Ladies and gentlemen, welcome to the Philips Lighting Analyst Conference Call Q1 '17. For the first part of this call, all participants will be in listen-only mode. Afterward, there will be a question-and-answer session. Please note that you are limited to one question and a follow-up question per round. I'd now like to give the floor to Jeroen Leenaers, Head of Investor Relations. Mr. Leenaers, please go ahead.
Good morning, everyone, and welcome to the Philips Analyst Conference Call for the first quarter 2017 results. With me are Eric Rondolat, CEO of Philips Lighting, and Stéphane Rougeot, our CFO. Eric will give you an update about our business and operational performance. Followed by Stéphane, who will go through the financial performance of Q1 2017. Eric will tell you more about our outlook for 2017. We will end today's conference with a Q&A session with Eric. Stéphane will be able to answer your questions. With that, I will hand over to Eric.
Thank you, Jeroen. Good morning, everyone, and thank you for joining us today. I propose that we move straight away to slide number three. The start of the year for Philips Lighting was consistent with our 2017 outlook and goals. Comparable sales growth improved compared to the previous quarters at minus 0.8%. As stated, Europe and the rest of the world delivered growth, while the Americas was impacted by an accelerated decline in conventional lighting and softer market conditions. Business group LED and Home achieved double-digit growth, driving LED-based sales growth around 19%. These businesses are now representing 61% of total sales for Philips Lighting in Q1. Operating profitability continued its gradual improvement trajectory with an adjusted EBITA margin in Q1 of 8.4%, an improvement of 130 basis points versus the same period last year.
We also reported an improvement of net income from EUR 14 million to €61 million. Our free cash flow improved by €80 million in the period to €2 million. We are positive from a free cash flow standpoint in Q1. In the first three months of 2017, we returned €82 million to our shareholders by participating in the share disposal by our main shareholder, as previously indicated, totally in line with the capital allocation policy previously explained. Let's move to slide four, where you can see an overview of the financial performance by business groups. Each business group contributed to the improvement of the adjusted EBITA margin, all performing in line with their strategic objective.
I would like to mention that the Adjusted EBITA in total increased by €21 million, and our business group LED Professional and Home, as you can see, have more than compensated the decline for lamps in absolute value. Let's now move to our four business groups, and we start with lamps on slide seven. Comparable sales have declined by 17.9% due to the technology transition to LED lighting. Overall, we believe that lamps declined less than the market. In the Americas, we noticed an acceleration in the rate of decline of conventional lamps. The Adjusted EBITA margin improved by 260 basis points to 22.9%. This includes a gain on the sale of real estate. If we exclude that specific gain, the margin would have been 20.9%. This performance is in line with our Adjusted EBITA margin last year, reflecting the successful implementation of our last man standing strategy.
I propose that we move to the next slide and talk about our LED business group. In Q1, we saw comparable sales growth of 16.7%. Volumes were effectively higher due to the continued price erosion and mix impact. All regions contributed to the growth. Although we noticed, once again, that countries with low LED penetration rates showed higher growth. Our comparable sales trend in Northern America improved compared to the second half of 2016, showing the benefits of the measures that we have taken in the previous quarters. These measures include different types of initiatives, expanding and diversifying our distribution coverage, intensifying our marketing pool activities, and market-based product innovation. Adjusted EBITA margin improved by 360 basis points to 9.2%, driven by operational leverage procurement savings, which more than offset price reductions as well as mix impact.
Excluding incidentals during the quarter, the margin for our LED business group structurally improved by 290 basis points. On slide seven, we see that Professional showed 2.5% comparable sales growth in Q1. Europe and the rest of the world showed growth. Saudi Arabia is still impacted by difficult market conditions, although performance was less affected than what we experienced in 2016. Excluding the impact of Saudi Arabia, Professional would have achieved a comparable sales growth of 3.8%, as you see on the graph. The Americas had a soft quarter. The order backlog improved during the period. This includes larger projects which will be executed and invoiced later in the year. Our Adjusted EBITA margin of 2.1% showed an improvement of 110 basis points, despite some write-downs on bad debt in Saudi Arabia, although to a lesser extent than what we experienced previously.
