as head of Business Group Lamps. I would like to hand over the presentation to Eric Rondolat. He will give business update and followed by Stéphane, who is providing an update about financial performance. After, we have a Q&A session. Eric, please, the floor is yours.
Thank you, Jeroen. Good morning to all of you. It is good to have you numerous on the call today. We will proceed exactly as we have done during the previous quarter, a small presentation to start with by myself and then Stéphane on the highlights for the quarter. Let us move immediately to slide three, where we look at the performance overall for Philips Lighting. We have declined in sales by 3.3% globally, while our LED-based activities have continued to grow by 16% and they now represent 56% of what we are selling in Q3. Also to be noted is the strong improvement in operational profitability. We gained 250 basis points in Q3 versus Q3 last year, at 10% for the quarter. The net income is EUR 51 million.
It has to be read in a specific fashion because there are EUR 30 million included there for the brand license fee separation cost and some financial expenses that were indeed not included in Q1 2015. We made the same remark in Q2. This is something we will have to live with, probably for the coming quarters. Our free cash flow was strong at EUR 164 million. This is mainly linked to working capital management. The next slide is about giving a global view about the businesses. If we look at Lamps, we have declined by minus 13%, pretty much in line or better than what we had expected. We have improved, once again, our operating margin performance by 460 basis points.
In LED, we grew still double digits, a bit less than our expectations. We are going to come back to that, for an improvement of the operating profit of 340 basis points. We declined in Professional by 3.8%. With a slight decline also of 60 basis points on the operating profit, while Home has grown double digits in line with the previous quarters, with a strong improvement also in the operating margin of 1,340 basis points. That leads the overall numbers that are a decline of 3.3% globally for the company and an improvement of 250 basis points on the operating profit margin. Let us look now at the performance by businesses. Lamps has continued to perform, that is on slide five, pretty much according to the previous quarters.
We had a top line and a revenue which probably declined slightly less than the bandwidth that was given, around 15%-20%, we are at 13% in Q3. We have been able to maintain, if not increase further, our operating profit margin at 21% in Q3, mainly driven by the fact that we anticipated on our cost base at large for a lower volume, and the volume is higher, and it brings immediately a benefit to the bottom line. Also to be noted that we have successfully divested our Quartz and Special Glass business in the Netherlands, which was a very important action plan that came to completion for us in Q3. If we move to LED. We see a growth of 11.5%, and we make no secret that we were expecting more.
We talked in Q2 about a situation in North America that has also impacted Q3, and especially, at the beginning of Q3, but it is still there. We have protections in place that we can talk about later down the track, and they will bring benefits, but they are not coming as quickly as we had imagined. We have also seen in some Europe countries where our LED penetration is high, and I believe that this is a normal phenomenon when the LED business starts to be bigger than the conventional part of the business, the LED business start to grow less than before. Another element which is important for that business is that the margin is still moving in the right direction, being above 10% in Q3.
We continue to develop new offers, and we have introduced to the markets, again, some interesting innovations that we can come back to eventually also later. Let's go to Professional. Professional has declined by 3.8% in the quarter. What we had started to see in Q1 and Q2 this year, not only continued in Q3 when we talk about the situation in Middle East and Turkey, but we have seen the environment worsening in Q3, which partially explains these numbers. We have seen also in some countries of Europe, the outdoor market being much softer than in the previous quarters. America has still posted growth on that business for Q3. The adjusted EBITDA has slightly decreased, compared to the same quarter last year, at 6.3% versus 6.8% last year. Also a few innovations on that business.
I could talk about what we have done for the stadium for the Juventus, completely LED with ArenaVision, LED providing to the fan an unprecedented light show pre-match. Or what we continue to do with L.A. in the U.S., where basically after having provided the connected nodes on the luminaire and the software CityTouch Backbone, we also now investing with them the possibility to boost acoustic sensing in the poles for them to be able to detect vehicle collision and send very quickly emergency services at the right place. Let me finish off with Home. Home has continued pretty much according to the trend that we have experienced in the past quarters in terms of growth. It is a double-digit growth. It is happening in all the businesses and in all the geographies.
Also to note for the quarter, the improvement in terms of operating margin because Home was in Q3 close to breaking even. Very interesting development here. The partnership that we're developing with Google for Google Home, a partnership that we're developing with Amazon for Amazon Alexa, which is voice-activated command on the lighting as well as the new Hue motion sensor that provides a lot of new possibilities and new features that were widely recognized at the IFA this year. This is what I would keep to cover according to the format that we've used previously. Now I will pass the mic to Stéphane, who will talk to us a bit more about the financial performance.
Yeah. Thank you, Eric. Hi, everyone. Let me turn to page 10. Here, we thought we would give you a little bit of an explanation about the comparative sales growth in Q3 versus last year, and how it compares to what we had seen in the previous quarter, meaning in Q2. You see on the graph that we went from a decline of 1.5% to a decline of 3.3%, 180 basis points degradation. As you heard from Eric commenting on the various divisions, essentially all the decline comes from our Business Professional. Again, the comments were made on the worsened impact of Middle East and Turkey, also some softer market conditions in some European countries.
