Results 2016 analyst conference call and webcast on July 22nd, 2016. At this moment, all participants are in listen-only mode. After the presentation, there will be an opportunity to ask questions. Please note that this call will be recorded and is also available after the webcast on the website of Philips Lighting. I would now like to hand the conference over to Mr. Jeroen Leenaers, Head of Investor Relations. Please go ahead, sir.
Thank you. Once again, welcome to the Philips Lighting Analyst Conference Call for the second quarter results. With me are Eric Rondolat, CEO of Philips Lighting, and René van Schooten, our CFO. We will start with an update on business and operational performance by Eric Rondolat, followed by the financial performance by René van Schooten. After that, there will be an opportunity for you to ask questions. I would like now to hand over to Mr. Rondolat.
Thank you, Jeroen. Thank you for all of you to join us today. Let me start by giving you a global view on our performance for the quarter. First of all, we saw our LED-based sales activities grow by 25% in the quarter, and they now are representing into to 53% of what we are selling. We were also pleased to post a seventh consecutive quarter of year-on-year improvements in operational profitability, while our net income of EUR 57 million is not directly comparable in 2016 versus 2015, as in the Q2 2016, it does include separation costs and brands license fee. When you look at the numbers, taking a bit more distance, you see the intake in terms of the adjusted EBITA at 9.3% and the stabilization at comparable sales growth level around minus 1.4% for the six first months of the year.
I would like to remind that last year in the full year of 2015, we declined by minus 3.5%. We see that we are improving on our growth profile. This slide is to express the fact that we are with my team at this point in time, focusing on improving in a continuous way in line with our strategy. Our strategy by businesses is the following one. In lamps, we know that we are declining, and the decline that we have experienced in Q2 of around 17% is in line with our expectations. We also said that for that business, we had to at least maintain its profitability. As you can see in Q2, at the other end of the table, we are not only maintaining, but we are improving our operational profitability by 270 basis points.
The three other businesses, LED, Professional, and Home, strategically have to grow, they're growing, they also have to improve on their profitability. You see that in Q2, this is also what is happening with an improvement of 550 basis points for LED, 110 basis points for Professional, and 850 basis points for Home. That's an important iceberg view on how our business are trending versus their strategic objectives. Now, let me run you through more details about each of these businesses. We said it, 17% decline for the conventional lamps business. This is pretty much in line with our expectation and directly due to the transition from conventional lighting to LED lighting. The performance in terms of operating margin is solid because we are confirming the performance that we had in Q1 above 20%, which is also substantially above what we achieved last year.
Here again, manufacturing footprint rationalization, mix procurement savings, and productivity savings have played a key role in achieving that performance. I want also to mention a successful divestment. We have to divest some of our activities in these declining markets, and our ceramic operation in the Netherlands was very successfully divested during the quarter. Moving to LED, we've seen here a double-digit growth with also a very good margin progression. The sales grew double digits, slightly lower versus last year than what we experienced, for instance, in Q1, it's mainly Americas related. In all the other regions, we enjoyed robust growth. The operating margin progression of 550 basis points is linked to procurement savings and operational leverage that are being offsetting price erosion.
As you can see from 5.6 in Q1 to 8.4 in Q2, or from 2.9 in Q2 last year, to 8.4 in Q2 this year. Once again, we are delivering according to what we had said. This is a business that we want to see growing top and bottom line. Just to mention of a very interesting offer that we have been launching on the market in Q2. It is called CorePro LED PLC, it really means that this is the first ever LED replacement for compact fluorescent lamps in the professional market. The good thing is that we just can click the LED lamp in lieu of the compact fluorescent lamps. We don't need to change the ballast, we gain 60% in energy efficiency.
We believe that there are around 150 million of these lamps in Europe ready to be converted. Moving to Professional. We've delivered growth, we've delivered margin improvement. I'm happy to say and to confirm once again that after having been growth neutral in North America in Q4, after having grown in Q1, we again confirmed that we are growing in Q2, that business has positively contributed to the growth of the Professional business in Q2. This was partially offset by the decline in Middle East and Turkey, which is due to difficult market condition. I think we had already talked about that, in Q1. We've seen again, an impact of that region on that business, in Q2. The operating margin has improved, driven by operational leverage on one hand, also procurement saving.
It's good to see that despite the difficult market condition in Middle East, that business has been able to improve top line and bottom line. A very interesting project that we did take during Q2, so we have to move to Dubai. The company Smart World has decided to build their HQ there under the approach of an intelligent building, and they've made the choice to use a Philips Lighting Power over Ethernet connected office lighting combined with a Cisco Digital Ceiling framework. In this specific building, we'll be able to offer the people working there enhanced working conditions, as well as more productivity. Home, to finish our fourth business, has first shown a very strong comparable sales growth of 14.3%. I would say to start with that both consumer luminaires as well as Home systems are growing in Q2 2016.
That growth has translated to the bottom line because we've seen here again an improvement of our bottom line, although it is still negative. We've seen improvement from -16.4% in Q2 2015 to -7.9% in Q2 this year. In this business, we have also taken in Q2 important steps towards rationalizing our footprint. We've closed the factory that we had in China, in Shenzhen, as well as our head office in Kontich in Belgium. This is what I wanted to tell you regarding not only the business at large, but also our individual business groups. What I propose now is that we go into more details about our financial performance. For this, I have René with me, who will guide you through some financial information.