Excluding the impact of these incidentals, the Adjusted EBITA margin improved by 280 basis points, driven by procurement saving, higher production efficiency and mix improvement. As previously said, we will continue to focus on improving our growth profile, which will become clearly visible in the second half of this year. Let's turn to Home, which achieved profitability in the first quarter of 2017. Our comparable sales growth show a significant improvement at 20.6%, supported primarily by the home systems business. All markets contributed to that growth. Home posted an Adjusted EBITA of €3 million in the first quarter. The Adjusted EBITA margin improved from a negative 9.7% last year to a positive 2% this year. This was primarily driven by sales growth, structural cost reduction that we implemented into 2016, operational leverage and procurement savings.
The performance of Home illustrates the success of our connected lighting system strategy. I will now hand over to Stéphane, who will tell you more about the highlights of Q1 2017 from a financial standpoint. Stéphane, the floor is yours.
Thank you, Eric, and good morning, everyone. Turning to next page 10. You can see here the evolution of our adjusted EBITDA. Like in previous quarters, our performance was driven by a continued improvement of our gross margin, which increased by 200 basis points, and also the continued implementation of cost reduction programs across the company. When you look at the gross margin, we were again able to improve our productivity to deliver procurement savings and also to benefit from a positive volume and mix impact. Like in previous quarters, this allowed us to more than offset the price declines. Our indirect costs were flat year-on-year. On the next page, we will provide you a bit more details. Overall, we also benefited from favorable currency effect on adjusted EBITDA.
On the next page, we show you the year-on-year development of our adjusted indirect cost base, which was 33.7% of sales in the first quarter of 2017, which compares to 33% a year ago. First, we had a negative impact from currency movement, which increased our cost base by EUR 8 million. Also, the first quarter of last year was positively impacted by a pension gain of EUR 4 million, while in the first quarter of 2017, we had an additional month of brand license fee with a negative impact of EUR 3 million. Finally, as you can see, we continued to implement our cost reduction actions, and we achieved EUR 7 million of savings on indirect costs compared to last year.
We see further cost reduction opportunities that should result in savings in selling expenses, IT, and other internal overhead like finance, HR, and real estate, and we are working on those opportunities. Moving to the next page on working capital, page 12. The working capital decreased year-on-year by EUR 170 million and reached EUR 695 million at the end of the first quarter. This represents 9.8% of sales, and this is an improvement of 180 basis points compared to a year ago. This reduction reflects the sustained improvement that we have achieved throughout the year 2016. The year-on-year improvement was driven largely by a reduction of our receivable in the first quarter. Our inventories, as you can see on the right side, as a percentage of sales reached 13.8%, which is about the same level as last year. Finally, moving to free cash flow and net debt.
We ended the quarter with a net debt of EUR 416 million, which is an increase of EUR 75 million compared to the end of 2016. During the quarter, as mentioned by Eric, we generated EUR 2 million of free cash flow. This is a significant improvement compared to the minus EUR 78 million in the first quarter of 2016, which, as I remind you, included a EUR 45 million cash out for pensions. Still, overall, in the first quarter of 2017, there was a significant improvement in free cash flow, which was driven by our increased profitability, lower cash outflow on working capital compared to the first quarter of 2016, and finally, a reduced net CapEx as a consequence of real estate gain. That has been partly offset by higher interest and higher taxes.
As you see here in February, as you know, we invested EUR 82 million in our own shares with the participation in the sell-down by our main shareholder. The 3.5 million share that we acquired in this transaction will be canceled in the second quarter.
I will now hand over to Eric, who will tell us more about the outlook for 2017. When it comes to the outlook for 2017, we are once again committing to what was said before. We see a further improvement of adjusted EBIT margin approximately around 50 to 100 basis points for the full year of 2017, which is in line with our medium-term outlook to gradually improve the adjusted EBIT margin to 11%-13% for the whole of Philips Lighting. We also have indicated that we will deliver solid free cash flow, while remaining committed to our ambition to return to positive comparable sales growth in the course of this year. With this, we are more than happy, myself and Stéphane, to answer to your questions.
Ladies and gentlemen, we are now ready to take your questions. If you wish to ask a question, please press zero one on your telephone keypad. That's zero one on your telephone keypad if you wish to ask a question. Please stand by for the first question. Our first question comes from the line of Daniela Costa with Goldman Sachs. Please go ahead. Your line is open.
