% of sales this quarter compared to 9.3% previous year. That's a 90 basis point improvement. The increase in margins was driven by higher volumes, operational improvements and cost productivity. Personal Health delivered 120 basis points of margin improvement. And maybe that's a good moment to come back to the announcement that Pieter Nota, the Chief Business Leader of our Personal Health businesses, and Chief Marketing Officer, will be leaving Philips. Peter and I have worked very well together for 6 years, and it is with regret that I see him leave after a successful tenure with Philips. Based on our strong internal talent pipeline, however, we expect to announce Peter's successor in the coming weeks, who we are sure will be able to build on the growth and margin expansion momentum achieved over the last couple of years in Personal Health.

Coming back to the performance. In a soft healthcare market, our Diagnosis & Treatment businesses improved margins by 80 basis points, and the Connected Care & Health Informatics businesses improved by 90 basis points. I'm confident that the performance of the professional health businesses will continue to improve in the second half of the year based on the strength of their order book.

Let me expand a bit on our strategic journey to leadership in Health Technology. As outlined at last Capital Markets Day, our HealthTech value-creation story is built on 3 key levers. Firstly, we create value by improving margins through better serving customers and raising operational productivity; secondly, we create value in our core businesses by gaining market share through deeper, more comprehensive customer partnerships and pursuing growth by increasing the geographic coverage; thirdly, we create value by expanding our innovative solutions along the health continuum through R&D investments, co-creation with customers and partners and selective M&A.

Let me detail that a bit further. On the first lever, our self-help productivity program continues to be an important margin contributor. And for the next 3 years, we have committed a cumulative total net saving of EUR 1.2 billion by 2019, averaging productivity savings of approximately EUR 400 million per year. In the second quarter, procurement savings amounted to EUR 61 million. The other productivity programs resulted in savings of EUR 48 million. So overall, we are well on track to deliver the yearly savings amount.

We continue to drive the digital transformation to serve our customers better and unlock value for them and Philips. For example, the Philips Sonicare DiamondClean Smart connected toothbrush reached a 94% customer satisfaction rating out of a full score of 100% with top online retailer JD.com in China, with consumers highlighting the benefits of the coaching app and the premium design. With this connected toothbrush, we can directly engage with consumers. And by leveraging the data related to the usage of the toothbrush, we plan to enhance the brush head replacement rates. While staying on top -- on the topic of digital and online marketing and sales, I can tell you that already 27% of revenue of our consumer categories are sold online, a number that doubled over the last 3 years. Part of our digital agenda is to increase the online relationship and intimacy with our customers and users of our products, through which we expect to stimulate recurring revenues of our products and services. With the acquisition of U.K.-based Health & Parenting, we have strengthened our global digital Mother & Child Care platform, uGrow. The Health & Parenting team creates easy-to-use and helpful apps to guide expecting parents through pregnancy and into parenthood. Its leading product is the Pregnancy Plus App, which is one of the world's most downloaded pregnancy apps, with approximately 12 million downloads from the Apple App Store and Google Play Store, over 1 million active users. And in the U.K., approximately 1 out of 2 expectant mothers use the app.

Building on the second lever of creating value is through -- building on the second lever of creating values through deeper customer partnerships and increasing geographical spread, I can tell you that in the second quarter, we signed multiple long-term, strategic partnerships, or as we abbreviate it, LSPs. For example, in France, we signed a 10-year managed equipment services contract for patient monitoring systems with Le Confluent private hospital. The agreement with the top-3 ranked French hospital for cardiovascular solutions includes maintenance, replacement and upgrades of patient monitoring systems as well as biomedical and clinical training. In Singapore, we entered into a multiyear partnership with the Singapore Institute of Advanced Medicine Holdings to provide solutions for its new oncology center with a range of Philips advanced diagnostic imaging systems, including the IQon Spectral CT and Vereos Digital PET/CT systems, combined with clinical informatics and services. Our funnel for LSPs for the remainder of the year and next year is strong.

We are pleased with the success of OneBlade, the innovative new product that taps into the growing market trend of male facial hair styling. OneBlade effectively broadens the reach of our Male Grooming portfolio. Leveraging our capabilities as the world's leading electric male grooming brand, OneBlade is on track for its rapid rollout and is currently available in 14 countries worldwide.

Thirdly, on the third lever, we create value by expanding our innovative solutions along the health continuum through R&D investments, co-creation with customers and partners and selective M&A. Our breakthrough R&D investments are delivering tangible results as we received regulatory clearance from the FDA for the Philips IntelliSite Pathology solution, which is the first and currently only digital pathology solution for primary diagnostic use, enabling us to market the solution in the United States. This further confirms our position as a leader in Digital Pathology, an important solution that is used in the diagnosis of complex diseases such as cancer. We also received FDA clearance for our IntelliSpace Portal 9.0 and a range of innovative applications for radiology. The platform gives clinicians a comprehensive overview of each patient, helping them to diagnose conditions using advanced analytics and quantification of medical images.

During the previous quarter, I spoke about the launch of Azurion within the Image-Guided Therapy business. Azurion is a major breakthrough and is our next-gen Image-Guided Therapy platform. The solution has been very well-received by our customers, and we are able to grow market share in the first quarter and strengthen our #1 position in that market.