Thank you very much, Eric. I'm trying to give you a little bit of flavor of things on the financial side, which we are very important. Some of our key KPIs and where we manage the business. If we look at profitability, we focus first and foremost on adjusted EBITA. You can see here that our, in an absolute value, our EBITA went up from EUR 139 to EUR 161. You see here also the individual components affecting that. Volume has a positive impact of EUR 33 million across three of our businesses, particularly LED, Prof, and Home. Of course, you can anticipate that the lamps declining rapidly has a negative impact in this context.
If you look at price, we are confronted always with price erosion, but this was particularly important for the BG LED, which basically accounts for more than half of that price erosion, with price erosion in the other business groups quite modest and in line with historical trends. We always try to compensate these price erosions with gains on the cost of goods sold. You see that we do that, EUR 108 compared to EUR 113. This is a combination of very strong procurement savings and productivity across the board, applicable for all the business groups. Again, most of the gains, in an absolute sense, for the BG LED, also there compensating the price erosion in that BG. Compared to last year, we didn't pay a brand license fee. That has an impact of about EUR 10 million.
You see that we compensate that by savings elsewhere, a touch more, EUR 11 million. Last element, which explains a little bit of a decline, is an impact of currency, minus half a percent point. Let me zoom in on something else which we find very important. That is our indirect cost, or sometimes we call them also NMC, non-manufacturing costs, SG&A, and R&D together. If you look at the amount we spent on that in second quarter of 2015, it was EUR 575 million. We now have an amount of EUR 555 million. That decline in absolute number is explainable by the impact of currency, so EUR 20 million down. You see the impact of two things, bringing it back to EUR 555 million. That is a EUR 10 million extra brand license costs, which were not applicable in 2015, compensated by, on a like-for-like basis, savings on other items.
If I go to working capital, also here, you see working capital historically has always a little bit volatile over the year. We see that we have always a low working capital and low inventories at the end of the year. That builds up, goes down again. We have made quite a lot of progress. Let me first look at inventories in limiting that increase. Of course, we have to increase because we are slowly preparing for a high season in September, October, and November. We see that the inventories are significantly lower than last year, 250 basis points. Also, the increase, the pattern is more stable. If I go to the left-hand side of this graph, you see that that is also applicable to working capital, which now makes up 12.2% of sales, and that was 15% of sales in 2015.
Also here, a more stable pattern. Let me hasten to add that this did not impact our supply performance. Also, our supply performance is at very high levels and higher than last year. If I compare the cash flow of second quarter 2016 with the first quarter, you see that we make a big improvement here. Free cash flow is EUR 60 million. You see, and I explained already, that is the impact of the lower cash outflow from working capital, provisions, and also our net CapEx is very well controlled. With the new financing structure, we have higher interest payments in the second quarter, and we have higher taxes, but still relatively low because we benefit from tax credits we have also related in a number of countries where we took some restructuring.
Other important point is that we have separation cost, EUR 15 million payout. Of course, they were there already in 2015. In 2015, they were reported under Royal Philips and not under Philips Lighting. I also hasten to add, and you are all aware of that, but it is a big amount. In the first quarter of 2015, we paid out EUR 45 million to de-risk our U.S. pension situation. The last thing I want to point out is that our net debt, at the end of Q2, is EUR 795. We have been quite good in generating good cash flow after the IPO. Also, an important point is, where do we see our currency exposure? You see that where our sales are on the left-hand side, 29% denominated in EUR, 26% in EUR, Chinese currency 7%, and then a large bucket of all kind of currencies.
You see that the impact on sales overall is -4.6, and on the adjusted EBITA, I already pointed it out earlier in the slide, EUR 70 million, which reflects 0.5%. It's not new. We have not changed our hedging policy. You see we hedge 100% of committed foreign exchange transactions, and also we anticipated transactions we cover in buckets depending on how far out they are. I think that concludes my contribution to this presentation. Okay. Operator, I would like to ask you to open the lines for the Q&A.
Thank you, sir. Ladies and gentlemen, we start the question and answer session now. If you have a question, please turn off the sound of your computer. To be registered for the question and answer queue, please press star one. To cancel your request, please press star two. Your questions will be answered in the order that they are received. Just a moment, please, for the first question. Our first question today is from Mr. Sven Weier, UBS. Go ahead, please, sir, your line is open.
Yeah, good morning. Thanks for taking my questions. A couple of questions, please. The first one is on your U.S. professional lighting performance. If I understood you correctly, your sales momentum did also improve there sequentially. If you could just give us an update here on the project inquiries that you see and also the measures that you have obviously taken over the last years, how they
Payoff specifically. The second question is on the LED growth rate. You pointed to the slowdown here a little bit in Q2. The comps are getting a bit tougher also in the second half. Are you foreseeing any special promotions here to ramp that growth rate up again? What's the kind of guidance for the second half? Just two housekeeping questions. I was wondering, the interest line, should it stay like that as in Q2? The currency impact, if the rates stay as they are, will it be similar also in Q3 and Q4? Thank you very much.
Thank you very much for your questions. Let me start with the U.S. professional. It is a good thing that after all the fixings that we had to do over the past years, we're now confirmed that we are in the mode where we are going back into growth. We are not any more in a situation where we need to turn around the business, but we need to reap on what we have sown. This is what was again confirmed in Q2, where we've grown, and that business in Northern America is profitable in Q2. The amount of actions that we deploy on that market, we're looking at different aspects.