Hi. Good morning, everyone. I would like to ask two things. The first thing, to get your views in terms of how your market share has evolved in the various divisions, whether you've seen any market share gains anywhere. The second thing, just on the point of the SGA and on manufacturing cost reduction that you talked about. I guess a lot of the transitional agreements with Royal Philips have come to the period of being close to ceasing now. When should we expect to start to see a more meaningful impact from non-manufacturing cost reductions in the P&L? Thank you.
Good morning, Daniela. Thanks for the question. Let me take the first one, and Stéphane will answer to the second one. Market shares are only available to us one quarter after the ongoing quarter because we need to get the numbers and add some time to analyze them. If we look from a distance at the predictions that were done by specialists on market growth, we believe at this point in time that with a decline of -17.9% in our lamps business, we believe that we are declining less than the market, which was forecast to decline far above 20%. This is, we believe, a good news, which is also consistent with what we have been experiencing last year.
At the end of the day, when we look at that business, our strategy of being the last man standing is to be able to capture the market share that others would leave on the table when they exit the market. You may have heard, again, in Q1, announcements that some companies are not investing as much as they used to in the conventional part of the business. When it comes to the LED, we have, I would say, gone back to the place where we wanted to be in terms of growth, understanding that for that business we're probably more than twice bigger than the next competitor. This level of growth is healthy for us as we see it.
We believe that in the geographies where we operate, it's not stable, also increasing our market share with definite actions as we have said it previously on different fronts in order to recoup on the growth rate and increase the growth rate versus what we had experienced last year. There are 4 dedicated actions on that business that are coming now to show benefits, especially in Q1. When it comes to professional, I believe that we are taking market share in Europe and the rest of the world. The market is clearly declining in U.S., when I look at the performance of some of the other competitors, we may be slightly losing market share in the small to medium-sized projects. On the other hand, I believe that on the market of bigger projects, we have done clear inroads in Q1.
We have been securing major projects in terms of order intake, they don't show in our invoicing pattern at this point in time, they will be invoiced later in the year, probably in Q3 and Q4. Home, we're growing 20.6%, I think we're taking market share there, especially in the home systems business, which has been performing at extremely high levels in Q1, but pretty much in line with what we experienced also in 2016. Even, Daniela, if we cannot be digital on market share because we don't have the information yet, I think that the overall trend is positive.
Yeah.
Yeah, Daniela, to your second question about SG&A and non-manufacturing cost. Well, first, as you know, this is something that we've been doing for a while without taking into account whether we were independent or not. In 2016, we communicated on the fact that we reduced our cost by a bit more than EUR 100 million, we reached
31.7% of sales. Of course, when you look at the first quarter, because it's a lower quarter in terms of sales, the percentage is higher, hence the 33.7%. I think we have indicated several times that in terms of our target, we see opportunities to reduce the amount of MNCs as a percentage of sales, we gave an indication based on a number of benchmarks, that which would be probably in the range of 29% or even below. There is room here to continue to reduce and improve as a percentage of sales. We have actions in place, they cover select SG&A, finance, et cetera. Those actions are providing results, we will see further impact in 2017, but also in 2018 and 2019. This is a three-year plan, we are executing that plan.
Thank you.
Thank you very much. Moving on to the line of Martin Wilkie with Citi. Please go ahead. Your line is open.
Yeah, good morning. Thank you. It's Martin from Citi. Just a couple questions going back to the U.S. You mentioned a moment ago that you've taken some share in larger projects and the backlog improved in the quarter. Perhaps you can let us know how much of the U.S. business is backlog-driven versus a book and bill business, just to give us some sort of sense as to how important that backlog will be for driving growth later in the year. Secondly, I was interested in your point that you made that you're losing market share in some smaller projects. Obviously, you've been putting effort in to rebuild relations with agents and specifiers to improve the U.S. business. Has that struggled? Is that part of the reason, or do you think it's product-driven?
Perhaps some color as to why you think you've been struggling with some of those smaller projects in the U.S. Thanks.
Thanks, Martin. It's not a business that has been so far pretty much influenced by the backlog, but it so happens that in Q1, we have taken projects that are, from a turnover standpoint, pretty material. This is why we are calling it. That's specifically for Q1. It hasn't been so much the case in the past quarters. As I said previously, we forecast to invoice these projects in Q3 in majority and also a little bit in Q4 this year. We're not commenting specifically on sizes, but as we have done repeatedly and we've been very consistent, whenever we talk about something that we believe that it's an impact which is material. On the smaller business front, I think it's particularly linked to Q1.
