Welcome to the Royal Philips third quarter 2016 results conference call on Monday, the 24th of October 2016. During the introduction, hosted by Mr. Frans van Houten, CEO, and Mr. Abhijit Bhattacharya, CFO, all participants will be in a listen-only mode. After the introduction, there will be an opportunity to ask questions. If any participant has difficulty hearing the conference at any time, please press the star followed by the zero on your telephone for operator assistance. Please note that this call will be recorded and is available by webcast on the website of Royal Philips. I will now hand the conference over to Mr. Pim Preesman, Head of Investor Relations. Please go ahead, sir.
Thank you. Good morning, ladies and gentlemen. Welcome to Philips' third quarter fiscal year 2016 results conference call. I'm here with Frans van Houten, CEO, and Abhijit Bhattacharya, CFO. On today's call, Frans will take you through our strategic financial highlights for the period. Abhijit will provide more detail on financial performance and market dynamics. After that, we will take your questions. Our press release and related information slide deck were published at 7:00 A.M. this morning. Plus, documents are now available for download from our investor relations website. A full transcript of this conference call will be made available by tomorrow on our investor relations website. Before I turn the call over to Frans, I would like to remind you of a few things. First, as you know, Philips retains a 71.2% stake in Philips Lighting, and therefore continues to consolidate Philips Lighting's results.
Because Philips Lighting reported its Q3 results on October 20, we will focus our commentary on today's call as much as possible on the performance of our HealthTech portfolio. We encourage you to review Philips Lighting's third quarter earnings materials, which are available on their IR website. Second, following the decision in 2014 to combine our Lumileds and Automotive Lighting businesses into one standalone company and to explore strategic options to attract capital from third-party investors, the profit and loss of these combined businesses is reported under discontinued operations, and the net assets for the business in the balance sheet on the line assets held for sale. The cash flow of the combined Lumileds Automotive businesses is reported in the cash flow from discontinued operations.
When we refer to adjusted EBITDA on this call, this represents EBITDA excluding restructuring costs, acquisition-related charges, and other charges and gains above EUR 20 million. With that, I would like to hand over the call to Frans.
Yeah. Thanks, Pim, and good morning to all of you. We had a solid third quarter with 5% comparable sales growth and 8% order intake growth in our HealthTech portfolio. Overall, Philips posted 2% comparable sales growth. Adjusted EBITA increased by 120 basis points and amounted to 11% of sales, compared to 9.8% of sales in Q3 last year. We delivered solid sales growth and margin expansion as a result of successful product introductions in our HealthTech portfolio and our ability to continue to realize synergies from the integration of Volcano with image-guided therapy. There were further improvements at our Cleveland site. Decisive actions from the Accelerate program continue to deliver performance improvements across the group, and these improvements are offsetting our investments in quality and innovation, such as health informatics, wearable patient monitoring solutions, and digital pathology.
Overall improvements at the Personal Health and Diagnosis & Treatment businesses, combined with continued improvements at Philips Lighting, led to the 120 basis point increase in the adjusted EBITA margin. I'm encouraged by the strong order intake growth in Connected Care & Health Informatics, which grew by double digits. Diagnosis & Treatment increased order intake by low single digit, leading to an overall order intake growth of 8%. Moving on to our specific businesses. We continued our strong momentum in the Personal Health businesses as sales grew by 7% on a comparable basis, and adjusted EBITA improved by 130 basis points as a result of higher sales volumes as well as improved cost productivity.
Sales grew across the entire Personal Health portfolio, most notably double-digit growth in Health and Wellness, as supported by high single-digit growth in Sleep and Respiratory Care, and mid-single-digit growth in Personal Care and Domestic Appliances. We continue to see strong adoption around the world of our leading Personal Health solutions. Growth geographies in Western Europe grew in the high single digits, while North America grew mid-single digit. We remain committed to sustaining mid to high single-digit growth in Personal Health, enabled by our strong innovation pipeline. To give you a few examples, last month at the IFA trade show in Berlin, we introduced a range of personalized health programs that demonstrate our continued innovation in oral care, sleep, and heart health, three areas where consumers are taking charge of managing their wellness, engaging with their personal care, and integrating our solutions into their daily lives.