Delivering our customer on the end-to-end chain in time, simplifying the portfolio, making sure that our sales force as well as our agents were coping and were learning the new catalog to be able to be efficient in place in that market as well as in all the other ones. Sales force that are dedicated to end users. We see also the funnel of projects in Northern America and in the Americas in general growing quarter by quarter. On the LED growth rate, we have many different actions ongoing to be able to grow further. Let me start to tell you that we see in the coming quarters a growth which is going to be slightly higher than what we have experienced in Q2. How do we grow that business?
It's not only about making promotion, but it's also bringing to the market new offers that are innovating. I was giving the information of LED CorePro. We've done this for compact fluorescent lamps, but we've also done a similar exercise, lamp chain, on the market, also new products that are going to replace halogen lamps in the hospitality segments. We need to make sure that our innovation machine brings to the market on a regular basis, month after month, offers that are going to be game changers in their environment. This is the way we have grown successfully the LED business so far. As you can see, a lot of people talk about commoditization, but it's not commoditizing. We continue to grow, and we grow profitably because we have also a quite healthy increase in the profitability for that business in Q2.
We have highlighted, I will finish with this, that there was a slower uptake for LED lamps in Americas in Q2. This is true. We have also to understand that for that business, we are comparing ourselves to a high Q2 2015 because we launched new offers and promotions in that same region at that point in time. We see us improving in the coming quarters once again. Maybe for the other questions, I will ask René to answer.
Thank you very much about the question about the interest expenses in the second quarter. Of course, there are a number of components in that. Some of those components will continue to affect our results throughout the year. I have to think about for the pensions, that will not much change in the next quarters. There is one specific element which I want to point out, which affected our Q2 results. In the whole separation, we had temporarily some loans from Royal Philips. We also had to pay on those loans interest. On the other side, there were loans from us to Royal Philips, but the currency mix was not favorable for us. We bought particularly in high interest currencies. Going forward, that will no longer be applicable. That will go down.
The second element of foreign exchange, we have no further guidance on how foreign exchange will develop at this moment in time. I will ask Jeroen Leenaers to later on give you a little bit more guidance. I can only tell you what the impact was in the second quarter. We will come back with what the impact will be on the basis that interest rate will stay the same, which is never the case, of course.
Thank you very much.
Well, thank you for your question.
The following question is from Mr. Peter Olofsen from Kepler Cheuvreux. Go ahead please, sir. Your line is open.
Good morning, gentlemen. A couple of questions. First on capital allocation. Could you talk about M&A? We haven't seen much in terms of M&A in recent years. As you're no longer fully owned by Philips, might that change? If so, what will be your priorities in terms of segments or regions? On some of the segment developments, starting with lamps, looking at the adjusted EBITA margin development during 2015. The margins were lower in the second half than in the first half. Is that normal seasonality, and should we see something similar? For the home business, it seems that the sales growth accelerated a lot in Q4 last year. Could you explain why that was? Looking at the upcoming Q4, clearly the comps will be more difficult. Should we look for a slowdown by Q4 this year?
My final question relates to procurement. The cost of goods sold was down something like EUR 113 million in Q2. How sustainable is that? Should we look for EUR 100 million plus in savings also in coming quarters? Thank you.
Thanks for your question, Peter. Let me start with the capital allocation and our M&A strategy. We've been saying very clearly that the main part of our story is an organic story. We also, with the cash that we're generating, looking at some acquisition in some very specific fields. We are very precise, that it needs to be totally in line with our strategic intent. Our objective is to continue focusing on the lighting business also through our acquisition strategy. We see three potential avenues for future acquisition. One avenue could be the acquisition of a luminaire company that would come for consolidation on the market. As the market leader, we would probably look at it, or we would also look at acquisition of technological bricks for systems and also capabilities and platform for services.
Totally in line with our strategy, which is to move from products to products connected lighting systems and services. In all cases, we are anticipating that these acquisitions would be bolt-on and from a small to medium size. This is what we have said all along, and we confirm it. On your second question about the conventional business and the margin that was lower in the second half than in the first half. The years do not always look the same. We are starting off a very good start in the first six months of the year at a level of operating margin, which is above what we had guided for. We said that we would be maintaining that level. We are not confirming that this level of 20% will be maintained over the coming quarters.
What we can say is that compared to our historical level, we will be at least on par, if not better. When it comes to home, there is a seasonal pattern in the home business. Q4 has been historically a high quarter for the consumer business because you have a few events during that quarter, Christmas being one of them, where consumers would spend more than what they spend in average for the previous quarters. We can expect again, to have a Q4 which will be higher in 2016 than the previous quarters. It's true that there is a strong base of comparison, but it is also true that the fourth quarter is a high quarter. We experienced the growth in the home business that we had guided for at the time that we had anticipated.
I think it's a strong growth, which is once again not only consumer luminaires, it's also home systems. We believe that we're going to be able to keep that trend line.
Maybe from my side to comment a little bit of procurement, if you go back, we have really in the last periods, have a strong record of procurement savings. There is no reason to believe that will go down very quickly. We have visibility going forward. The trend is strong. That will continue for the short term. Of course, we don't know how that will develop further out, but for the foreseeable future, direct foreseeable future, that trend will continue strong.