When you look at NEMA, the local association in the U.S., they have been stating very clearly that the market of luminaires, after six years of positive dynamics, would shrink in 2017. That's what we have started to see in Q4, and it has continued in Q1. I think in Q1, the expectation of the actors on the market was that the growth would be slightly higher. I think the competitive situation in Q1 was very, very tense, and this is why I think that we have lost market share, given that specific situation in the U.S. in Q1. When I look at our structural improvement on that business, they are there. They are paying off, but probably Q1 surprised the market in terms of market dynamic for those smaller size projects and the competitive intensity was probably a bit stronger during that quarter.
This is why I made that comment.
Thank you very much.
Thank you.
Thank you very much. Moving on to the line of Lucie Carrier with Morgan Stanley. Please go ahead. Your line is open.
Hi. Good morning, gentlemen. I have one first question, is actually a follow-up on the professional business. Can you give us a sense of how the margin dynamics have evolved between your three key region, i.e. North America, rest of the world and Europe, so we can kind of get maybe an insight on your progression there? That's question number 1, I'll have a follow-up after that.
Lucie, we're not specifically commenting on the margin for the businesses by region. Let me put it this way. The good sign of the performance in that business this Q1 is, first of all, an improvement of the operating margin versus last year of 110 basis points. If we take into account that we had positive incidentals last year, the structural improvement is around 280 basis points. If you were to imagine that we would be able to reconduct that improvement on quarter-to-quarter for the professional business, that gives you an indication of the potential performance and margin increase of that business all along to 2017, that's pretty much in line with the guidance that we have given in the medium term. What we see also is that all the regions for the year, I believe, are going to be contributing to that improvement.
Okay. Thank you. My second question would be around your raw material exposure. I was wondering whether you could comment on that in regards to the recent inflation we've seen in plastic prices, metals also. We know that the prices of LED chips are still declining, but maybe to a slower pace than before. I was just wondering, how are you managing normally that inflation around potential procurement materials, and whether you had done actually a component pre-buy at the end of last year, because we've seen that at some other manufacturers when they had started to see raw materials going up.
Some of the key raw materials that we are using in our products are effectively metal, plastics, also optics, that we use quite extensively. It's true that we see more tension on the price of raw material in 2017 than previously. That's also the case for the chip manufacturers. For us, we working on a daily basis on opportunities for procurement savings. We have a plan with our suppliers for the full year, and we're monitoring that as we speak with regular negotiations, depending on the type of commodity we're talking about, that can take place on a quarterly basis.
What we are doing at this point in time, Lucie, we are trying to understand what could potentially be the impact of these raw material price increases on our bill of material, and anticipate it to make sure that that is integrated in our plans to continue to optimize the gross margin. It's a very structured approach that we have, which is led by our procurement head, and this has been functioning well in the past, when we could reduce substantially our bill of material. We still believe that we're going to reduce substantially the bill of material with the view we have today into 2017, even if we do it a bit less than in the previous years.
At the end of the day, we will also do what we have to do commercially, in front of the markets and manage prices, to make sure that the gross margin continue to be optimized. This is muscles and reflexes that we have been using quite a lot in the past years, and we're continuing, but we're extremely attentive. We only, maybe in some very specific cases, we would have both components in advance in very specific long lead time components, but it's not something that we do commonly and on a regular basis. We have discussion with our suppliers, and we build the plan with them for the upcoming rolling four quarters. That's the way we proceed.
Much.
Thank you very much. Moving on to the line of Andreas Willi with J.P. Morgan. Please go ahead. Your line is open.
Yeah. Good morning, gentlemen. My first question is on the home division, which is doing very well. You've reached a break-even target. At the time of the IPO, you haven't specified a longer-term ambition there going first for that break-even level. Maybe you could flesh out a little bit what you see as a longer-term or medium-term margin potential, particularly given the solid growth or very strong growth you now see there, and then I come back with a follow-up question.
Yeah. Thanks, Andreas. Nice talking to you. We are pleased to see the development of the home business. If we talk a bit about the history of that business, we decided to invest extremely heavily in the past three years on that business to develop home systems. At this point in time, we see a very positive traction. At the time of the IPO, if you remember, the credibility on that business in terms of performance was not there. We indicated that we were seeing that business breaking even in 2017 as one of the first steps we wanted to commit to. When you look at the performance and the trajectory, we were positive in Q4 last year. We were also positive if you aggregate Q3 and Q4 last year, and we are also positive in Q1.