In the second quarter, we further strengthened the leadership position of our Image-Guided Therapy business by expanding our portfolio of therapy devices with the agreement to acquire the Spectranetics Corporation. Spectranetics has an impressive product portfolio of catheters for the treatment of coronary artery disease and peripheral vascular diseases. This involves the opening of obstructed blood vessels around the heart and in the legs with devices such as the laser atherectomy catheters and drug-coated balloons. In addition, they are the market leader in the minimally invasive removal of implanted pacemaker and internal defibrillator leads. Spectranetics' highly complementary portfolio, including these laser atherectomy catheters and the AngioSculpt X Drug-Coated Scoring Balloon, the (inaudible) drug-coated balloon will all support Philips' expansion in Image-Guided Therapy devices. The combined Spectranetics and Philips Image-Guided Therapy Device business, Philips Volcano, is expected to grow by strong double digits to approximately EUR 1 billion by 2020. This transaction is expected to be accretive to Philips' adjusted EBITA and adjusted EPS by 2018, mainly driven by sales growth, channel synergies and overhead reductions, while we expect limited integration complexity.

With the acquisition of Spectranetics, we are building on our successful track record of integrating acquisitions and rapidly improving growth and profitability. To remind you, Volcano had a stagnant top line at the time of the acquisition in 2015. It reached double-digit growth rate in 2016, and we are continuing that trajectory. In addition, we have reduced over $40 million in cost to drive the business to profitability. The acquisition of CardioProlific will further strengthen our longer-term innovation pipeline of catheter-based therapy devices. The development of CardioProlific's differentiated thrombectomy technologies, combined with our suite of Image-Guided Therapy solutions, will help our customers drive the procedure innovation for the treatment of peripheral vascular disease. Furthermore, to reinforce our leading position in ultrasound, Philips acquired TomTec Imaging Systems, a leading provider of clinical applications and intelligent image analysis software. This acquisition will strengthen our #1 position in cardiac ultrasound and will support a further expansion in other clinical areas such as obstetrics and gynecology or OB/GYN. TomTec will be accretive to growth and margins as of the first year.

Within the Personal Health segment and Sleep & Respiratory Care, we signed an agreement to acquire RespirTech, a U.S.-based provider of an innovative airway clearance solution for patients with chronic respiratory conditions, highly complementary products to our existing portfolio to help those patients to receive the care they need at home. Also RespirTech will be accretive to growth and margins as of the first year.

As you have seen, we signed agreements for a significant number of bolt-on and strategic acquisitions during the last quarter. We have been following these companies for a long time, and we are pleased to reach final agreements, which coincidentally, all came together in the second quarter. Spectranetics is, obviously, the only acquisition of real significant size. And with these acquisitions, we are executing on our strategy.

In line with our earlier guidance on June 30, we announced completion of the sale of an 80.1% stake in the combined Lumileds and Automotive businesses. With the completion of this transaction and the recent sell-down of our stake in Philips Lighting, we are nearing the completion of Philips' transformation into a focused health technology company. Additionally, we announced a new EUR 1.5 billion share buyback program to be initiated in the third quarter of 2017 and to be completed in 2 years. This comes in addition to the EUR 3.5 billion in share buybacks that were already completed between 2011 and 2016. The program is intended to more than offset the share dilution in connection with Philips' long-term incentive programs and dividend in shares. Philips intends to execute part of the program through a series of individual forward transactions unevenly distributed over the 2-year period. The buyback is in line with our capital allocation policy, which aims at a balanced mix of investments in organic and inorganic growth opportunities, actions to drive balance sheet efficiency and returns to shareholders.

As stated in the press release and as previously reported, we continue to be in discussions on a civil matter with the U.S. Department of Justice, representing the FDA. The discussions are focusing primarily on the external defibrillator business in the United States and are arising from past inspections by the FDA in and prior to 2015.

Despite continued volatility in the markets in which we operate, our outlook for 2017 remains unchanged as we expect further operational improvements and comparable sales growth in the year to be back-end loaded, this supported by a strong order book. We are on track to deliver the 4% to 6% comparable sales growth and an improvement in adjusted EBITA margin of around 100 basis points per year.

And with that, I would like to turn the call to Abhijit, who will provide more detail on financial performance and market dynamics.

Thank you, Frans, and good morning to all of you on the call and webcast.

Let me start by providing some color on the second quarter growth of 4%. On a geographic basis, mature geographies delivered 4% comparable sales growth. Western Europe showed a strong 8% comparable sales growth, mainly driven by The Netherlands, Iberia, Denmark and Norway, with double-digit growth. North America grew 4%, while other mature markets posted a 7% decline, driven mainly by Japan. In mature geographies, Diagnosis & Treatment grew high single digit, and Connected Care & Health Informatics and Personal Health posted low single-digit growth.

In the growth geographies, 3% comparable sales growth was largely driven by strong double-digit growth in countries like Russia, Turkey, Indonesia, Thailand and Argentina. We are pleased with the continued high single-digit growth in China in the quarter. In the growth geographies, Personal Health recorded double-digit growth; Connected Care & Health Informatics, low single-digit sales growth; and Diagnosis & Treatment, mid-single-digit decline compared to Q2 of 2016.

In HealthTech Other, net sales decreased by EUR 9 million as royalty income decreased by EUR 14 million due to the foreseen expiry of licensees. This gave us a headwind of 30 basis points for the overall growth of the group in the second quarter.