Our connected consumer health products such as the Philips Sonicare FlexCare Platinum Connected toothbrush with built-in sensor technology, which enables real-time feedback and coaching to further improve oral health care. The uGrow medical grade baby app, which enables parents to better monitor the development of their newborn based on data from a suite of connected devices, leveraging Philips HealthSuite, which is our Internet of Things and clinical data platform. Another successful innovation is Philips OneBlade that targets millennial males and features patented technology to trim, edge, and shave any length of hair in one stroke. This product requires replaceable blades approximately four times per year at average usage. We expect to generate a nice recurring revenue stream with the build-out of the customer base.
After its successful launch in France, U.K., Germany, and our largest market, the U.S., in the second quarter, we now continue to expand the distribution of Philips OneBlade in these markets. Sales have more than exceeded our already high expectations, and we plan to replicate this success in other markets. The Diagnosis and Treatment businesses grew 6% on a comparable sales basis and showed solid operational performance improvements. Adjusted EBITDA margin improved by 210 basis points, mainly driven by cost improvements within image-guided therapy, as well as improvements at the Cleveland site, where our investments in augmenting our quality standards are continuing. The Cleveland-related activities contributed to an improvement of EUR 43 million year to date, and for Q4, we expect this to be a similar amount. Order intake showed low single-digit growth overall in Diagnosis and Treatment. Growth geographies showed strong double-digit order intake growth, particularly driven by China.
Another great example of bringing our innovations to market is the Philips IQon Spectral CT, which is the world's first and only spectral detector computed tomography modality that provides clinicians with a comprehensive view of the patient's anatomy with a single low-dose examination. We have been shipping this solution from March this year and are achieving market success due to its superb image quality and disease assessment in particularly for oncology for cancer patients. Philips Volcano continues to perform well, demonstrating also this quarter both the benefits of the acquisition and the success of the integration. In Q3, we delivered a third consecutive quarter of double-digit comparable sales growth and continued operational improvements, driven by growth across the smart catheter product portfolio, synergies with image-guided therapy systems, and expansion into new geographies.
Philips is a pioneer and leader in image-guided, minimally invasive therapies, a fast-growing field because of the benefits for patients, hospitals, and health systems. Building on our expertise in interventional cardiology, we entered into a five-year collaboration with DeltaHealth in China for its new DeltaHealth hospital in Shanghai, which will specialize in cardiac care. As part of the interventional cardiology solutions agreement, we will provide interventional X-ray systems, ultrasound imaging, software, and services. We also have been expanding our efforts in interventional oncology, as we are convinced that image-guided therapies will have a positive transformational impact on cancer treatment. In the quarter, Philips launched its next generation OncoSuite planning and navigation solution for enhanced live 3D image guidance for liver tumor embolization and ablation procedures.
Moreover, through our collaboration with Elekta, we are making good progress in the new field of MR-guided radiation therapy delivery, a potential game changer in cancer care. The global increase in the use of MRI for radiotherapy planning is evidence that MRI is emerging as a promising oncology tool for disease localization and quantification, therapy planning, treatment guidance, and therapy assessment. Turning to the Connected Care and Health Informatics businesses, where mid-single digit comparable sales growth in healthcare informatics solutions and services was offset by a low single-digit decline in patient monitoring solutions. Adjusted EBITDA margin decreased by 180 basis points, mainly as a result of lower revenue in patient care and monitoring solutions, which is primarily a matter of timing, and the installations are still largely expected for this year.
In healthcare informatics, solutions and services, we expect margins to continually improve as we transform this business from a hardware-oriented to a software-driven business, which is a higher margin model with a stream of recurring revenues. We signed a sizable three-year agreement with a large healthcare provider in the U.S. to deliver picture archiving communication solutions and associated services. While patient care and monitoring solutions sales decreased slightly this quarter, order intake showed a strong performance. We are pleased with the build-up of our order book as we continue to build our expertise in integrated solutions consisting of smart devices, software, and services to address specific customer needs.
For example, we signed a three-year patient monitoring solutions agreement with Rush University Medical Center in Chicago, a hospital known for many specialties of care, areas of research, and consistently ranked among the nation's top hospitals in the U.S. News & World Report. We are excited about the possibilities in population health management, where we already offer solutions to provide ambulatory care for high-risk patients outside the hospital, and we help to deliver prevention and personal health programs for the general population. The recent Wellcentive acquisition complements Philips portfolio with cloud-based IT solutions to import, aggregate, and analyze clinical claims and financial data across hospital and health systems. We see strong synergies between Wellcentive's upstream data aggregation and analysis capabilities of patient populations and Philips downstream care programs to facilitate a data-driven deployment of these care programs by our customers that will also be aligned with existing reimbursement models.