We're clearly moving in the right direction, and we believe that that business will be positive, will be breaking even, and maybe more than breaking even for the full year. We will see the trend in the upcoming quarters, and if need be, we will try and articulate better a midterm objective for that business, but not at this point in time, Andreas. We are very focused on continuing our journey, which is to make sure that that business becomes positive for the full year of 2017.
Thank you. The follow-up question, what's your explanation for why the U.S. luminaires market declines in an environment of reasonable GDP growth and solid non-residential construction growth? Is it pulled forward replacement and refurbishment on the energy efficiency argument over the last few years? Is there a risk we could see something similar in Europe as well, maybe in a couple of years, when some of that refurbishment cycle just kind of laps tough comparables?
Yeah, that's a very good point. We investigated this quite extensively. Let me
Put forward what we came up with. First of all, I think the situation in Europe and the U.S. is fairly different. I don't see that as a direct link to refurbishment cycle. When you see the rate of penetration of LEDs in the Northern American market, and there's still a fabulous potential ahead, and here I'm talking about construction, non-res, a lot about indoor and type of applications. There's still a fabulous potential ahead. What we have seen in the past month is we believe that customers have financial capabilities, but probably that at this point in time, given the uncertainty of the landscape, they would refrain to do the investment now, and probably they leave it for a later stage. That's the best answer I can come up with, after all the discussions we had with our team there.
It's not a lack of need and financial resources, it's probably waiting and a bit of expectation, a bit of cautiousness because of the uncertainty of the global environment there. That's the best answer I can come up with at this point in time.
Thank you very much. Thank you very much. Moving on to the line of Finn Ryer with UBS. Please go ahead. Your line is open.
Good morning. Two questions from my side, please. The first one is on your EBIT bridge and the EUR 21 million improvement in the adjusted EBITDA. I mean, some EUR 9 million from FX, low double-digit from real estate. How do you see those factors developing in the rest of the year? Do you still see further real estate transactions? What would be the currency impact if rates wouldn't change? The second question is just simply, what was the impact of the real estate in the incidentals on the cash flow in the first quarter? Thank you.
Yes, Finn, looking at the bridge, first overall in terms of currency, you're right, EUR 9 million. We've seen a strengthening of the dollar. This is helping us as we have more sales than purchase in dollar in particular. Also an impact of the renminbi. Difficult to predict for the whole year. There may be some further gains, but again, it's extremely difficult because there is quite some volatility in the currency. We will figure out on that one. With respect to real estate, of course it's important for us, especially in our last man standing strategy to make sure we can monetize all our assets. Part of it is real estate, we have a number of real estate assets and we constantly look for either restructuring and improving their performance and profitability or for monetizing those assets.
That's what we've done in Q1, we've been working on that one quite a bit. We haven't disclosed the overall amount, but if you look in the appendix of the press release on the P&L, the other income is EUR 16 million, the vast majority is the real estate gain. By the way, the free cash flow impact is more or less the same. As we have disclosed in the business group performance, most of the gain is in lamps and you have most of the rest that is in LED, we've been transparent on those impact. That's the order of magnitude. Whether there's going to be more in the course of the year, of course, we don't know and it's too early to say.
Any way we can find to monetize assets and generate value for the company, of course we will do so, every time we do it, we may disclose it.
Okay. That's very clear. Thank you very much.
Thank you very much. Moving on to the line of David Vos, Barclays. Please go ahead. Your line is open.
Hi, good morning, gents. Thanks for taking my questions. The first one, please, on pricing. I note that pricing as a percentage of sales has gone down or has gone much more negative, both sequentially and year-over-year. If you can comment on that, please. The second question would be kind of following on the previous question around expectation around real estate and other incidentals. Just to confirm, when we look at the guidance for 50-100 basis points of improvement in the margin, just how much incidental is already in there? I mean, I can calculate around 20 basis points just coming from the Q1 effect. Can you confirm that that's it, or is there more to come in the rest of the year? Thank you so much.
Let me start with the last one. That's an easy one. You're right. EUR 15 million on a full year basis is about 20 basis points. That one, of course, when we gave our guidance a couple of months ago, that sale was going on and you're never sure you're going to close, but we assume that that would be part of what we have in 2017, those 20 basis points are part of our guidance. This is also why we give ranges, those 50-100 basis points. To your question, is there more to come? Again, as I answered before, we don't know, and there may be, and we will of course disclose. Of course, if there is anything that's really meaningful, that may affect our guidance.