Turning to order intake. As Frans mentioned, comparable order intake overall grew by 8%. The Diagnosis & Treatment businesses grew by 7%, with Image-Guided Therapy business growing mid-single-digit, and both Diagnostic Imaging and Ultrasound growing at high single digit rates. The Connected Care & Health Informatics businesses grew by 8%, recovering from a slower start in the first quarter.

In growth geographies, order intake on a comparable basis grew mid-teens compared to Q2 2016, mainly driven by Latin America, India, Russia and Middle East and Turkey. Comparable order intake in Western Europe declined with 8% on the back of double-digit growth in the previous quarter, while North America posted a strong 9% growth. On the last 12-month basis, comparable order intake grew with over 4%.

Let me now turn to the EBITA development for the group in the second quarter. Adjusted EBITA margin of 10.2% in the quarter was 90 basis points higher than the year before. This margin increase was driven by an improvement of 120 basis points in Personal Health, mainly attributable to the operational leverage from growth. In Diagnosis & Treatment, the margin increased by 80 basis points, mainly due to higher volumes and product mix. In Connected Care & Health Informatics, the margin improved by 90 basis points, mainly due to cost productivity. In order to further improve our financial disclosure and to align with our new peer group, we have included an adjusted EBITDA metric as from Q2 2017 in our press release, which also includes the bridge from income from operations and provides historical numbers for 2016. Our performance improvement in the second quarter is driven by higher volumes, improved operational performance and meeting our cost productivity targets. More specifically, net overhead cost reduction amounted to EUR 15 million in nonmanufacturing cost. The productivity program contributed EUR 33 million to the gross margin. And procurement savings, in part driven by our Design for Excellence program, delivered EUR 61 million of bill-of-materials savings year-on-year.

In HealthTech Other, the adjusted EBITA of minus EUR 32 million was EUR 8 million better than our guidance. The decline of EUR 18 million compared to Q2 2016 was driven by lower royalty income. In the second quarter, the income tax expense was EUR 44 million, which was a decrease of EUR 19 million compared to the second quarter of 2016. The decrease was mainly due to the release of tax provisions, partly offset by higher tax charges resulting from the higher income. Q2 2016 also included tax cost related to the Lighting separation.

Overall, net financial expenses decreased by EUR 43 million year-on-year, mainly due to lower net interest expenses as we redeemed bonds of -- in a total of $1.5 billion during Q4 2016 and Q1 2017. Net income from discontinued operations, which now includes the results of Philips Lighting, along with Lumileds and Automotive businesses, decreased by EUR 185 million year-on-year, mainly due to the Funai arbitration award in Q2 2016. Net income of the Lumileds and Automotive business decreased by EUR 42 million. This was mainly due to EUR 66 million net loss from the sale of the 80.1% stake in the combined Lumiled and Automotive business. Taking into account the gain related to the sale of real estate of this business, which was recognized as income from continuing operations in Q1 2017, and in addition, trademark license revenues which will be recognized in income from continuing operations in the future, the sale of the combined businesses will result in an overall net gain. Return on invested capital, which is calculated on a 5-quarter MAT basis, was 15.4%, which is a 7.1% -- point improvement -- sorry, which is 7.1 percentage points above our WACC and improved by 8.4% compared to Q2 2016.

Our drive to increase working capital efficiencies continued to yield results as inventory as a percentage of sales decreased to 14.4% year-on-year, an improvement of 120 basis points. Overall, working capital improved by 130 basis points to 9.8% of sales. Net cash flows from operating activities decreased by EUR 104 million, mainly due to higher working capital compared to Q1 due to seasonality and higher tax paid.

Let me now provide you with an update on the U.S. market and our outlook for Western European and China markets.

Healthcare in the U.S. is undergoing fundamental change. With our scope and scale in the U.S., we are well positioned to support public and private healthcare organizations to reduce healthcare cost, improve the quality and outcomes of care and move from a volume-based to a value-based system of reimbursement and service delivery. For example, with the help of our Intensive Ambulatory Care program, Banner Health in the U.S. reduced hospitalizations for chronically ill patients with multiple conditions by nearly 50%, reducing overall cost of care by more than 1/3. The market uncertainty stemming from the ACA legislative process continued in Q2, particularly around larger and longer-term customer commitments. We continue to monitor events closely and stay focused on the needs of our customers.

We saw continued slowdown of government spending. Given these uncertainties, we continue to expect the U.S. market growth to be in the low single digits while we closely monitor further developments. At the same time, we are currently able to increase market share as we expect in the second quarter, and hence, remain confident in our ability to grow revenues.

In Western Europe, we expect modest low single-digit market growth. And in China, we expect mid- to high single-digit market growth for 2017. Overall, we estimate the global market growth to be in the low single-digit range for 2017.

Let me now give you some guidance on HealthTech Other and Legacy Items. In the HealthTech Other segment, we continue to expect approximately EUR 16 -- EUR 60 million net cost at adjusted EBITA level for the full year. On an EBITA level, we now expect approximately EUR 70 million of net cost for the year. The increase compared to the previous guidance of EUR 40 million reflects higher restructuring charges and incidental items. For the third quarter, we expect a net cost of approximately EUR 15 million at an adjusted EBITA level. In Legacy Items, we expect to -- we expect remaining Lighting separation costs for the second half to be around EUR 10 million and remain with our guidance for separation cost of EUR 30 million for the full year. Other Legacy Items are expected to be EUR 5 million for the second half. We now expect approximately EUR 95 million of net cost at the reported EBITA level, an increase of EUR 30 million almost fully driven by the CRT legal settlement in Q3. At adjusted EBITA level, we expect EUR 40 million net cost for the year.