In the quarter, Advocate Doctors, a physician-owned network spanning more than 600 providers and 500,000 patients across New Jersey and Pennsylvania, selected Philips Wellcentive as its partner to derive population health and care management technology and delivery. As a further example of Philips Wellcentive's success in the quarter, CHRISTUS Health, a large international not-for-profit health system, further expanded its existing partnership with Wellcentive. As indicated in the last quarter, we expected the performance of Lumileds and Automotive to improve in the second half of this year based on the good order book and the measures we have taken in the beginning of the year to improve cost productivity. I'm pleased to report the improved performance as the 20% sales growth contributed to the EBITA improvement of 10 percentage points compared to the same quarter last year.
We continue to actively engage in discussions for the sale of the combined Lumileds and Automotive businesses, we will provide more detail on this process when appropriate. Our outlook for 2016 remains unchanged as we expect further earnings improvements in the fourth quarter of the year. Going forward, we remain concerned about risk due to volatility in the markets in which we operate. With that, I will turn the call to Abhijit, who will provide more detail on financial performance and market dynamics.
Thank you, Frans. Good morning to all of you on the call and the webcast. As Frans mentioned, in Q3, we delivered a 5% comparable sales growth in our Health Tech portfolio, including the 3% declining in comparable sales for Philips Lighting. Overall sales increased by 2% on a comparable basis. Let me focus my commentary on the Health Tech portfolio, where comparable sales for growth geographies grew by double digits, driven by double-digit growth in China, as well as countries like Russia, Indonesia, Argentina, and others. Personal Health recorded high single-digit growth, Diagnosis and Treatment double-digit growth, and Connected Care and Health Informatics showed mid-single digit growth. Comparable sales growth in the mature markets was driven by low single-digit growth in Western Europe and North America and stable comparable sales in the other mature geographies.
Personal Health recorded mid-single digit and Diagnosis and Treatment low single-digit comparable sales growth in mature geographies, while our Connected Care and Health Informatics businesses saw a low single-digit comparable sales decline. In Health Tech, other sales reflected a EUR 14 million lower royalty income due to the expected expiry of certain licenses, partly offset by strong double-digit growth in emerging businesses. Let's have a look at the order intake. On a currency comparable basis, equipment order intake grew by 8% in the quarter. Connected Care and Health Informatics businesses generated a strong double-digit growth and Diagnosis and Treatment businesses, a low single-digit growth in the third quarter. Geographically, we reported a double-digit growth in comparable orders in our growth geographies, driven by double-digit growth in regions like China, India, ASEAN, and Africa. In North America, order intake grew a healthy 6%, while Europe posted a low single-digit decline.
On currency comparable basis, order intake growth in Q4 last year was 15%, hence we expect Q4 this year to be about flat. Let me now switch to the EBITA development in the quarter. The adjusted EBITA margin of 11% in the quarter was 120 basis points higher than in Q3 last year. This strong margin increase was driven by an improvement of 130 basis points in the Personal Health businesses, 210 basis points in the Diagnosis and Treatment businesses, 250 basis points in Philips Lighting. Partially offset by 180 basis points decline in Connected Care and Health Informatics businesses. This was caused mainly due to lower sales in our patient monitoring and solutions businesses, where some of the sales were not recognized in the quarter and will flow into Q4.
The overall improvement was good considering the fact that we stepped up our advertising and promotion expenses to support the strong launch of our OneBlade proposition as well as increased activity in our oral health care businesses in North America. We had mentioned this to you in our Q2 call earlier this year. Our Accelerate! program continues to improve operational performance and drive efficiencies. Overhead and end-to-end productivity programs were largely offset by higher manufacturing costs in the third quarter, which is partly due to timing, and the balance is expected to return to similar levels as we have seen in the first half in the fourth quarter. Design for excellence or DFX, which is aimed at improving value, delivered EUR 102 million of additional bill of material savings year-on-year, and are on top of normal run rate procurement savings of EUR 107 million.