With respect to Lamps, having a better performance in terms of growth compared to what had been posted in Q2, Home being pretty much at the same level of growth as in Q2. We thought that was a way for you to better understand the trends in growth in Q3 compared to what we had seen in the previous quarter. Turning to the next page 11, deep-diving a little bit into the adjusted EBITDA performance. In absolute value, you can see a material increase this year compared to in 2015, a significant improvement in the margin to now 10%. This has been driven very largely by the growth of our gross margin. In value terms, the gross margin increased by EUR 36 million compared to last year. As a percentage of sales, it increased by 410 basis points.
We were in Q3 almost at 40% gross margin during the quarter. That has been a very strong performance. In terms of the driver of the gross margin improvement, they are pretty much similar to the patterns we've seen up to now in previous quarters. Volume and mix being positive, in particular driven by LED. Price being negative across a number of Business Group, but also in particular in LED. We have been able to more than compensate the price decline by the efficiency that we have in our operations, by the efficient procurement savings that we are able to secure, also by the productivity that we have in our manufacturing plants. When we look also at the cost base outside of the gross margin, it is something important for us, in terms of optimization and reduction.
Despite the fact that we had some additional costs which we didn't have last year, like the brand licensee, we've been able to reduce the cost base and we actually took out EUR 10 million out of the cost base in the third quarter compared to last year. A very good quarter, both in terms of gross margin and in terms of cost reduction. Turning to page 12, working capital. Sorry, going to page 12 on the overall profitability. We thought we would step back a little bit and look at the trend over the last few years. If you look at the right-hand side, this is for the first nine months. You see in terms of adjusted EBITDA, EUR 457 million and now very close to 9% EBITDA margin. The first nine months, that's a significant improvement compared to the same period in 2015.
That is very consistent with the improvement that the company has been able to post since 2013, as you can see on the left-hand side. Again, we are on an improvement path in terms of operational profitability. You can see this every year, and you can see this not only in the quarter but since the beginning of the year. Turning to page 13. Working capital has been also a key point of attention of the company and the various businesses since a few years. When you look at the performance since the beginning of the year, and in particular in the third quarter, it's been very strong. On the right side, you see the inventory level, which is at 13.8%, which is almost two point below last year at the same period, and also which is below the end of June.
Knowing that the third quarter is usually a quarter where we build up inventory, it clearly shows that there's been a very healthy management of inventories across our businesses. We've been able to extract cash out of this, as you will see when I comment on the free cash flow. Working capital as a whole on the left-hand side, 11.2%. Again, this is almost three points below last year, and that's a point below the end of June. Overall, a very good management of the various working capital items. You can see now much more stability in the level of the working capital across the year. Turning to cash flow. A very strong cash flow during the quarter, EUR 164 million.
It means that year to date, we are now at EUR 146 million, which is very close to the cash flow generated for the same period in 2015. That's despite the fact that we had a number of additional charges and cash out on the brands license fees on interest and a number of things which were not in the cash flow last year. It's a very good performance. In the quarter, it's been driven by not only the earnings improvement and the increase in adjusted EBITDA, but also the comment I just made on the working capital. We generated during the quarter EUR 73 million of cash out of this working capital management, and that's the case across the various business groups. Finally, on page 14, one quick comment about our Forex. Nothing very different from what you've seen so far.
The breakdown of our sales by currency is relatively similar. With respect to the impact of Forex, in Q3, we've been impacted to a lesser extent than the impact in Q2. From a sales standpoint, it impacted us for 2.1 point of sales compared to last year. We had the impact of the Argentinian peso, which decreased by close to 40%. The British pound compared to last year, for sure, has also decreased. Finally, at the level of the profit and adjusted EBITDA, actually, we see a positive impact because a lot of our costs are in renminbi, that also helped, which means net at the EBITDA level, it was a EUR 9 million benefit. That concludes my part of the presentation, I think we can now turn to the Q&A.
Operator, please could you continue?
Yes, thank you very much. Ladies and gentlemen, we will now start the Q&A. Please note that you're limited to one question per round plus a follow-up. Please press 01 on your telephone keypad if you wish to ask a question. 01 if you wish to ask a question. Please stand by for the first question. Our first question is from the line of Citi, Martin Wilkie, please go ahead. Your line is open.
Yeah, good morning. Thank you. It's Martin from Citi. The first question was just really around the LED growth number. You highlighted the Americas, you mentioned that last quarter as well, now you're also talking about Europe. In the past, you've mentioned that you thought LED would be a low teens market growth. I just wanted to sort of pick apart the European comment in particular. Has that been pricing worse than expected, or is it to do with, as you said, sort of a comp number on volume? Should we start thinking that low teens market growth into next year could be more challenging, or just really to go through the sort of components that made up for that slowing growth in LED? Thank you.