At that point of time, if it happens, we'll tell you if it has any impact or not on our guidance. At this stage, based on what we've done in Q1, there is no impact and no reason to change our guidance for this. To your question on pricing, you're right. There's still a pretty material impact of price decline. You can see here, EUR 87 million. As a percentage of sales, it's a bit lower. We've seen a bit less price decline in some areas, especially in LED and especially in electronics. As you remember, every time we comment on prices, it's also related to not only volume, but also raw material tension and what we can extract out of bill of material.
When we extract less, we know that as an industry, it means also the price decline is going to lower. I guess this is what you see here. Of course, it's a combination of many price evolution within our product portfolio. Overall, that's how we interpret that slightly lower price decline as a percentage of sales compared to previously. What it means for the future, of course, we don't really know. What matters to us is to make sure that we can generate as much as possible bill of material savings and productivity improvement in order to be able to be competitive on the market, to reduce prices on the market, to take market position, and to increase volume. That's how the overall model works.
Thank you very much, gents.
Thank you very much. Moving on to the line of Alexander Virgo with Bank of America Merrill Lynch. Please go ahead. Your line is open.
Thanks very much. Good morning, gentlemen. A couple of questions. I wonder if we could come back a little bit on professional. If you ex the Saudi drag, you're growing that business at about 4% underlying. I wondered if we can take that as a run rate despite the declines in North America for the balance of the year. Is that something that we can see sustained as presumably the drag from KSA ends up being de minimis in the second half? The second question just on conventional margins, the lamps margins. Underlying or ex, the real estate gain, I suppose you're doing about 21%. Again, is that something that we can see as sustainable for the balance of the year? Any comments you can make around that would be great. Thank you.
On the first question, Alexander. For KSA, what we said from a top-line perspective is that we believe that the market will still be impacted throughout the whole year. Once again, much less than what we had experienced in 2016. This is what happens in Q1. It's only a bit more than 100 basis point impact, when it was close to 400 basis point impact in the whole 2016. I've got to be very honest, I'm not extremely optimistic on the KSA market moving forward. The impact will be of a magnitude that is not going to be worse than what we experienced in Q1. That's our projection.
We're not giving indication or outlook on how we see the businesses performing. What I can tell you is that in Q1, we've seen a very positive trajectory in Europe and also in the rest of the world. We've already commented in other situation in the U.S. From a more general standpoint, yes, we are positive on what we see happening in professional in Q1, and we will have additional positive news from a top-line perspective, as I've mentioned it before, in the bigger size projects that have been building our order intake in Q1 in Americas, and that we will invoice later down the road during 2017. On your second question about lamps. 20.9% performance in terms of adjusted EBITA margin is pretty much in line with what we experienced as an average for the full year of 2016.
We continue to manage that business, we believe in an optimized way. Could it be at that level, slightly lower? This is what we are aiming at for the full year. This is what we have said previously. In all cases, we imagine a performance between 16%-20%, probably closer to the higher interval of that range.
Okay. Very clear. Thank you. If I could just follow up on LED growth. Obviously 17% in organic terms in Q1 versus last year. You've seen some pretty meaningful acceleration from the low double-digit growth in the back half of the year. Again, can we think about that in the same context of, I suppose, seasonality for the rest of this year? I think Q1 was only about 22%, 23% of the total number last year. Any comment you can make around the sustainability of that growth rate would be very helpful. Thank you.
When we experienced in Q2 last year, a downtrend in the performance of LED, we were very clear that we're working on it. We've been defining for that business very clear and dedicated four actions in order to be able to improve our growth rate. It took a little bit of time to see that happening, but we see that in Q1. I will tell you that I'm quite optimistic when it comes to that business for the rest of the year. We need to forcefully and extremely rigorously
Continue to implement the action that we have started to implement. We also know, and you also know that the second semester for that business will be an easier compare than it was the case in Q1, because we started to have a lower growth rate for that business in Q2 last year. With all these elements, I think that gives you an understanding of where we could end up. We are working on all cylinders on that business to continue to maintain our position and gain market share.
Very helpful. Thank you very much.
Thank you very much. Moving on to the line of Alok Katre with Société Générale. Please go ahead. Your line is open.