Based on the cumulative savings achieved in the first three quarters and the outlook for the year, and the outlook for quarter four, we remain on track to achieve the cost savings targets for the year that we have set for all three programs. Our improvement trajectory in Cleveland remains on track and contributed positively with an additional EUR 34 million or 60 basis points to the adjusted EBITA margin improvement. In the third quarter, the income tax expense was EUR 6 million, which is in line with the third quarter of last year, but lower than the normal run rate. Main reason is tax benefit arising from a release of certain tax provisions. We still expect the effective tax rate for the full year of 2016 to be around 30% excluding incidentals.
Net financial expenses were EUR 102 million higher in the quarter, of which EUR 98 million was due to the tender offer related to the earlier redemption of debt, which was completed in October 2016. A total amount of $285 million were redeemed in the offer, which should result in approximately EUR 18 million lower interest expense in the coming years. The transaction will result in a cash outflow of EUR 345 million in the fourth quarter and will result in a EUR 7 million positive impact in the fourth quarter, which will be recognized in the financial income and expense line. Net income from discontinued operations was EUR 15 million higher than in Q3, which is mainly due to the improved operational performance of the combined businesses of Lumileds and Automotive.
The return on invested capital, which is calculated on a five-quarter match basis, was 8.3%, excluding the total one-off charges of EUR 345 million related to pension liability de-risking in the U.S. and the U.K. in Q4 2015. The ROIC was 11.3%, which is over two percentage points above our WACC. Our drive to increase the efficiency of our working capital continued to yield results as inventories as a percentage of sales decreased to 15.4% year-on-year, which is an improvement of 140 basis points, both on nominal and currency comparable basis. Free cash flow for the quarter amounted to an inflow of EUR 280 million, compared to an inflow of EUR 58 million in the same period last year. This was mainly due to improvements in income from operations and working capital, partly offset by the EUR 63 million outflow related to pension liability de-risking in the U.S.
By the end of the third quarter, we completed 98% of our three-year, EUR 1.5 billion share buyback program that we started in October 2013. The share buyback program was fully completed on October 20th. We have decided not to start a new program at this point of time as we plan to further improve the efficiency of our balance sheet by, for example, redeeming some more high coupon debt and further de-risking of our pension position. Let me provide you with some healthcare market perspectives for the U.S., Western Europe, and China. In the U.S., we expect to see low single-digit growth in the healthcare market in 2016 following a strong 2015. This was partly driven by an increased procedure volumes as more people are under the insurance umbrella. The number of uninsured has gone below 10% for the first time in the U.S.
We expect healthcare providers of all types to continue to implement process changes as Medicare introduces incremental steps in the transition from fee-for-service reimbursement to value-based payments. Examples include penalties for hospital readmission and recently, pilot programs bundling reimbursement for all steps in an episode of care. From pre-hospital assessment to post-hospital recovery into a single risk shared payment. These incentives continue emphasis on coordinated decision-making across the health continuum. The European healthcare market coming off slight growth in 2015 is expected to be flat in 2016. We continue to see an uptick across Europe in more sophisticated multi-year solution-oriented deals, although cuts to public spending budgets have offset this growth driver. In China, we see a gradual recovery from a slowdown in healthcare spending in 2015. Government investment focus has been on primary care, with recent attention to rural hospitals.
In urban hospitals, we detect a gradual change in our customers' purchasing decision-making, shifting perspective from the impact of price and performance of individual equipment items on hospital departments to the impact of integrated solutions enterprise-wide. Overall, we estimate the global healthcare market growth to be in the flat to low single-digit range for 2016. Let me briefly summarize our guidance for HealthTech, Healthcare Other, and legacy items. In the HealthTech Other segment, we expect net cost to be in the range of EUR 85 million-EUR 95 million at EBITDA level in 2016. We expect to incur approximately EUR 40 million of restructuring costs and other incidental items. Following the successful IPO of Philips Lighting in May, we expect separation costs for the fourth quarter to be EUR 45 million and consequently, approximately EUR 165 million for the year.
Other legacy items are expected to be in the range of EUR 10 million-EUR 15 million for quarter four, meaning EUR 70 million-EUR 75 million for the year. As Frans mentioned, our outlook for 2016 remains unchanged as we expect further earnings improvement in the fourth quarter of the year. Before we open the line to questions, I'd like to remind you that we will host our Capital Markets Day in London next week on the 4th of November, where we will provide a strategic update and deeper insights on our path to value of our HealthTech portfolio. We look forward to meeting most of you in London and hence will not be on road show this week. As such, we would limit the Q&A session to the performance of this quarter and leave the discussion on strategic issues to next week.