Mid-July, we made a contribution of $250 million to the U.S. pension fund to further improve the funding ratio. This will further decrease Philips' interest cost going forward.

In summary, we are pleased with a solid first half of the year, with mid-single-digit order intake growth, earnings improvement, working capital improvement and our cash flow performance. With the scheduled product launches and the development in our order book, we continue to expect further improvements in our operating margins for 2017 to be at the back-end of the year. We continue to target a performance trajectory to deliver 4% to 6% comparable sales growth and around 100 basis points improvement in adjusted EBITA per year.

With that, we'll now open the lines for your questions. Thank you.

(Operator Instructions) The first question comes from Ms. Veronika Dubajova from Goldman Sachs.

I have 1 and 1 follow-up, please. My main question is around the outlook for the remainder of the year. If I look at, say, organic revenue growth is at 3.2%, but in spite of that, you've already delivered 90 basis points of margin improvement year-on-year. So I'm just trying to understand, if we do see growth acceleration into the second half of the year, how much of that incremental growth would you expect to drive operating leverage above and beyond the 90 basis points that you already delivered in the first half of this year? And then my quick follow-up is just on the M&A transactions. So far, year-to-date, obviously, it's been a very second quarter for you. And Frans, maybe can you just talk about to what extent you feel that your team, both on the business development side of things and integration, has capacity and capability to do more than the 7 transactions that you've announced year-to-date?

Yes. Veronica, good morning. Let me take the M&A question and then turn to Abhijit for the outlook question. So let's say, a condition for me that I always apply is that the business group needs to be ready to absorb an acquisition, right? Our Image-Guided Therapy business group, under leadership of Bert van Meurs, has proven with the Volcano acquisition that they are capable to handle that. The Volcano integration is mostly completed, and they are ready to take on Spectranetics. The CardioProlific is a very small team and doesn't require real integration. TomTec goes into the Ultrasound business group. That's a high-performing business group with very capable management, Vitor Rocha, and they can handle this. Moreover, TomTec decides they will also continue with serving the external customers. So I consider the integration not to be very complicated. And then, for example, RespirTech and APSS both go into Sleep & Respiratory Care. Again, a high-performing business group that is delivering steady, mid-single-digit growth and high profitability there, very capable to absorb these acquisitions. And then lastly, Health & Parenting is a very small team, goes in our high-performing health and well-being business group under leadership of Egbert van Acht. So what you can derive from that is that we have looked for a spread. We have not piled everything in the same unit, and we -- I can hold individual business group leaders accountable for delivering results, exactly what we did before. So I think we are well positioned to take this along. Obviously, our focus will be on execution. We have said that this will all be growth and adjusted EBITA and adjusted EPS accretive next year in the aggregate, and for the most important ones like Spectranetics and TomTec. So that is now the name of the game, everybody focused on execution, right? So for now, I think our plate has been filled. Abhijit, what about you?

So I think on the outlook, Veronika, for the first half, the growth was at 3%, 3.2%. We were slightly handicapped because of the loss of license revenue that impacted us by 30 bps on the overall growth of the group. So if you see where we talked about the 100 basis points year-on-year improvement, we had said we expect about 100 bps from volume, 190 bps from gross margin and about 50 bps from overhead reduction, which would be compensated then by price erosion of 130 and inflation of 110 bps. In the first half, because our growth has been slightly shy of the 4%, our volume impact is around 80 bps. So as the growth picks up in the second half, we expect then the volume impact to go up by about 20 bps compared to the first half. And then for the first half, we are about 85 to 86 bps improvement, so we have to drive slightly over 100 bps in the second half to make the average 100 for the year, which we are pretty confident in doing, partly because we expect the volume growth in the second half, as I just mentioned, and then, of course, our productivity programs will gather further steam as the year goes on.

That's very helpful. And can I just quickly ask, CMS announced a review of MRI imaging in the U.S. Any thoughts you have on that, Frans, or expectations for what that might mean for your business? And I'll jump back into the queue on that.

No, I need to study it further, Veronika. So no comment, no.

The next question comes from Andreas Willi from JPMorgan.

My main question is on Connected Care & Health Informatics. You've had a period now of pretty lackluster organic sales growth, though you've had better orders now. You talked a lot about the product rollout, the breakthrough R&D you've spent. Should we now go into a period of a more sustained kind of mid-single-digit organic sales growths trend? Or will this remain a bit more lumpy in terms of getting the confidence that these investments are driving superior revenue growth going forward?

Yes. Thanks, Andreas. You're right, we will now go into a more sustainable growth period. In fact, we talked about it before that some of these orders deal with more complex, larger-scale installations that at enterprise level in the IDNs need to be signed off and integrated. In fact, some of the revenues again was pushed out into the third quarter. So you're right, we should expect a much stronger revenue level in the second half year versus the first half so that we can make up for the slowness and overall land in a good growth rate in the same target area as we have guided.

And my follow-up is for Abhijit on Healthcare Other. Obviously, the run rate and the Q3 guidance implies quite an improvement then also needed for Q4. How much visibility do you have on the licensing income, which I guess is part of the positive you kind of imply for Q4 and the generally better results for the second half?