Yes, Martin. Important question. Let me give you a global picture on the LED business and its growth trend, and then we will come back to the specific point about U.S., Europe and the pricing. We're still growing double digits. It becomes quite sizable business. We have also, and we worked a lot on analyzing the numbers we have in the future also to anticipate that the growth will not be able to remain at the 30% level that we have experienced a few quarters ago because it becomes a very sizable business. We have a situation in the U.S., which is pretty much a go-to-market situation that we have to manage. We have started in Q3 to implement actions at different levels, both at the push and at the pull level.
I strongly believe that at this point in time in the life of the LED business, we need to pull the market more. We need to inform
Our customers about the benefit of the technology and the benefit of our offers. They are, at this point in time, comprehensive campaigns in the U.S., but also in other markets that are being prepared in order for us to do so, which is one other element to bring a level of differentiation on the market. Specifically in the U.S., we have also push actions, which is to try to identify new go-to-market accesses, and we will identify them in order to sell through more channels than what we used to do previously. All these actions are ongoing. We have still been impacted in Q3 by the U.S. situation, and especially at the beginning of the quarter. We've seen the situation improving at the later end of the quarter. That's the situation in U.S. The actions are in place.
They have not completely brought their fruits in Q3. We believe it's going to take a bit of time before they come to full completion, but actions are in place. What we are seeing in Europe, we are seeing that in markets where the penetration of LED is high, and we have some markets in Europe today where we sell more LED, and we are on the lamp side of the business, more LED lamps than we do sell conventional lamps. When this shift happens, we also have witnessed that our potential growth in these markets is lower than what we have experienced in the past. Hence the comment about Europe. Pricing. Pricing is also a very important dimension, not only in Q3, but since the beginning of the management of that business.
What we've seen also in Q3 is, for us, not only price erosion, but as you can see, we can follow the price erosion because price is eroding, but we continue to improve on our profitability on the basis of a double-digit growth. The P&L is working from that standpoint. What we have experienced also is that we're selling, compared to Q3 last year, product of lower price because we sell in proportion more basic LED lamps than it was the case in Q3 last year, which also has an impact on the top line and the growth in percentage as a whole. That's what I wanted to say, Martin, to be very complete on the LED business and also telling you that the actions are put in place in order to counterbalance what we've experienced in Q2 and still felt the impact in Q3.
Just as my follow-up then, obviously the issue that as penetration increases, obviously the growth rate becomes more challenging, and that'll be true for many countries in the future, not just Europe. Do you still think that there will be a low teens market growth in the medium term, or is the maturation of the LED market now changed a little bit compared to what it was, say, last year?
I think that at one stage, the growth of that business as it takes a bigger proportion of the market, will get closer to the overall market growth. That will happen with time. Now, the issue that we have is the difficulty to predict when this is going to happen, because from a geographical standpoint, we have still huge gaps and huge differences in terms of penetration and in terms of sales growth rates. Yeah, this is the situation, Martin, I would echo what you're saying. When that business starts to be the major part of the market, then it will take a growth rate which is much closer than the market growth.
Okay. Thank you very much.
Thank you very much. Moving on to the line of David Vos, Barclays. Please go ahead. Your line is open.
Yeah, good morning, gentlemen. Thank you.
Good morning.
taking my question. I was wanting to dig a little bit deeper in the price erosion trajectory here, because if I've done my math correctly, it seems to suggest, the bridge in the presentation seems to suggest that it's gone down by about 100 basis points versus Q2. Where is that coming from? Is that incremental price erosion in the LED side, or is it somewhere else in the business, please?
I can start and maybe Stéphane will complement. What we've been seeing in the past quarters, and I would say probably in the past 2 to 3 years, is a systematic same pattern. As you can extract a lot of cost from the fact that the technology is becoming more mature and from also the fact that we are gaining volume which are further reducing our cost, I'm talking about LED-based activities in general. We've seen that we're capable to extract a lot of cost benefits that are also compensating for the price erosion. That's a mechanism that we've seen on and on. For the question, which is more detail about price erosion, I can let Stéphane intervene.
Yes, David. When you look on page 11 at the price erosion impact, the EUR 123 million.
It's probably a little bit higher than the absolute amount that was, for example, in Q2. I think across all businesses, we've seen an absolute amount that's a little bit higher. The sales level is not exactly the same. I wouldn't say that there has been any material increase in the price erosion in a particular business. It depends also on the type of product that are being sold. That's a little bit what we can say, but as mentioned by Eric, nothing fundamentally different from what we've seen in previous quarters. On the cost side, again, we've been able to take a lot of cost and actually more cost out than what we had in previous quarters.
Perfect. Thank you so much. If I may ask my follow-up on the lamps business. Clearly a bit of a shift in trajectory there on the growth side, and a corresponding increase on the margins. What can you say about the future? Is this a new trend that we should be extrapolating? Was it a one-off? If you can comment on that, please. Thanks.
Yes, David, I will take the advantage of having René to answer that recurring question.
Okay.