With that, let me open now the lines for your questions, which Frans and I will be happy to answer. Thank you.
Thank you, sir. If any participant would like to ask a question, please press the star followed by 1 on your telephone. If you wish to cancel this request, please press the star followed by 2. Would you please limit yourselves to one question with a maximum of one follow-up? This will give more people the opportunity to ask a question. If you are using speaker equipment today, please lift the handset before making your selection. There will be a short pause while participants register for a question. The first question comes from Mr. Mark Troman from Merrill Lynch. Please state your question, sir.
Yeah, thank you very much. Good morning, Frans. Good morning, Abhijit. Just one question, please, on the profit bridge I think you have on slide 24 in your presentation. Generally, we're seeing the price wage inflation component be a bigger drag than the COGS improvement driven by DFX, typically 60, 70 basis points each quarter. I noticed that the overhead productivity was pretty low this quarter. I guess that was due to some investments. Going forward, when you look for margin improvement, should we expect bigger overhead productivity, or can we close that gap between the price wage inflation and the COGS in terms of the initiatives you have running? Thank you very much.
Hi, Mark. Good morning. If you have seen for the last couple of years, we have had an operational improvement of bigger amount. It's roughly about 80 basis points or so. I think this quarter is a bit of an aberration. Couple of reasons. I think we had mentioned to you last time that we would do bigger spends in A&P. That has partly, let's say about 30 basis points, has gone from that bucket. We also have had lower than anticipated growth, as we mentioned earlier on patient monitoring, which is a high margin business, that also has affected for the quarter. As I said earlier during my introduction, that we had certain expenses which came into this quarter, which offset the productivity savings. The productivity savings at a gross level are still at a very good level.
In this quarter, things like our investments in the cybersecurity program and a couple of other things have, from a timing perspective, made the number look low. I think overall, if you look year to date and if you look at the year as a whole, we will still be in the 70 to 80 basis points improvement operationally, going forward.
Yeah. Mark, Frans here. Let me just echo that. The self-help story at Philips will definitely continue over the next years. More to come at our Capital Markets Day.
Okay, thanks very much.
Thank you. We will now take our next question from Max Yates, Credit Suisse. Please state your question, sir.
Hi. Thank you. I just wanted to understand a bit more about the connected care division, because if I look at the patient monitoring part of that, it looks like it's lost between EUR 15 million and EUR 20 million of revenues year-on-year, if it was low single-digit decline. The EBIT decline on that is around EUR 13 million, if we assume that all of the connected care EBIT decline was from patient monitoring. That seems like quite a high drop through. I was just trying to understand whether any of the investments within informatics or population health management had also stepped up year-on-year, and if not, then why the kind of operational leverage on the decline of the volume were as high as they were on patient monitoring.
Yes, Max, Frans here. The PCMS revenue shortfall, we see that as a blip. It's a timing matter. We expect that revenue to come in in the fourth quarter. It had to do with customer installations that were just taking a bit more time and could not be finished in the quarter. As a consequence, you not only have the profit of PCMS missing, which is the most profitable business, but you therefore also have a mix change within the CC&HI cluster. There's also some cost items that weigh on the quarter. Overall, if I give you my perspective on CC and HI, that segment is on an upward trajectory with regards to profitability, say, if you even out the influence of the single quarter. Nothing to worry about.
Okay. Thank you. Just one follow-up. When I look at FX for the quarter and the EBIT bridge, it was quite a bit better than I think suddenly I expected. For guidance for the full year, the impact from FX at current spot rates, what would you expect that to be in the EBIT bridge?
We expect it to be flat. I think we had said that also in Q2. We expected for the full year to be flat, which meant that we would have a recovery in the second half. I think we have seen that. I think Q4 will also be flat. I think for the whole year, you can take around the flat impact.
Perfect. Thank you very much.
Thank you. The next question comes from Andreas Willi, JPMorgan. Please state your question, sir.
Good morning, Frans. Good morning, Abhijit. If I look at the Accelerate! investments more broadly, there will keep being a headwind for the profitability development. If we look going forward, should these be flat or are they actually going to drop out of the P&L in terms of are these just kind of one-off investment boost or are these going to stay at the current level?