Yes. We've got a bit of a knock there in Q2, but for license income, we are close to flat for the second half. So the decline in the year was largely in the first half, and therefore, you will see the second half year-on-year comparison being better than the first is. So we lost, I think, EUR 28 million in the first half year, and the second half will be about flat.

The next question comes from Mark Troman from Bank of America Merrill Lynch.

Question, please, on pricing, Frans. 90 bps in the quarter, I think from your profit bridge. And the long-term sort of guesstimate seems to be 130, a bit more than that. I wonder if you could comment on the pricing environment and maybe how that is developing by category. You always do it. Obviously, there's some innovation, but you're trying to do more system selling, there's more IGT. So is there a better pricing mix that we can expect? In other words, can we expect a little bit more robust performance in that pricing variable in the bridge?

Yes. It was a little bit lower than our longer-term guidance, but I would not say that that's a trend break. As you know, we work very hard to move towards more of a solutions orientation, looking to have a combination of systems, software and services that improved mix -- that improves the mix, but it also takes the direct attention away from a naked box sale. So maybe that's part of the explanation. But I'm not able to promise you that 90 basis points is the new normal. We will stick for now with our longer-term guidance.

Okay. And just one quick follow-up on where are you seeing the most share gains? You comment about market share gains. Is that Cleveland? Or is that across other businesses other than that?

The strong order intake in North America clearly outpaced the low single-digit market growth, and that is why we also believe we are gaining share. The order intake growth was across the board, so also for DI, Diagnostic Imaging. And notably strong was the order intake for the enterprise informatics, Healthcare Informatics area.

Patient monitoring also.

And patient monitoring also, yes. So across the board basically. Now the official reporting in North America will undoubtedly confirm this, but, let's say, our overall track record of growth bodes well.

The next question comes from Mr. Patrick Wood from Citi.

Perfect. The first one, I guess, would be on the oral care and Personal Care category. You guys have been taking share fairly considerably and consistently for quite some time versus sort of the FMCG peers. I wonder how long you feel you can keep doing that and whether that -- is that pure innovation? Is that NPD? What's really driving the share gains? And how confident are you that those can keep going? And just as a quick follow-up as well if I may, maybe following up on the North American imaging side of things. A bit stronger than I think some of us here expected. Have the conversations with hospitals changed at all? There's a lot of uncertainty surrounding healthcare reform in the U.S. and it's surprising that the -- I guess, you and peers have had pretty robust growth and even taken share back. Have you had any change of discussion? Is this pent-up demand? Or what's really driving that North American market growth that you're seeing?

Yes. All right. Thanks, Patrick. Well, oral, so your question was specifically, first, is the FMCG guys, right? So in oral care, you see an ongoing shift from manual brushing to electrical brushing. That is a macro trend that will continue. So that creates a fundamental for our oral care business that is very, very healthy. Moreover, we have completely overhauled the product range in Oral Healthcare, and we have been stepping up our investments in advertising and promotion. So -- and lastly, we are still adding countries to our franchise, right, I mean to address the geographical expansion. So this is a potent recipe that has been working extremely well for us and can continue to drive, let's say, the growth rate that we have been enjoying. Then on Personal Care, a few years ago, we kind of anticipated that male shaving with the traditional electrical razor was not necessarily appealing to young men, and we started to invent the OneBlade. Now OneBlade is a kind of a hybrid between a traditional handle for wet shaving and an electrical shaver and is particularly targeted towards this grooming area. We are selling the OneBlade in the traditional shaving aisle, basically where the wet shaving classical competitors are, right? So it's, for us, an extension of our market reach into a new segment. And it is, in our opinion, taking share away from the classical categories in shaving. And then moreover, we entered into, let's say, beauty segments. So again, because of this strategy, we can sustain growth in Personal Care. We said in the introductory speech that OneBlade has just increased its geographical coverage to 14 countries, up from last year, 6. That means that we are still in the ramp-up phase, and we expect more growth to come. So that is, I think, where this growth is coming from. And for at least the foreseeable future, we expect this to continue. Then your second question on hospitals. Let's say, in North America, there is a lot of uncertainty around the ACA, and the conversation with hospital C-suite is that people are concerned, especially if you have a high exposure to Medicare and Medicaid, then your funding is at risk. This is, in the market, slowing down overall investments. Moreover, it has -- there is a slowdown at the Veterans Administration due to their procurement rules that favor small veteran-owned companies. All of that has not stopped us from driving hard, let's say, our innovations and gaining some share. I do see more reluctance in the near term for long-term, large-scale project commitments, right? So that is something that I think we need to be a little bit more conservative in our estimations on because nobody is going to commit themselves structurally in this uncertain situation. So I hope that answers your question, Patrick.

The next question comes from Mr. Ian Douglas-Pennant from UBS.

So the first is on the process improvement costs in CC&HI. Can we -- should be take this as a sign that you are acting in response to the concerns that FDA raised and that DOJ may or may not enforce already? I don't know whether you can give any comments on that or how new those costs have been -- how quickly those costs have been rolled out and how recently? And then the follow-up question is to...

Sorry, Ian, did you say process improvement cost? I'm not sure I heard the word that you used.

That's what I said, yes.

Okay.

If that's not exactly the same language as in your release, I apologize but...

Okay, no problem.