Thank you very much. If you go back to and look at the slide on lamps which Eric presented before, that you can see that we are in a certain bandwidth in decline. This is a lower decline than we have seen in the last couple of months. I am not going to extrapolate that into the future necessarily. It's only a first quarter where we see some less decline than we have seen before. That's on the top line. If I look at profitability, we have guided for the medium term. That's not now and next quarter, that we will be in a band of adjusted EBITA around 16%. We're now doing much better, but it's all related very much on taking early on steps to address our cost base and our portfolio base, against an expectation of decline.
We are doing better than we have prepared ourselves for and benefit from that. We have to see how long we can maintain that going forward. We have, of course, some visibility. It's not that we will drop back to the 16% quickly, but I'm not going to promise that we will stay at the 21% either.
David, maybe to complement, it's difficult to make of the results of a quarter a trend, and especially when it comes to the top line, because it also depends on the base that you're starting from. If you look at, and you have all the elements to be able to compare, in Q3 2015, we had a rather steep decline, after a Q2 that was very close to Q1. In Q3 2016, we were comparing to a base that was probably more degraded than it was the case the previous quarter. I think we need to look at the trend in terms of top line more, accumulating the quarters one after the other one than looking at quarter to quarter and trying to find new trend.
If I may maybe add one thing here is, of course, that clearly our strategy is one of the last man standing. I think at least there is more and more evidence that that strategy is working and also we can reap the benefit.
Okay, understood. Thank you so much, gentlemen.
Bye.
Thank you very much. Moving on to the line of Peter Olofsen, Kepler Cheuvreux. Please go ahead. Your line is open.
Good morning, gentlemen. Also from my side, a question on the lamps business. I understand that as of September, certain traditional products have been banned in Europe and also in China. To what extent have lamp sales in recent months benefited from that? i.e., have you seen some of the wholesalers and retailers that you work with building up incremental inventories?
Thank you for asking. Very good that you follow very closely when the bans become effective. Yeah, we have seen a little bit of last time buy, but in the bigger scheme, it has no real material impact, particularly because this affects the halogen. Halogen is a important category for us overall, but not the most important category. Yes, it's true, but the overall impact is relatively modest.
Okay, that's clear. Maybe a follow-up on currencies. I understand that at a group level, there was a 60 basis points benefit to the adjusted EBITA margin. Could you shed some light on how it did affect the margins in the various segments, and which segments benefited most?
Yes, Peter. That had mostly to do with the cost base being in renminbi. From that standpoint, I think probably BG LED had some benefits on the Forex side at the margin level, at the adjusted EBITDA level, and probably more than most of the other divisions. Most divisions benefited from it, but I would say probably more BG LED.
Thank you.
Thank you very much. Moving on to the line of Nigel van Putten, ING. Please go ahead. Your line is open.
Hi, good morning. Question on the prof side. You said excluding the Middle East and Turkey, comparable sales growth was positive. What about the margin? Would that have increased year-over-year? How should we see the impact in the fourth quarter, current quarter, because of these developments there?
Hi, Nigel. We decided to talk about the impact of Middle East and Turkey. Not that we like so much to do this. We take the performance as integral, we had to highlight that the magnitude of what happened there is really impacting that business. It's true we would have been profitable. Otherwise, the underlying performance from a gross margin standpoint, even with Middle East and Turkey, is good for the professional business. As you may have heard, during the previous call, the impact that we have from Middle East and Turkey is not only at the top-line level, it's also at the bottom-line level. At the bottom line, I would say at two level.
The first level, because we're losing top line, we have an effect at the bottom line, also because we have to take provisions for bad debts as one of the elements of our performance in Middle Eastern countries, the fact that we are not being paid by some of our customers. We have in a very rigorous manner, whenever rules apply, to take provisions for bad debt. Yes, there is also an impact at the level of the bottom line. At this point in time, we don't wish to disclose it specifically. If we mention it's because it is also, and once again, material for that business.
Thank you. A follow-up on the cash balance, which amounted to about EUR 700 million at the end of the quarter. I am assuming it is set to grow again because of the seasonality and working capital next quarter. What is your thinking about the capital allocation? This must be ahead of your estimates previously. Are you thinking about revising your dividend policy, or do you see room for alternative ways to return some of this to your shareholders, perhaps?
We won't change our dividend policy. We said that we would be distributing a dividend between 40%-50% of our net continuing income, that we would do that for the first time in 2017 on the basis, Nigel, of the full year 2016. That will stay. What are we doing with the cash that we can be left with? We've also said that we have no specific urgency at this point in time to delever. I think the position of the debt of the company at this point in time is the right one, and the condition that we have for our loans are the right conditions for us. There's no absolute urgency to delever. We have the possibility to do acquisitions, we've been also very clear.
The main part of our story is organic, that doesn't mean that we're not looking at acquisitions that could be of small to medium size and in three very clear domains. It can be luminaire companies that are coming on the market for consolidation, technological breaks for connected lighting systems or eventually capabilities and platforms for services. That hasn't changed. We could imagine if need be, we are left with some cash because we're not going to rush into making any acquisition because we have cash. We may think about additional shareholder distribution schemes.