Okay. That's helpful. Maybe one final question on the LED segment. Could you talk about the pricing trend for LED bulbs as well as the pricing trend for LED chips and whether the differences between these two, how that affects the gross margin development
Well, Peter, on the LED chips, I will not really comment because that's not our business. On the LED bulbs, we see again in Q2 a price erosion that we have to fight at two different levels. First, by making procurement saving, and René has just talked about it. You've seen that that performance has been strong because we have more than offset the price erosion with the productivity savings that we have done on the bill of material. Also by launching to the market new offers, as I was describing before, that are a game changer and that have the fast mover advantage. Now, if I look at that business now in factual terms, the profitability, the operating margin is improving in Q2 to above 8% with a 15% growth.
From a dynamic standpoint, we confirm that we are on the same trend line as what we have described in the previous quarters for that business. There is still a price erosion in LED lamps business that we are fighting with new offers, giving us a game changer advantage and a strong productivity on bill of material.
Okay, thank you.
Thank you, Peter.
Next question, operator.
Our following question is from Mr. David Vos of Barclays Capital. Go ahead please, sir. Your line is open.
Good morning, gentlemen. A couple of questions from my side, please. First of all, if we look at the cash flow, could you give us a rough indication of what division or how that splits up by division? Secondly, if we look at your professional business, clearly it is much improving in terms of both margins and growth. The growth still lacks your main competitor, Acuity, in the U.S. by quite something, I would have guessed from the numbers you've printed. Could you comment on that development and particularly how quickly you would think you can catch up with Acuity, which I believe should be your ambition? Then finally, on the license income, you have a fairly substantial suite of licensees, some 600, if I'm not mistaken.
Could you just shed a bit of light of just how much revenue you generate through that part of your business, please? Thank you very much.
Thank you for your question. Let me comment you first on the cash flow per business. We provide only cash flow numbers for the whole of Philips Lighting. The only thing I can say on the individual businesses that most or nearly all of our business contribute to cash flow.
Maybe a complementary element that is important to understand. Of course, we have a conventional business which is profitable and cash generative, but the cash which is generated by that business in absolute value, since that business is declining, is also reducing. As our cash flow is well positioned, you understand that the other businesses are also now contributing positively to the level of cash flow that we have in absolute value coming from the conventional business to position us in a good position in Q2. What we're losing from the conventional business is compensated by the other businesses. You've asked the question, David, on the professional business. Yes, the growth today is 3.8%.
We have stated that it is having a favorable impact from the growth we have in North America, but we also have to take into account that we are being, at this point in time, it's again in Q2 the case, as it was in Q1, impacted by the difficult market conditions that we are experiencing at this point in time in the Middle East and Turkey region. This is impacting us not only at the bottom line level, but also at the top line level. We are in that business having a high penetration of the LED products as well as connected lighting systems and services, which are growing strong double digits. Our objective is to continue performing, improving, and driving the growth of that business worldwide.
As far as the license income is concerned, the numbers that we are getting from the licensing program that we have been putting in place are affected by business, so they are fully integrated in the performances by business that we are reporting, but we are not, David, at this point in time, giving a very specific disclosure on that amount.
Okay, thank you very much. Just following up on the professional question then, could you remind us just how that business splits up in terms of geographies so we can perhaps better picture that Middle East dynamic there?
Let's say that Americas is a substantial part of the business, but probably the split that we have is fairly consistent with the overall split we have for the lighting businesses in general across geographies. Middle East is quite material. We did an acquisition a few years ago.
Yeah.
Increased our participation to that market. We've grown substantially there and one of the relevant markets for the professional business.
Okay. If I may, one more on the cash flow. I understand your comments around the relative decline of the cash contribution from the lamps business, being offset by the rest of the divisions. Would it be correct to assume at this point in time that the FCF split roughly follows the contribution of profit? Is that the wrong way to think about it?
Profit is an important element of cash flow, I think that's the kind of detail we provide.
Okay. Thank you very much.
Thank you.
The following question is from Ms. Daniela Costa of Goldman Sachs. Go ahead, please. Your line is open.
Thanks for taking my question. Good morning. I have three questions as well, the first two which are interrelated. One you mentioned in the statement that you're confident that you will see sort of turnaround in growth somewhere during the year. Can you comment basically by business where you're more confident in that turnaround, basically what drives that statement? Related to that, what have you been seeing in terms of market share or any areas where you're particularly gaining market share or recovering market share? The final thing, just on the pensions, do you foresee any sort of further top-ups being needed at some point? Thank you.
Thank you. When it comes to growth, the growth of Philips Lighting is the combination of the decline of conventional and the growth of the LED-based activities. In a nutshell, in Q2, conventional declining by around 17%, and the LED-based activities growing by 25%. That still, after it's combined, brings a negative growth of -1.5%. What we're looking at is the growth in the first six months of the year compared to last year. In the first six months of the year, we have declined by -1.4%, when we declined for the full year 2015 by -3.5%. What we see is when the proportion of the conventional business in our overall portfolio is declining, our growth profile is also improving.
This is why we have said, and we have confirmed that we see, given that mechanism, that Philips Lighting as a whole will go back to growth in the course of 2016. When it comes to market share, we cannot really comment on the market share in Q2 because we don't have the elements. I can give you directionally an indication of what we saw in Q1, not to enter in too many details, we saw in Q1 an improvement of our market share on the conventional side of the business and a market share that was stable on the LED part of the business.