Hi. Thanks for taking my questions. I have a couple as well. Firstly, just following up on the market development in the U.S., perhaps you could talk a bit about Europe as well. In the U.S., you sort of mentioned that you sort of lost a little bit of market share on the small and mid-size projects, perhaps because of more competitive dynamics. Is it something that you expect to continue through the rest of the year? Because I guess the expectations, at least from some of our peers, are a bit more sanguine now than perhaps they were at the beginning of the year. Is it something where you should see a bit of easing of those dynamics in the U.S. on the mid and small projects?
Perhaps you could talk a little bit about Europe as well from a professional perspective, because it's probably the second quarter where you've seen a bit of growth there. That was the first, the second one was just stepping back and looking a bit at the capital allocation policy. You have a dividend and the buyback that you're sort of executing. If you look at inorganic growth opportunities, just wondered how should we think about those and any priorities over there, such as any regional gaps that you would like to fill, or are there any product lines within software or lighting controls that you are sort of thinking about as well? Any comments there would be useful. Thanks.
Thanks, Alok. Let me take the three questions. First of all, we need a confirmation of this, I think that's what we experience in terms of competitive dynamics because the further market softness surprised competitors on that market. I see that really as a Q1 situation and not something that will last in the coming quarters. Europe still shows substantial growth in the professional business and in most of the countries where we are operating and playing on the full spectrum. Not only LED offers that have performed extremely well, but also moving up to lighting connected systems. We've seen interesting gains in most of the end-user segments that we are serving in Europe. If you look at the global level of Philips Lighting, lighting systems and services for professional is again performing at a very strong double-digit level.
These are the good news for Europe and also globally when it comes to lighting systems and services. When it comes to our capital allocation policy, I would say that if you were looking at the priority order, the first one would be to invest inorganically in future growth opportunities. Number two would be to return money to the shareholders, and number three would be eventually to de-lever. When it comes to M&A, we are, one, very clear, and second, extremely strict. We do acquisitions if we have the management bandwidth, because doing acquisition takes a lot of management attention in order to make sure that we don't only close or sign a deal, but we post-merger integrate it in the right way. At the same time, we need also to have the right target in front of us.
We've said from the very beginning that if those two conditions are not there, we will not proceed with acquisitions and we will go with our priority number two, and this is what we've done and what we've commented at the end of last year. There is a clear set of priorities when it comes to our M&A strategy. It will be mostly bolt-on acquisitions, and we would be looking in luminaire companies in order to improve or increase our market share in some parts of the world, or eventually acquire some specific luminaire technology that we may not have. Otherwise, the two other areas for M&A are technological bricks systems. It can be control devices, as you've mentioned, or any other type of technological brick that would complement our systems architecture. Thirdly, capabilities and also platforms for services.
At this point in time, Alok, let me probably give some more color to this. We have been in those three domains, listing potential targets that could be interesting for us. We have shortlisted a few of them, and we are working as companies have to be doing it on a regular basis on opportunities for inorganic growth. These will be activated whenever we not only have the right target, but we have also the capability to properly integrate them.
Moving on to the line of Nigel van Putten, ING. Please go ahead. Your line is open.
Hi. Good morning. Most of my questions have been answered, but I have one follow-up on the pricing environment for LED lamps specifically, with LED packages seemingly stabilizing or continuing to stabilize. Do you think the market will remain rational? I think, Stéphane, you just mentioned that. Do you think that maybe smaller Asian players perhaps will also adjust their pricing accordingly? As a follow-up, do you still or continue to believe you have a sustainable advantage in terms of your cost base due to scale economies and on especially the purchasing footprint?
Hi, Nigel. Thanks for the question. Look, I don't want to look complacent. Neither would I want to look arrogant, but at this point in time, in that business, we're probably twice bigger than the number 2 on the market. We're probably much bigger than some of the Asian companies that you're mentioning. Our profitability in Q1 is above 9%, when probably the number 2 may still break even, if not make it. We have a real advantage when it comes to not only the size, but also the profitability of that business. If there is less potential to extract cost, we believe that the market price will decline less.
We also believe that we are in a better position than others at this point in time, given our size, but our profitability also, to be able to manage prices and try to extract value also from differentiation, segmentation of the offers, bringing further innovations to the market as we have done it repeatedly. I don't know if you have heard and if you read that we have, once again, launched on the market 2 very interesting innovation. One in the domain of the Master LED T5, which is a one-to-one replacement for existing fluorescent lamps. On the other side of the spectrum, the candle, colored lamp as well as white lamps, part of the Hue family, which was very expected by the market.