All right. Thanks, Eric.
Thank you very much. Moving on to the line of Andreas Willi, JP Morgan. Please go ahead. Your line is open.
Yeah, good morning. Thanks for the time. On the first question on foreign exchange, which you highlighted before as a benefit. We've seen quite strong headwinds earlier in the year. Maybe you could elaborate a little bit if you look forward, what we should expect on FX benefit to the operating profit line. Also, as we lap some of these big headwinds we had, particularly in Q1 this year. Maybe also explain why, despite the hedging policy effects, it's a relatively big fluctuating driver for your profitability. The follow-up question to that is basically also related to that. U.K., obviously, the currency has declined again. What's the exposure there? You've mentioned on Bloomberg, I think, you're increasing prices, can you increase them fast enough now given that the currency took another step down and what's your hedging position there?
Okay. Andreas, yes, on your first part of the question regarding Forex. Well, of course, it's always difficult to predict what's going to be the Forex impact because we don't know about currency evolution in the coming quarter. Now, if you compare to last year, yes, for sure, the British pound is lower today than it was in the third quarter, and it's going to be the same in the fourth quarter, pretty likely. We would continue to have an impact on sales from that standpoint. The impact we had from the Argentinian peso, it's probably likely also in comparison to last year to last for the fourth quarter and maybe a little bit longer. Those have an impact essentially on sales. As you saw in the third quarter, the impact of Forex on sales was substantially lower than what it was in Q2.
From that standpoint, probably in Q4, still some impact on sales and closer to the level of Q3 than what had been seen in Q2. Now on profit, the plus EUR 9 million, it's a little bit difficult to anticipate what could be the impact on Q4. Again, we'll see, depending on how currencies evolve, and in particular in China. Yes, we could have still a little bit of a positive impact
Again, the magnitude is very difficult to anticipate now.
Maybe, Andreas, to your question specifically on U.K. to complement what you've heard this morning. Yes, we're impacted by the depreciation of the pound. At this point in time, we are selectively pricing up, but our pricing initiatives are not compensating at this point in time fully the depreciation of the currency. We have, for very specifically, that market, a hit on the gross margin. We are working as we speak to continue at two levels. On the pricing side, but also on the cost side, to see what we need to do to adapt to that situation. Today, no, we are not fully compensating in U.K. the impact of currency.
Just to clarify, your hedging policy is to hedge up to 80% of anticipated transaction volume. Given, I guess, that you have relatively low costs in the U.K. but high turnover, isn't that difference now still protected by hedging and therefore this is more of a problem in a couple of quarters out rather than now?
I think you're probably right. The impact should be alleviated compared to what we had seen before. Unless, again, the British pound continues to deteriorate from one quarter to the other.
Thank you very much.
Thank you very much. Moving on to the line of David Vagman, KBC Securities. Please go ahead. Your line is open.
Yes. Good morning, Eric, Stéphane. Just a first question on the like-for-like growth in lamps and LED. Is there any correlation that we could make, any link that we could make between the, let's say, the softer decline in lamps and then lower growth in LED? That's my first question.
Well, if you look at it, let me, because we're working on this subject, as you can imagine, very much. Now, what you see in euros has to be translated also in terms of quantities of products sold. They are a much closer connection, when you look at the quantities than when you look at the euros. Now, in absolute thinking, yes, a softer decline in lamps would also translate into a softer growth in LED. In the situation in which we are today, I would not for Q3 correlate both. We've explained how and why we're performing the way we're performing in lamps. In LED, I would not associate the softer growth of LED to our lesser decline in lamps.
I think in LED, we're still growing double digits, but there are areas in the world where I believe we should extract a bit more growth, and we're working on it.
Mm-hmm. Okay. Thank you. Maybe a follow-up on the gross margin. Could you grossly quantify how much you think is really sustainable and split it up by division very roughly?
Well, maybe I can start, and you can-
Yeah
You can continue.
I think that what we're seeing today is also structural improvements in the gross margin because we're working a lot on the cost of goods sold, as we've done in the past years, and we do that quite successfully. At the same time, when the portfolios are simplifying because we have less conventional products on the market, we have a stabilized product portfolio. With a year, we can segment much better the offers on the market from a pricing perspective. There's a lot of work ongoing when it comes to the margin positioning. Now I can let Stéphane give a bit more color, understanding that we don't give the gross margin-
Sure
by businesses.
Yes. What we saw in Q3 is that every business improved its gross margin in percentage. If you put aside lamps, of course, because of the revenue decline, the other businesses increased their gross margin also in absolute value. There's been a very good performance across the businesses on the gross margin front. To your question, is this sustainable and where do we see it in the future? There are so many variables that are impacting the gross margin. It's difficult, but for sure, this is a fundamental driver of the operational performance of the company, and we are managing it very tightly.
Okay. Thank you again.
Thank you very much. Moving on to the line of Peter Reilly, Jefferies. Please go ahead. Your line is open.