Maybe a response on your question on pensions. We have done a major de-risking exercise in the first quarter where we paid out EUR 45 million. That is important for the U.S. situation, we don't anticipate another de-risking exercise. We stick with the other guidance as before. If at all, I would anticipate a somewhat lower outflow for pension cost.
Thank you.
Operator, please, next one.
The following question is from Mr. Ben Uglow from Morgan Stanley. Go ahead please, sir.
Oh, good morning. Thanks for taking the question. I had a couple. First of all, on the price figure that you give in your margin bridge, the EUR 108 million, roughly 6% of sales. Can you give us a frame of reference? Can you give us an idea of how that pricing number has trended over the last year or so? What I'm interested to know is that normal or is it higher or lower than what we've seen in the recent past?
Yeah.
That was question number one. Question number two, I don't know if it's related. When I look at the Americas growth, pardon me, the LED growth, it's come down from 29% in the first quarter to 16% in the second quarter. Is that deceleration? Can you give me a sense of how much of that is simply volume? Whether there is a deterioration. Is this related to price as well, particularly in the Americas? That was question number two. Question number three is just on the free cash flow. I think we're all struggling to figure out what free cash flow may be this year. I don't know if you're able to give any kind of guidance. If not giving specific guidance on free cash flow, can you talk about working capital? You've had an EUR 80 million working capital outflow in the first half.
Should we expect with normal seasonality, does that fully reverse in the second half?
Yeah. Let me first come back on the pricing. If you look at price erosion, the trends in price erosion are also relatively stable over time. That doesn't necessarily mean that every quarter is exactly the same. It goes for a little bit up and a little bit down, but it's roughly in the same bandwidth, so very limited for lamps. A little bit higher for Prof, and of course, also the trends in LED seem to be relatively stable. There is not a major fluctuation in this context.
Okay. This sort of 6% level is a sort of normal level that we could think about each quarter, roughly?
I think it's affected, of course, by the mix.
Okay.
Yeah. On free cash flow, we give no explicit guidance for the remainder of the year. I would like, however, to make some comments, which I've said before. You have to appreciate that particularly, in the early bits, we see some volatility in working capital and provisions as well because of the separation. Going forward, we will manage our working capital well, and I highlighted how we do that, and particularly on inventories. With the breakup, particularly, the fact that our 2015 numbers are an addition of basically what lighting was in the past and a share of the IG and EBITDA cost, the payables position is still something which also shows some volatility. We have guided that over medium term, we will have an improvement of our working capital very steadily, but very limited.
Can I just follow up on that question specifically? I mean, René, correct me if I'm wrong, but at the time of the IPO, I think the expectation was that working capital could be slightly positive, nothing significant, even in the current year. We've had an EUR 80 million outflow in the first half. Are you saying that we may not be able to be positive on working capital over the course of 2016?
I think I have to repeat what I said. We don't give short-term guidance on cash flow in 2016 on the days of working capital.
Okay. On the other question on LED growth?
Yeah, I'm coming to that one, Ben. First, let me rephrase the question. You said 28 to 15 for Americas. The 28.8% to 15% growth Q1 and Q2 respectively.
That works.
is for the overall-
Yeah
LED business. What we have seen is that in the 15% number for Q2, we see a robust growth, in all geographies except Americas, where we have seen a slower uptake in Q2. Also, linked to the fact that the Q2 2015 for that specific geography was a high quarter because we launched an offer at that time, which had a lot of traction on the market. We're working to go back to higher level of growth in the coming quarters in that business. There's a dual contribution of pricing because we still see a price erosion on that business worldwide, and I would say not more in the Americas than in the rest of the world, and probably even a bit less in Northern America than the average.
Of course, you have another very important component, which is the volume, illustrating the overall growth, double-digit growth of 15% on that business.
That's helpful. Thank you very much.
Yeah. Thank you.
Next question, Mr. Philip Scholte of Kempen & Co. Go ahead, please.
Yes. Good morning, everybody. The first question is around your net debt level. In the prospectus, you said you were going to be floated with a net debt of about EUR 950. You now come out at EUR 800. Can you sort of help us explain how you actually get to that much better number? The second question is, on the U.K. Are you able to share with us your total exposure to the U.K. in terms of sales? The third question is actually, I'm interested in your progress on, let's call it your separation cost, but actually more the underlying process of setting up your own IT systems. Can you update us a little bit on where you are, when you expect to finalize that, and how you maybe look at the operational risks potentially associated with that?
Shall I first answer the question on net debt? You know that we IPO'd at the end of May. At the end of May, all the transactions with the mother company, Royal Philips, were such, we're moving all the bits, that at that moment in time, we had a net debt of EUR 950. The conclusion, of course, is that if you go to the end of June, where we are a little bit below EUR 800, in that period, we generated cash to bridge that.
On your question, Philip, regarding the Brexit and our exposure in the U.K. We are not giving specific and detailed figures about our exposure by geography. What I can say is that we don't see, as the Brexit, a direct impact on our business at this point in time. As a team of Philips Lighting, we are adapting to whatever macroeconomic situation we find in front of us. I can tell you that we've been in U.K. for many, many years. We are very committed to continue to support not only the businesses that we have in the U.K., but also our customers there. On the IT system, since February 1st, we have our own IT system. I would say that already from February 1st, we are working with our IT systems as a standalone company.