Wherever we bring those innovation to the market, it has a very positive effect on our businesses in general and mainly the LED business. That's the way we see it. We don't see so far irrational behaviors. Frankly speaking, it's not going to come from us anywhere.
Can I squeeze a quick follow-up on the outlook then? I think in this call you said that most of it will come from cost containment, but also the bill of materials.
Two questions, please. Firstly, I'm just trying to understand why the real estate gains are included inside your adjusted EBITDA performance. According to the perspective, it says that adjusted EBITDA is a measure of the underlying performance of the business. Maybe you can explain why a real estate gain is a measure of underlying performance. Secondly, on Professional, you've talked about having additional revenues in the third quarter because you'll be billing the large projects you're currently booking. Can you talk about any potential margin impact? I would imagine these are quite competitive projects. Will we see a negative margin impact when we get the additional growth coming through in the third quarter? Thank you.
Let me take the first one, Peter. On real estate gains here, we are just applying the accounting policy that has been applied always and is consistent with the one of Royal Philips. Since we are still consolidated, of course, we need to apply this. There is a very clear rule, which is every gain like this that is below EUR 20 million is part of the OBI, and when it's above EUR 20 million, then it's below the OBI. To us, it doesn't really matter because at the end, we disclose them. We want to make sure we understand and we share the real underlying performance. Even if they were included, like it's the case here in the adjusted EBITDA, we make sure that on a global basis and by division, you have a view of what is the true underlying improvement.
That's the way we do it. For the rest, we just apply the accounting policy the way it is designed and applied within the Royal Philips scope. For the U.S. project, Guido, that we have commented. These projects are connected lighting systems, their margin is above the average.
That's very helpful. Thank you very much.
Thank you very much. No further questions in queue. Ladies and gentlemen, as a reminder, please press zero one on your telephone keypad if you wish to ask a question. Zero one on your telephone keypad if you wish to ask a question. Please stand by for the next question. The next question is coming from the line of Lucie Carrier with Morgan Stanley. Please go ahead. Your line is open.
Hi. Thank you again for taking my question. I just had one, actually two follow-up. One follow-up on what you just said about the U.S. projects in professional. You said they were above average margin. Maybe I didn't get your response fully, but do you mean above average margin of professional, above average margin of the group, or above the average margin of your professional business in the U.S.?
Above all of them. I was answering-
pretty much above the average margin of the group.
Yeah. I was answering the question of Guido. We will see a positive impact on the margin and the operating margin of Professional coming from these projects whenever we invoice them.
Okay. Just one which is kind of more arithmetic. It seems that the restructuring this quarter was maybe a bit less than what was expected in consensus. I just wanted to ask, how should we calibrate kind of restructuring expenses for this year? Maybe if you can give some indication around the phasing.
Yeah. On calibration, and especially on the quarterly basis, that's a very difficult question to answer because as you can expect, it's really based on specific actions in every business and when it's decided and implemented. We have a plan for the year, but then the real execution and when it takes place exactly can always change. It's difficult to predict by quarter. That's why this quarter it was only €10 million of charge. Then on the full year basis, we've always given a clear indication that we believe that the spend is in the range of 1.5% of sale, 1.5%-2% of sales. This is the overall charge that we took in 2016, and this is what we believe we will take also in 2017. Again, it's all based on very specific actions.
For the savings, look, we don't communicate specifically on savings for each of our restructuring initiatives. Generally, we look at them, and we ensure that there is a payback that is in the range of anywhere between as low as one year, and depending on the country, sometimes it can be more than two and sometimes up to three years. That's the way we approach it, and we look at it and take those decisions. There are some other things that we do as we finalize those restructuring. We monetize the value of the assets like we've done here in real estate. That's the overall approach we have on restructuring.
Thank you very much.
Thank you very much. There are no further questions in queue. With that, I would like to return the call to the speakers.
Thank you, ladies and gentlemen. Thank you very much for attending the call and for taking part in the discussions about our results. If you have any additional questions, please don't hesitate to contact investor relations. We are happy to answer your questions. Again, thank you very much, and enjoy your day.
Ladies and gentlemen, this concludes today's conference call. Thank you very much for attending. You may now disconnect your lines.