Good morning. I wanted to start with a philosophical question for Stéphane as the new CFO. Your preferred performance metric is adjusted EBITA, which excludes restructuring costs. You've given medium-term guidance of 1.5%-2% of sales on restructuring. According to my analysis, you've been taking a restructuring charge every year for about 15 years now. Can you just help us understand why margin before restructuring is the right measure if restructuring charges have been there for 15 years and will be there for the medium term?
Well, I would say in previous companies, I've seen this in a consistent way. I don't think everybody's doing it exactly the same way, but it was not really a surprise for me. As long as there is a clear communication about the restructuring moving forward.
To your question, is this something that's going to be forever? I don't know about the last 15 years, and I don't know specifically about Philips Lighting. What I know is that for sure, a business that is undergoing such a transformation, in order to stay competitive on all fronts, you need to be able to rationalize. At some point, that transformation is going to be well advanced, and it will very likely alleviate the level of restructuring charge. I think being able to show what is the operational profitability before restructuring and at the same time communicating on what is the amount that is being reserved and spent every year, I think is the right way to measure the profit.
Maybe a small complement, we guided for 1.5%-2% over the medium term. We've said that after that, our restructuring charges will lower to 0.5%-1%.
Okay. If I can just follow up, coming back to Martin's question about the countries where LED sales are now becoming a large part of the market. When you get to a certain level, say LED is more than 75% of the market, do you go through a phase in those more mature countries where LED sales actually start to decline because you've replaced a lot of the install base? LEDs last a lot longer. In the natural cycle of an individual country, is there a contraction phase when you reach maturity because you've done the replacement for the installed base?
We don't see that at this point in time. What we see, we see that the growth rate is lowering.
Do you think it should stay positive in most countries, that there shouldn't be any structural death because of the longer life?
If we read the people who made surveys on our business, I think they indicated that around 2020, the business of LED lamps will start to decrease, but linked to two phenomena. The first one is the fact that the longer burning hours, what you're mentioning, but the other one is also linked to the fact that people may not replace an LED lamp for an LED lamp, but will replace an LED lamp for an integrated luminaire. What we used to call Ledinaire in our own jargon, or an integrated LED fixture. We see at this point in time, but it's at a minor level, but we see already today, sometimes that instead of changing a lamp for a lamp, our customers would go for an integrated LED fixture. It's happening at this point in time.
It's not impacting today the growth rates for LED lamps, meaning that we don't see any negative growth rates. Once again, the official forecast that we have on the market is that this could potentially happen in 2020.
Okay. Thank you very much.
Thank you very much. Moving on to the line of Philip Scholte, Kempen & Co. Please go ahead. Your line is open.
Yes, good morning, everybody. A question on the home segment. Do you think you can actually maintain your growth rates in the home at a double-digit rate despite the comp base about to turn more positive? Related to that, do you think that you are guiding for home to return to a profitable situation during 2017? Given the excellent progress you have shown actually in the last couple of quarters, that looks conservative. It actually looks like the whole of 2017 could actually be very well profitable. Do you have any updated views on that?
Sure. Thanks for the question, Philip. First of all, we have very dedicated growth actions, sales measures to grow in that business, and they are bringing results. They are bringing results in all the geographies for all the businesses. That's something that we're very pleased to see. We have to take also into account that we have a fast growth that we've always mentioned for home systems, understanding that we have not opened all the geographies. We are opening a few markets on a yearly basis, and we still have a fabulous potential ahead. I believe in the growth potential of that business moving forward. And yes, we're going to be compared to a higher base, but we believe that we're doing the right action, that putting the right actions in place to drive the growth of that business.
Will it be exactly where it is today in the future? I don't know, but we still believe in the growth profile of that business moving forward. To your second question, when we first talked about the possibility to be breaking even in that business, also understanding that we are investing heavily in home system. We were not so credible a few quarters ago. Our job is just to implement the strategy and to come to you with the numbers that are undeniable. It's true that Q3 is not a quarter with an extremely high top line compared to what normally Q4 is. It's a very good news for that business indeed, that we are close to breaking even in Q3. We know why this is happening. It's on the base of many different actions.
You may have noticed that in Q2, we took important measures in terms of closing our [contact] historical headquarters and also a plan that we had in that business in China, which are going to show benefits mainly in 2017. We are doing what's necessary to achieve what we had said that we would be breaking even at one stage in 2017. If we can do more, we'll do more, but certainly that in Q3 we have a very good sign that what we have guided for is clearly doable.
Right. If I may, a short additional question on your dividend policy, because I still believe actually that the definition of your dividend policy leaves room for interpretation as in what exactly is continuing net income. Are you already willing to share some more details on that, or should we wait for Q4 on that?
Well, I think we're going to wait for Q4 on that. We had said at the time it's the net income to which we add some non-recurring restructuring charges. Let's give to ourselves a few weeks or one or two months to be able to come with not only a clearer definition, but a clear understanding to all of you on how we're going to distribute the dividends.