There were a few temporary service level agreements between Royal Philips and us because we could not move all the applications day one. All these application and all these TSAs will be closed in February 2017. We are closing them as we speak, at the expected speed, if not even faster than what we had anticipated. That's happening as we speak, and it has been a very positive outcomes. At this point in time, we already have our IT system, so we don't anticipate any operational issue because we are already operating on our platform. We just need to finalize a few satellite application that are still being shared with Royal Philips. As I've said, we're going to be totally on our own in February 2017.
I would like to add that we're making a lot of progress on the front of the IT system by simplifying the modules and the applications that we are using because on top of the operational objective that we can expect from the IT systems, we know also that we have a fantastic opportunity to reduce our cost of IT moving forward and starting in 2016.
Right. Can I briefly follow up on that? Because how does that compare to your previous guidance of the EUR 60 million-EUR 70 million in separation costs, especially related to IT system? It sounds like you're actually already almost done with that, while the level of cost has actually been quite moderate.
We repeat our guidance for separation costs for the year of about EUR 60, and we guided that also for the third quarter. You will see that a lot of the things in the cost impacts will take place in Q3 and Q4. That relates particularly not on applications, but on, how do you say, separated, where the systems are running on.
Right. Okay.
We confirm basically our separation level indicated before.
Sure.
For the year.
Okay. Operator, may I ask you for the next question?
Ladies and gentlemen, you can still press star one for questions or remarks. I would request you please to limit the number of questions to one with one follow-up question. Thank you. Our next question is from Mr. Martin Wilkie of Citi. Go ahead, please. Your line is open.
Yeah, good morning. It's Martin from Citi. Just coming back to the North American market, and particularly in professional. We can see the organic growth for the division as a whole. It sounds from your comments that North America was better than the 3.8 for the division overall. If I look at some of your competitors in North America and some third-party sources, essentially all the data suggesting the market is growing at probably a high single-digit rate. I wonder if you could just say whether or not you agree with that or not. Do you think that the period of losing market share, which I think continued really into last year, is that now done? Do you think you've sort of stabilized at those levels, or are you even beginning to take back some of that share that you've lost over the past five or six years?
Thank you.
Yes, Martin. On the North American market, what we see, we see the non-residential construction still being dynamic. Probably not at the levels that we've experienced in the past years, but still quite dynamic. And we believe that we are benefiting and will continue to benefit from that market dynamics. In terms of market share, we see us taking back market share in some specific parts of the market. And I would give you one specific element because we've studied that in depth. We see that in the outdoor parts of the business, we are taking back some market share. So we are growing, we are profitable in Q2 for the North American professional business, and we start to see some pockets of end-user markets where we are gaining back some share.
And when we think about the cost of doing that and the margin potential in North America, obviously one of the fears that people might have about regaining market share is that you have to do that through price, or you have to ratchet up R&D substantially to drive new product development. If you could just talk a little bit about how you see the profitability of the North American business moving. Can it expand as you're going through this rebuild of your market share?
Yeah, that's a very important point. What we're seeing at this point in time is that while we go back to growth, our gross margin, hence our profitability, is also moving in the right direction. So, there are a lot of things that we've done to adjust our P&L and our cost to the reality of the market. And now that we are growing, we have a direct leverage of the growth on the bottom line. But I tell you, it's positive. We know where we're going, we know how we're positioning our offer, and we can extract gross margin, hence operating margin.
Okay. Thank you.
Thank you. Operator, please.
Ladies. Yes, sir.
Yes.
Ladies and gentlemen, please limit your question to one with a maximum of one follow-up question. Thank you. Our next question is from Mr. Peter Reilly of Jefferies International Limited. Go ahead, sir. Your line is open.
Well, good morning. I'm just trying to understand the trends better at the professional business. In the first quarter, you had a EUR 12 million profit from selling receivables back to your partner in GLC. Can you tell me, was that EUR 12 million profit booked inside your adjusted EBIT? It looks like there was another EUR 2 million in the second quarter. In the previous year, did you actually take a charge for writing off those receivables? I just want to understand the year-on-year trend.
Let me just think about it. I think it was in Adjusted, yeah.
That was clearly a one-off benefit just by selling some receivables.
Yes, that was a one-off benefit.
Professional profits in the first half of the year were actually lower than the previous year if you back out the gain from selling the receivables.
Yeah.
Did you take a charge for selling the receivables in 2014? Was it a EUR 24 million swing, a EUR 12 positive in the first half and then a EUR 12 negative in the first half of last year?
No.
Okay. Thank you very much.
Thank you.
Our next question is from Mr. Nigel van Putten of ING. Go ahead please, sir.
Hey, morning. I have a follow-up on the growth mechanism for the second half of the year. You're saying, as always, that as the conventional lamps shrink, the growth for the group should improve. I understand that and the mechanics behind it, but only if I sort of assume a sort of stable top-line trend for the BG lamps division. I guess my question is, does this imply that you're not seeing an acceleration of the conventional lamps decline in the second half of the year versus the first half?