And then the other one is a follow-up question related to -- after Veronika's question earlier. I wasn't quite sure what you were for guiding for. Were you saying that you're going to hit the 100 basis points of margin improvement this year? Or by the second half this year, you're going to be annualizing at 100 basis points as in -- if that makes sense? There's quite a big difference for the run rate for next year.

Well, we carefully phrased 100 bps per year as an average, so it could be 1 year at 90, another year at 110, averaging across the years at around 100. For this year, we have said that the second half year will be stronger in terms of revenue growth than the first half. We have not specifically guided on what that does for profitability, other than saying that for the full year, we intend to be around the 100 bps without further precision. On your first question, in CCHI, a couple of things going on. Yes, we are stepping up a bit the cost for -- to be ready for regulatory inspections. We are always ready, but you can certainly do more when you are in a situation as we are in, and that specifically relates to the Basel and Andover sites. Moreover, in CCHI, we also have a restructuring, and I turn to Abhijit to maybe say a few words about that.

Yes. The restructuring is part of the, let's say, overall footprint program that we're running, but we're also stopping one particular product, which leads to a slightly higher restructuring in this quarter.

Okay?

Is the reason for that product discontinuation, is this just a standard SKU reduction? Or this is...

Yes, yes, that has nothing to do with it.

It's nothing to do with the defibrillator, anything like that?

No, it has nothing to do with the whole FDA thing. It would have happened anyway.

The next question comes from Mr. Max Yates from Crédit Suisse.

Just my first question is on Personal Health. You've obviously shown another quarter of very strong growth against a tough comp. You also talked about, I think, having advertising revenues that were burdening this quarter's margin. So should we be thinking that, kind of, as we move into the second half, if we can sustain similar growth rates, that we should get a greater amount of margin expansion? Or do you expect to have some further advertising costs and product launch costs in the second half as well?

There's no reason to expect a stronger second half than the first half. If we can continue to perform at this rate, that will be outstanding in my book.

Okay. And just the -- the follow-up was just on China and what's happening there. I think you're sort of talking about the market growing at mid- to high single digit. And I think your business has been growing double digit for the last couple of quarters. So I think you've talked about in the past kind of the government -- or the government favoring local players there. Yet you seem to sort of continuously be actually outperforming the underlying market that you talk about. So could you give us a little bit of a feel for how health care in China is developing and maybe sort of explaining sort of your ongoing strong performance there, and how sustainable that is?

Yes, a couple of years ago, there were several issues, one of which was the local players and the preference that they were being given by -- in some provinces and some hospitals. The other one was the kind of clampdown on procurement methods in hospitals. The latter factor has gone away. The China 5-year plan clearly identifies health care as a growth area, in particular, in the more rural areas and also, favoring private hospitals expansion, right. The share of private hospitals is expected to increase from around 10% to 25% in the next 4 or 5 years. That is good for us because private hospitals are not bound to this kind of political game in certain provinces with favoring local vendors. Nevertheless, this local preference thing has not gone away. We occasionally bump into that. And then we cannot really participate, especially when it is some larger bundle deals, so it's a reality that we try to work around. The strategy that we have, to become more of a solutions provider, also is at work in China. And that, increasingly, is well received, in particular also with the private hospitals who look for solutions and are not necessarily keen to be a systems integrator on their -- in their own right. So we have somewhat outperformed the China market, not by a lot, I would say. We talk about the market being mid- to high single digit, and we are kind of hovering around the 10% growth. So it's nice performance. It also means we have recovered from 2015 when we were much lower. I must say that Andy Ho and his management team are doing a great job. That's our leader for China. And I -- for the foreseeable future, I see this as sustainable growth, right. So I'm confident about our ability to perform, at least, let's say, for the foreseeable horizon. Longer term, look, I read The Economist and other magazines, and then you can say longer term, is there a macroeconomic issue? But at least nothing that we near term need to worry about.

Okay. And actually, just while I'm on this. One number that would be really helpful, you talked about in Personal Health trying to do more to increase your recurring revenue and customer sort of relationships. Would you be able to give us an update of how much of Personal Health is now recurring revenue or at least on the sort of toothbrush and (inaudible)?

Yes. Off the top of my head, the recurring revenue in Personal Health is currently around 10%, and that has been steadily increasing.

The next question comes from Mr. David Vos from Barclays.

The first one is on the healthcare other line actually, where you expect quite a bit of a break in the trend between H1 and H2. Could you just comment on that? Particularly in relation to the innovation line, is that also stepping down quite a lot? And if that's the case, is that then because you now feel that you need to invest less? And therefore, we can expect a similar amount going forward, i.e., a lower amount? And I'll ask the second question after that.

Maybe you ask your second question now, so that we can look up the first question.

Okay, that's also fine. The second question was more of a housekeeping one around Lumileds. If you could confirm already what the expected net cash amount in will be once the -- once you recognize that in Q3? And then also if you expect the stranded costs to run in the EUR 5 million range for the foreseeable future? And if so -- and if not, how that steps down?

Yes. So maybe let me just address your first question on HealthTech Other. There is no real significant change in the run rate on innovation between the first half and the second, maybe a little bit. It's more that in the first half, we had certain one-off charges, which we will not have in the second. And the other thing is in the first half, we had, compared to last year, a deterioration in the license income. And therefore, the EBITA related to that were about EUR 28 million, which is not there in the second half.