Right. Thanks.
Thank you very much. Moving on to the line of Alok Katre, Société Générale. Please go ahead. Your line is open.
Hello. Hi. Thanks for taking my questions. Alok Katre from Soc Gen. I just have two follow-ups, actually. Firstly, on the professional, clearly [yourself] were quite good in explaining the Middle East impact. I just wanted to confirm one thing, is excluding the Middle East and Turkey region, should we sort of think about sales and margins better in third quarter versus second quarter, including the North America? Perhaps you could also talk a little bit about how you see things shaping up in the coming quarters across the key sort of regions. That's follow-up number 1. The second was in terms of LED lamps. I appreciate that growth rates are sort of slowed by perhaps slower than what we've seen so far.
I was just trying to sort of get a sense of how much cost you can still take out, whether it's product cost, whether it's productivity, et cetera. Or rather, how much growth would you need to maintain the margins, especially about 10% over the next sort of 12-18 months? Are you confident on that front?
On the first question, which is regarding professional. What we have said is, yes, if we net the Middle East and Turkey impact in Q3, we would not only have improved the top line, we said that professional would be growing and profitability would be, of course, also improved, although we are not giving the specific number here. I have alluded to the fact previously that it's made of 2 components, additional bottom line coming from the additional top line and also the fact that we had to take provisions for bad debt in that region. Alok, this is what we have decided to comment on and clearly indicate. We want to be cautious in the coming quarters because we have seen the trend that we experienced since the end of last year in Middle East and Turkey worsening in Q3.
I think there's quite a high level of uncertainty around that region at this point in time. There are many happenings. We are fairly well invested, and especially in the professional business, it's quite a substantial part of that business. I think the visibility for us is not exactly clear on how the market conditions are going to materialize. Once again, let's be very clear on our position there. We are not just passively looking at the situation. We're also taking measures. We've been taking measures there in terms of restructuring, and we have done two very heavy restructuring in the region to take into account the market conditions.
We have also launched specific sales measures, more on the distribution side on one hand, and then looking at specific end user segments that are less touched by the crisis in order to develop our capabilities and to develop our sales in those directions. The actions are in place. I have to be here probably a bit constrained on how I see the future because it really depends on how the local conditions are going to improve. We are not staying idle. We're moving ahead and we're implementing the actions that we believe are necessary from a sales measures perspective as well as from a cost measures perspective. On LED lamps, the cost is not the main driver.
What we have seen so far is that when there is price erosion, it means that there is also cost gains on the cost of goods sold and being the leading company in that business at this point in time, we have also the highest volumes on the market for that business. We've been able to extract cost. The story of the LED business is that, yeah, it's a business which is growing. There is price erosion, we are capable to compensate or more than compensate the price erosion with our cost reduction actions. That works. On the other part of the cost, it's a business which is growing, and we are monitoring the level of cost that we still invest in that business. It's not that we need a given level of growth to be able to cover our cost.
Our costs are already covered. They are covered by the business that we're doing at this point in time. In absolute terms, if we were not growing today in that business, we have the right level of cost. With the business growing, we have immediately an operational leverage, and we decide how much more we need to invest in the business to sustain it. This is the situation of LED to answer to your question, Alok.
Thanks. If I just have a quick follow-up in terms of the BG Professional, if you could just talk a little bit about the North American market trends over there. Clearly, I think a couple of your competitors were a bit cautious, maybe you could just talk about how things have shaped up, PLS North America particularly. Thanks.
We've seen in Q3 some softening in the North American market when it comes to public outdoor. We are monitoring that as we speak. This is on the contrary to some of our local competitors. We have a higher market share, and we are more invested in outdoor than others. We are looking at it as we speak. Otherwise, there are no major difference in trend on the American market than what we have seen previously. Once again there, we have very dedicated actions that we have started to put in place a while ago and that are delivering benefits on a regular basis. Another element that we are working on pretty much in North America, but I would extend that also maybe to other region, but specifically in North America, is also on our supply chain.
When we have the changeover between conventional and LED technologies, we have to make sure this is seamless. When we support and service our customers moving from one catalog to the other one, and we have lately also reinforced the teams that are working on these specific dimensions.
Thank you. Fantastic. Thanks.
Thank you very much. Moving on to the line of Ben Uglow, Morgan Stanley. Please go ahead. Your line is open.
Well, good morning, everyone. Thanks for taking the questions. I had a couple. I guess the first one relates to the previous question. Just, I don't know, Eric, if you can give us any more sense or color just around the professional luminaires in North America. I think at the time of the IPO, there were some interesting slides which seemed to imply that the profitability, and well, certainly the KPIs and potentially the profitability was improving. Is it fair for us to assume that that trend has continued? Obviously the reason why I'm asking this is that the overall profit level in the division does seem to be somewhat subdued. Basically, can you give us any sense on whether North America is actually contributing more to the bottom line? That was question number one.