Well, the mechanism requires two things. That we decline in the conventional, but that we also grow in the LED-based activities as we've grown in Q2 by 25%. This is the combination of those two mechanisms that should normally lead us to a positive growth in the course of 2016. We need to look at those two elements, not only the decline of conventional. Now, are we anticipating a higher decline in the second half for conventional? We've always said that we believe that the rate of decline of conventional should be between 15%-20% for the year. Let's see where it leaves us. In any case, we've shown that we have the means to adapt the company to make sure that it goes in the right direction, whatever the decline is.
All right. Thanks. One follow-up on indeed the BG LED growth. Would it be fair to assume that the electronics growth versus the lamps was a bit more positive, more in line with the LED luminaire growth trend, or is that not the case?
Well, given the slower uptake that we had in Americas in Q2 in LED lamps, probably what you're saying is right for Q2, but it would not be right in general.
Okay, thanks.
Next question is from Mr. Alok Kumar of Société Générale. Go ahead, please. Your line is open.
Hi, thanks for taking my questions. I have one on the bad debts side. Looking at your release, it suggests that you actually had a write-off of bad debts in Middle East and Turkey in the second quarter of this year. So I just wanted to clarify whether there was a write-down, meaning write-off, of receivables this quarter and just in the context of the EUR 12 million that was referred to by Peter Reilly earlier. So if you could just confirm that. The follow-up, just in terms of the growth side of things. If I look at the broad picture, well, traditional lamps sales decline accelerated, LED lamp sales growth has slowed. I know there's this comparables effect and so on.
Clearly, is this something that we should also then expect in the second half of this year in terms of the muted growth, just because the comparables there are quite strong, just LED versus conventional at the group level as well? How does that tie in with the expectation for return to positive growth sometime in 2016?
Let me answer you, Ben, about the provision for bad debt. There is no relationship with the EUR 12 million. I think that's something totally different. We provided for bad debt in the first quarter, and we provided for bad debt in the second quarter.
Could you give us the magnitude, roughly, of the bad debts?
We don't give explicit numbers, but a couple of EUR millions.
Okay. Not two, sorry. Let's say a couple of EUR million write-down of bad debts in first and second quarter, and that was offset by, let's say, EUR 12 million, write back or collection on those bad debts that you had seen. We're talking essentially.
The EUR 12 million was nothing to do with debt. The EUR 12 million was by the sale of some of our stock.
Okay. Fair enough. Great. Thanks. Then just on the growth.
On the growth. Let me comment that when we look at the growth, I like also to look at it on a six-month basis. When we look at conventional lamps, we decline probably a bit less than what's expected in Q1. You're at -14.5%. We are around -17%, which is in line with what we could expect for that business. Let's look at the average of the decline of that business in the past six months. That's probably a better proxy than looking at what happens quarter after quarter. You can see on the slide that we've shown also that the pattern in terms of decline is not regular.
When it comes to LED, I believe that we have to aim at seeing in the coming quarters growth rate slightly above 20%, due also to the fact that we are now starting from a much bigger base. This is a business which is already sizable and which is increasing double digits. We see also the overall growth in percentage coming down when we build out the stronger sides for that business.
That would mechanically mean that the, let's say, the growth rate that you're seeing just now should fade a bit more in the second half of the year. I'm just trying to square that with the expectation that you will see positive growth rates at some point in 2016, perhaps more in the back half.
Yeah. If you take back the numbers that we have shown for the global of lighting, we see that our growth pattern is improving with time. If I take Q1 2015 and Q2 2015, we were around -4%. Q3 2015 and Q4 2015, we were around
Remove them now
-3%. Q1 2016, Q2 2016, we are around -1.4%. We see that improvement happening gradually. We need now to see what is going to happen in the second half of the year. We are forecasting another improvement. This is what strengthen our confidence that we have the potential to go back to growth in the course of this year.
Okay, thanks.
Thank you.
Our next question is from Mr. Marc Hesselink, ABN AMRO. Go ahead, please. Your line is open.
Yeah, thank you. There are actually two items where I think you're running well ahead on your IPO guidance. That's the gross margin and the margin in conventional lamps. Can you talk about if that's indeed also ahead of your own expectations, or what you expect on both of them going forward?
Yeah. Thank you very much. If you see, I think we have said that before, of course, in lamps, we know that the decline, the structural decline is coming. We have prepared ourselves for that decline. Because we have taken the preventive actions, we benefit in lamps from basically our ability to take cost out early and to keep on driving procurement savings and of productivity gains. Another important element, of course, is that particularly the decline is not even across the board. It tends to be a little bit steeper in consumer and a little bit less steep on the professional side. Particularly on the professional side, we hold better market position, and in general, the margins are accretive compared to the rest.
Although I hasten to add, if you make 20% profitability on an adjusted basis, every way you slice and dice the business in lamps, these are good profitability numbers.
Okay. Thanks.
Sorry, we couldn't hear you entirely.
Sorry. The gross margins for the group, I think there are a lot of moving parts there, like LED in professional, for example, being higher margin conventional and the other way around for the lamps business.
Yeah. In general, of course, if you want to comment on the gross margin in LEDs, of course, they're also stronger because we benefit that there is price erosion in that area, but we benefit from procurement savings, which are steeper and leveraging the size of the business.
Okay, clear. Maybe a follow-up on the LED market on earlier questions. You explained that you expect to have stable market shares, also price erosion relatively similar than we have seen before.
Yes.
There is more limited growth in the LED volumes in general for the market. Can you give an explanation? What are you seeing why that is the case?