Yes. I see that, Abhijit, but I struggle a little bit to make the bridge then between first half, in which you've done kind of a EUR 70 million negative, and the second half, which should be EUR 10 million positive to reach the EUR 60 million adjusted EBITA guidance. Unless I took that number down in the wrong way, I'm not really sure how we get there.

Let me -- I'm more than happy to give you that offline and here as well. Like I said, the first half was more severely impacted by the license income, so if we give you, let's say, on a call separately, the review on license income for the second half. And in the first half, we also, like I said, had some one-offs in the quarter, which you see in the HealthTech Other line of EUR 10 million. That also will not repeat in the second half. So I think those are the 2 big -- we have quite a big quarter in Q4 on license revenue. So although year-on-year, it remains flat, but through the year, the license revenue in the second half of the year is significantly more than the first half, and that also is what creates the additional income in the second half.

Okay, let's take it offline then.

Yes. So if you keep the innovation costs the same, but if you have much larger license revenue, you will have a much better income for the second half.

And the cash amount for Lumileds?

And the cash amount for Lumileds has already come in; was, I think, the EUR 1.35 billion. So it was what we had announced earlier, and that money has come in Q2.

Coming in Q2. Okay.

Sorry, what was your question on the Lumileds stranded cost?

Oh, the stranded cost, yes. You mentioned EUR 5 million in the other items in legacy. Is that a one-off or is that...

Yes, that used to be there as stranded cost, but now that Lumileds is gone, we will get rid of that cost, so that will disappear in the coming months.

Next question comes from Mr. Yi-Dan Wang from Deutsche Bank.

This is Yi-Dan from Deutsche Bank. Just one quick question. Can you provide a bit more color on the performance in the other mature markets? It seems to be a lot weaker than mature markets in general. And what are you doing there? When could we expect that performance to improve? That would be great.

Yes. That's -- I can be quick about it. That's mainly driven by a sales decline in Japan. What is now good is that in the second quarter, we had a very strong positive order growth. And therefore, we are going to be able to turn around our performance in Japan and get back to positive sales growth in the coming quarters.

So that's just quarterly fluctuations rather than something in the (inaudible)?

Well, I would call it a little bit more than a quarterly fluctuation because, in fact, our Japan performance has been, yes, a little bit on the soft side for the last several quarters. And we appointed new management about 3/4 of a year ago and we are now seeing the positive impact of that new management. Very pleased with the strong, very strong order growth in the second quarter. And therefore, I'm optimistic that going forward, we will see a much more steady performance.

What was wrong with it? And what did they do to turn it around?

It's just a matter of new energy and leadership into the team. I mean, there was no specific single root cause, other than that a newly appointed leader brings new energy and takes the team forward.

Okay. So products are fine, but there was a management issue?

Exactly. Yes.

The next question comes from Mr. Scott Bardo from Berenberg.

The first question just relates to the order book bounce-back of 8% this quarter, which is encouraging and good to see. But I just wanted to understand in historical context because it appears that North America was a major driver of the rebound, but it was against a comp which I think was one of the worst growth comps for order book that the company have had for some time. I think you were down something like 10% in the prior year. So is this effect, to large extent, normalization rather than market share gains? Perhaps you could comment a little bit about how we put that in context of history.

Well, if you take last 12 months order growth for Philips as a whole, then we are a little over 4%, I think 4.1% off the top of my head. That, I would say, is a little bit above global market growth. With the strong order growth in the second quarter, you probably will see this LTM average go up a little bit. North America specifically is also at a 4% LTM. And I like to point out that this year, we have not yet had orders from the VA given that the VA is withholding all orders due to this legislative issue around giving preference to small VA-operated -- veterans-operated enterprises. There are hearings going on with regards to this, and we hope this will be resolved later this year. We are not certain yet. Philips has a very strong market share in the VA, so this is material for us. Notwithstanding the VA not ordering, we had 8% order intake growth, hence, my conviction about market share performance.

9% even.

9%.

Yes.

Okay, thanks, Scott.

And just maybe just one follow-up, if possible, please. So free cash flow generation, I think, in the first half was about EUR 165 million, which is perhaps a little bit soft of the trajectory for EUR 1 billion, EUR 1.5 billion that you outlined for HealthTech. Can you talk a little bit about the drivers for free cash flow in the second half? And following on this, if Abhijit could take a stab at what the net debt position for the business will be at the end of the year considering the Lumileds inflow and in the absence of further sell-down for Lighting, that would be very helpful for us to get a feeling for balance sheet position.

So I think from a cash flow perspective, we are pretty good, well placed. If you look at the first half of this year versus the first half of last year, as a business, our cash flow largely comes in Q3 and Q4, so we are actually pretty okay with the EUR 1 billion to EUR 1.5 billion guidance that we've given. Regarding the net debt, we probably will be on the lower side of the 1 to 1.5 turns of net debt-to-EBITA that we target, so closer to the 1 than the 1.5.

That's excluding Spectranetics, Abhijit, though?

No, that's including. I mean, we will pay for Spectranetics now, right, so we will fund that as well.

Next question comes from Mr. James Moore from Redburn.

I wonder if I could ask a little bit about the profitability in D&T; progressing nicely, but maybe a little slower than consensus was expecting. Perhaps we were all a bit too high. But I was wondering if you could perhaps provide a little color on the year-on-year development for margin between the units, DI, IGT, Ultrasound. Specifically, I'm trying to understand how much big iron is coming up, with or without Cleveland. And whether Ultrasound, the step-back that we saw last year, whether that's stopped or it's still continuing?