Question number two is really going back to this issue that we've heard several times around working capital. You've had a very big EUR 87 million working capital inflow in one quarter. I'm curious, can you sort of tell us how much of that is related, for example, to conventional lamps? This is a sort of simple, it's kind of dumb question. If I look at your inventory and receivables, they're about EUR two and a half billion. If I assume that you shrink that business at, or you're able to work on that at 5%, you're coming out with a working capital release of something close to EUR 100 million. Can you tell me why we won't continue to see working capital increases in future, please?
Okay, good. Ben, I'm going to take the first question, and I will let Stéphane take the second one. Yes, we've seen an improvement also in the bottom line, during the year.
for the professional luminaires in North America. To answer to your question very clearly, yes, it is contributing to the improvement, but without disclosing specific number, still, the performance of that business is below our average.
Okay.
Ben, to your question on working capital. Yes, Q3 has been a very good quarter in terms of the inflow overall. Again, it's not just inventory, it's been across also.
Yeah
Account receivable and payables. If you look at it with respect to the various divisions The inventory has been very well managed in LED, especially given the growth. There has been a very good performance there and also in the professional business. If you look at BG Lamps, which is one of your question.
For sure, over time, the working capital that is being used by BG Lamps is decreasing, and we see this on a regular basis. I won't comment specifically on this quarter or on any quarter because then from one quarter to the other, and also as a comparison to the previous year, it makes the whole comparison complicated. Again, on BG Lamps, for sure, there is a reduction overall, in terms of the working capital being used, and so cash being extracted as sales are declining.
I think you answered the question, but just to sort of clarify thematically, when I think about it on a one, two, three, four-year view, in principle, the BG Lamps business should be releasing working capital on an ongoing basis, as that business ramps down. I'm not barking up the wrong tree there?
Yes.
Okay.
Yes. No. In absolute value, yes, for sure. Over three to four years, yes, it's going to decrease. Sales are going to decrease, and therefore, there is less working capital.
Mm-hmm. Okay, brilliant. Thank you very much.
Thank you. Moving on to the line of Sven Weiher, UBS. Please go ahead. Your line is open.
Yeah, good morning. Thanks for taking my questions. The first one is following up on lamps. You were mentioning halogen. I understand you don't disclose the exact share of it, but maybe you can give us kind of a direction about the shares of halogen and the various businesses there. Also on the cost cutting, I think you mentioned obviously the great progress you've been making on the footprint optimization. The kind of restructuring cost has actually been not so high this year. Is it still you benefiting from the measures you implemented last year? The kind of original plan you had on the factory closures, is not running more quickly than you thought. Some additional color maybe on that. Then just finally, just coming back on U.S. professional lighting.
You sounded like you still had a year-over-year improvement in Q3, but it was less strong than in Q2. Is that the right observation here? Thank you.
Yeah, thank you very much. On the first two questions related to lamps. Yes, halogen is, of course, very important to us. Maybe in relative terms, not as important to us as maybe to our number 2 competitor. In the overall picture, it impacts us because of the bans or the last time buys remains very limited. Let's not forget that this relates only to a part, a relatively small part of the halogen portfolio. A major next step, which really will impact us, is in September 2018. Also the bulbs which look like incandescent with a halogen burner inside will be banned in Europe and probably in years thereafter also in other geographies. Relatively limited impact. On the closures, yes, of course, we benefit of all the movements we have done before.
What is also, I think, very important, that we don't only do closures, we also do right sizing in the factories which are still there. I think what is a major, at least satisfying move for us all, is that we have been able to find new destinies for a factory in Uden where we make ceramics, and a factory in Winschoten where we make special glass. That's not a closure. We really created a platform which was interesting for somebody who was a real specialist in ceramics on the one side for Uden, and a specialist in glass for the site in Winschoten. It's not only about closures. We also have seen that the volumes are declining a little bit less fast. Closing factories is not per se our objective, it's a consequence. On your question on U.S.
Professional, yes, we see the Americas still growing in Q3, less than what we've seen in the previous quarters.
Okay. Maybe just one final follow-up on lamps. Is there any comment you have to make on the disposal of the OSRAM lamp business to MLS? Is there anything you would be expecting any change, or is it simply too early to make a comment on that?
Well, I don't know which type of comment we could make. We see our market attractive, and it's normal that people want to invest in that business. No specific comment at this point in time. We are watching with a lot of attention what is, of course, happening on the market and specifically for the transaction that you're mentioning. No specific things to say on our side at this point in time.
Okay. Thank you.
Thank you.
Thank you very much. Ladies and gentlemen, there are no further questions in queue. If you would like to ask a question, please press zero one on your telephone keypad. Zero one on your telephone keypad for any follow-up or a new question. As there are no questions in queue for the moment, I would like to return the call to the speakers.
Yes, thank you very much, everyone. If someone has more questions, don't hesitate to contact investor relations at Philips Lighting. Many thanks for your questions and your interest. Thank you very much.
Thank you very much. Ladies and gentlemen, this concludes today's conference call. Thank you very much for attending. You may now disconnect your lines.