Sorry, can you rephrase the second part of your question?
Yeah. You have the LED market. You're explaining that you expect to have stable market share. You say that price erosion is relatively stable over the last few quarters, still we see now the growth rates on an organic level coming down. What's the main reason for the volume decline of the less volume growth in the market, or the market being less than it was before?
Just maybe to correct, I didn't say that we expected a stable market share. I said that we have seen that our market share was stable in Q1. The dynamic of that market is linked to the replacement of conventional by LED lamps, also by the innovation that we are launching on the market in terms of LED lamps. I've given some examples that are providing very energy-efficient replacement to conventional lamps. All that is driving the LED business. Of course, there is price erosion. What we have said as far as price erosion is concerned is price erosion is directly linked to cost improvement potential. As you have seen, we are able to more than offset price erosion with the productivity we do on the bill of material.
You have a direct link between what the technology enables in terms of cost saving versus the price erosion. As we are the leader on that business in the world, and we have more volume than others, we believe that we are faster than others to capture those cost down potential, which help us to have a position and a price position on the market that helps us to lead and to continue generating profit. There's still a strong dynamic when it comes to the LED-based activities. I was just mentioning previously that since our business is also growing in terms of size and as the market is more penetrated by LEDs, probably that the growth rate is coming down slightly, but it's still double digit.
Okay, that's clear. Thanks.
Thank you.
The next question is from Mr. David Vagman, KBC Securities. Mr. Vagman, you can ask one question and one follow-up question. Go ahead, your line is open.
David Vagman from KBC Securities. One question on the gross margin. Could you very roughly indicate or split up the gross margin improvement on a divisional basis and split it up between procurement versus efficiency/productivity? Then a follow-up question on the professional luminaire. If you could indicate what kind of target you have in term of profitability for the U.S. and whether it should come from sales or cost savings. Thank you.
On gross margin, we give an overall number. We give profitability per business. We don't provide gross margins per business, I'm afraid. I can't answer that first question, of course.
Between procurement and the gross margin improvement, whether it comes more from procurement than savings than efficiency, productivity, or?
Yeah, I can give you a little bit of guidance there. Of course, procurement is a major factor, but also in our other areas, in just sheer productivity, we also improve. We improve in all areas.
Okay. It's not more one than the other?
I think procurement is a strong pillar.
Okay, thanks.
Your second question about professional luminaires. When I look at the U.S. today, the objective is growth. By growing, we see all the different elements of the P&L improving accordingly. Of course, we have an objective in terms of profitability on that market, but our main objective is to grow quarter after quarter, we see the whole P&L benefiting from the growth.
Okay, thank you.
Next question is from Mr. Akash Gupta of JP Morgan. Mr. Gupta, one question and one follow-up question. Go ahead, your line is open.
Yeah. Hi, good morning. I just have only one question. That is on, if you look at 2016, then it is final year for Royal Philips' three-year plan, where I believe various layers of management incentivize to deliver on the margin target. Coming back to lighting, can you please talk about, from your side, how much of the margin improvement that you have seen in second quarter is coming from the measures that you have taken as part of that three-year plan. Also if you can talk about how your involvement in three-year plan, is the management below, I would say tier 2, tier 3 management, if they are incentivized as part of this three-year plan. Thank you.
We have seen a margin improvement and as we've said it previously, this is our seventh consecutive quarter of year-on-year operating margin improvement. Yes, it's part of the longer term or the strategic plan that we're doing every year, that we were doing every year in Philips Lighting, that we're going to continue doing in Philips Lighting moving forward. We have a three-year plan, and then we have yearly objectives, and we manage that as I guess many other companies are doing it. I could not say that specifically, the margin improvement is coming from the three-year plan. The margin improvement is coming from the objective that we set to each other, of course, on a three-year basis, but also on an annual basis, depending on how we see the evolution of the environment.
As far as Philips Lighting is concerned, we have, during the IPO process, given an indication and an outlook on the midterm. We have now to build at the level of Philips Lighting, a long-term incentive plan, which will take into account some of these objectives that we have in the medium term to be able to incentivize management on the achievement of these objectives. That will happen probably at the beginning of 2017, where we will define a long-term incentive plan for Philips Lighting.
Thank you.
Thank you.
Our final question is from Mr. Peter Olofson of Kepler Cheuvreux. Mr. Olofson, one question and one follow-up question. Your line is open. Go ahead.
One question, actually. Could you shed some light on the revenue trends in China? I think it was down quite significantly in 2015. What are you seeing in 2016?
We have improved greatly in China. China is also a country where you see a clear difference between the conventional part of the business, which is declining and probably declining above average, and a very dynamic LED and connected lighting and services business, which is also growing. You would see in China a very similar pattern than what you see worldwide in terms of growth dynamic. If we talk about what happened after 2014 and during 2015, I think we are now moving and we are over. We've made the changes that needed to be changed in China, and we are back in a normalized situation with dynamic growth on the LED connected and lighting systems and services.
Thank you.
Thank you.
Okay, operator, and people also on call, I would like to thank you a lot for your interesting questions. If you have any follow-up questions, please don't hesitate to contact me. I'm happy to answer your questions. Thank you a lot.
Ladies and gentlemen, this concludes the Philips Lighting second quarter 2016 analyst conference call and webcast on July 22nd, 2016. You may now disconnect your line. Have a nice day.