Abhijit?

So if you look at DI and the improvement in the first half, we see that actually pretty much across the board. So you see we have improvements in DI, for sure, because also the improvements in the CTM -- CT and AMI results. We have had good improvement in the results of IGT. And what is also very good is that we have good improvements in the results of Ultrasound because Ultrasound growth is back. And therefore, these are high-margin businesses, which have very strong operating leverage. So I think that is helping us. And also, the added growth so far from IGT and Ultrasound gives us a positive mix impact in the overall numbers. So CT, AMI coming, cost reductions on track, good volume so far, and then a bit of mix that comes from the Ultrasound and IGT businesses growing fast.

Very helpful. And the other question was on trademark license revenues. I might have misheard you earlier, but will there be a change in the sales or profit and -- besides the impact, going forward from either Lighting or Lumileds auto?

Sorry, I didn't mention anything...

The brand license income.

No, I didn't mention anything about that. So we had said there are certain licenses which expire, and we have guided to that earlier that we would lose this year around EUR 28 million to EUR 30 million. The loss of that revenue is basically in the first half of the year. So the second half year-on-year will be close to flat.

Yes, but -- so Lumileds will start contributing to the brand license income going forward now that there are -- Q3 being deconsolidated.

That's what I was trying to understand. We've got this dropping out and then Lumileds coming in. And basically, big picture, if we look at next year versus this year, license income, is it broadly similar? Or how should we think about that?

Brand license income is seeing a steady increase over time.

And in terms of the profit impact of that, does it move with it? Are there things we need to think about?

So you see within the licensing portfolio that we are losing license income from intellectual property patents, and we are gaining license income from the brand. In terms of profitability, it's probably similar. And Abhijit already said that the decline of IP&S was primarily in the first half, whereas the second half year-on-year is more comparable.

(Operator Instructions) We have a follow-up question from Ms. Veronika Dubajova from Goldman Sachs.

I just wanted to ask a question about the order book growth? And the 4-plus percent that you're running at over the last 12-month period, Frans, how sustainable do you think that is? And other than U.S. CapEx, which you have flagged as a sort of maybe an area of concern, are there any other risks that you see to that 4% growth rate?

Yes. Veronika, that is sustainable. In fact, I would like to have the order growth to be in the same bracket as our guidance for revenue growth. We see that we have done that over the last 12 months. I flagged that Q2 will help that average. And also, looking forward, looking at our opportunity funnel, we use Salesforce.com, so we can actually analyze our opportunity funnel pretty well. I feel confident about our ability to do that. Okay, are there any other questions?

And we have a follow-up question from Andreas Willi from JP Morgan.

Just wanted to ask about foreign exchange and the sensitivity to it. Obviously, we had a translation impact from the stronger euro. But historically, Philips have, at times, quite material impact on the transaction side. I mean, a weaker dollar should generally be good for some of your sourcing cost, but maybe you could just talk about that a bit more in terms of what some of the implications are as to big currency moves we are currently seeing? How far out you're hedged? And whether we should expect much in the earnings bridge in terms of margin impact in the second half and into next year?

Yes. I think for the second half, not really anything significant. If you see, we are largely hedged in terms of our position. If there's just a strengthening of a dollar, you will get an impact both on the sales as well as on the absolute amount of EBITA, but from a margin perspective, not too much. So we have changed quite a bit on our hedging strategies in the past. So therefore, you've seen in the last couple of years we don't call that out as large as it used to be. Of course, if emerging market currencies fluctuate big time, that could have an impact. But if it's just the euro-dollar, we should be okay for this year. And then for next year, it's a bit too long term to see, but then we hedge accordingly as well or take pricing action. So one of the 2.

But did you have a big net exposure? I guess you export some products from Europe. You export others from the U.S. Is there a big net exposure prior to...

No, no, not really.

The last question comes from Mr. Scott Bardo from Berenberg.

Yes. It just relates to the ongoing regulatory discussion with the U.S. Department of Justice. Obviously, this is an overhang, and it's been kicking on for some time now. I just wonder if you could -- I appreciate there's limited things you can share here, but can you share some sort of feeling as to the likelihood that these discussions culminate in a consent decree with the regulator? And perhaps you could share some thoughts there.

Scott, well, discussions are still going on with the DOJ. And obviously, discussions with the DOJ are serious, right, otherwise, you wouldn't have them. So we take it very seriously. Now it affects, primarily, the defibrillator business. And therefore, the impact of any measures would be targeted to, let's say, parts of the PCMS business group. Other than that, I really don't want to run ahead of ourselves and first come to a conclusion with that discussion, which is taking a little bit of time. So -- but let's take it when it comes, and then we will inform you in detail on the next steps.

Thank you. Mr. van Houten and Mr. Bhattacharya, that was the last question. Please continue.

Okay. Well then, I'd like to say to everybody, thank you for attending. We had a strong, let's say, quarter. We look with confidence at the future. That is what we wanted to radiate. And we'll stay very focused on execution, and that's what you can expect from us. Thank you very much for attending.

This concludes the Royal Philips Second Quarter 2017 Results Conference Call on Monday, the 24th of July, 2017. Thank you for participating. You may now disconnect.