Hi, Andreas. Frans here. I think you're referring to the step-up in R&D, especially in emerging businesses and adjacencies. Is that right? Is that what you're referring to?
Yes.
Yeah. Over the last two years, we have gradually increased our R&D investments as we are building the health continuum portfolio, putting more effort in health informatics, medical wearables, digital pathology. We expect the overall investment level now to be stable, with revenues gradually going to come in. If you take R&D investments to be stable and the top line growing, then you would get operational leverage or basically a return on those investments over the coming years.
That was clear. Thank you. On the earlier question on foreign exchange, it's quite difficult to model from the outside what's going on. Given now you basically, after the big gain in Q3, you don't expect much in Q4 anymore. We had still headwinds last year in Q4. Why is this jumping around so much, and why don't we see a benefit again in Q4, given that some of the rates have continued to improve for you and the year-on-year comparable is still quite easy?
Yeah. I think, Andreas, couple of things. One is, we had changed, let's say, our hedging policy in the beginning of the year. The other is the movement of certain other currencies like the yen, et cetera, which, unfortunately for Q4, doesn't give us the benefit. That's also what we had seen earlier. The last but not the least, we have also significantly reduced our cross-currency exposures on the balance sheet, which I think we had also mentioned earlier in terms of redoing some of our contracts and also changing our intercompany payment habits. All that results, let's say, in a one-time gain, and then we will not see that coming back in Q4, at least based on the current spot rates.
Thank you very much.
Okay.
The next question comes from Ian Douglas-Pennant from UBS. Please state your question, sir.
Thanks very much for having me on. On your guidance for the full year, I'm just trying to gauge how positive you are on Q4, because at last quarter, you were trying to talk us down for the full year to get us below that 11% number. I just wanted to get your updated thoughts there. For example, how much of those revenues are you expecting to shift from Q3 to Q4? How much of that strong order book will come in within CC&HI? That obviously, some of the other divisions are looking up as well.
All right. Ian, I'm smiling a little bit because I'm not sure that we were trying to talk you down because the consensus was more like 10.4%, 10.5%, and we maintained our around 11% guidance. We maintained that guidance, so we still aim to be around 11% adjusted EBITDA. Did I miss anything in your question there?
Yeah. Maybe I framed it slightly wrong, but you were certainly trying to talk us towards the bottom end of that range, or say the consensus was correct to be at the bottom end of that range. I wonder whether it might be reasonable to think we might be closer to 11% or even above 11%, given what we've seen this quarter.
Okay. Well, look, we continue to see a positive path, expecting a good fourth quarter. We say we will continue to see profit improvement. You all know that we are very dependent on the fourth quarter. We stay committed to that guidance, but I'm not going to be precise about 10 basis points here or there. It's important that we, as management, feel that we are on this trajectory in a good sense, with forward momentum.
Fine. If I could ask a follow-up question there, or to reframe the same question I just asked. For Connected Care & Health Informatics, would it be reasonable, if you were doing my job, to keep the full year Connected Care & Health Informatics organic growth number unchanged, given the weakness this quarter? I.e., would you expect to see all of those sales shift from Q3 to Q4? In terms of the cost savings in Diagnosis & Treatment, you've done 200 basis points year-over-year in Q3. Would it be reasonable to assume something similar to that in Q4? I'm just talking about orders of magnitude. I'm not asking you to guide us on the division exactly.
Yeah, I think couple of things. I would not change, let's say, I don't know what is your specific number on year-on-year growth for CCHI, but the growth trajectory that we have seen, we don't see a shift because of the shift between quarters for the full year. For Diagnosis & Treatment, yeah, we will see continued profit improvement into the fourth quarter. Again, not to give a specific number on that. I think that is part of the plan which helps us to improve our Q4 profitability.
Okay. CC&HI is on track with your expectations. Okay, great. Thank you very much.
We will now take our next question from Ben Uglow from Morgan Stanley. Please state your question, sir.
Well, great, thanks. Morning, Frans. Morning, Abhijit. I had questions around the imaging businesses, specifically. Frans, there was a very detailed kind of geographic understanding of the order insight. Can you just give us a sense, when you look at the imaging business, what's happening in MR, CT, ultrasound, how things are playing out by modality? Second question, I was a little surprised to see the ultrasound sales down in the quarter. Can you give us an idea what may be happening there? Finally, when I look at your slide 35, it gives you a kind of idea on the sequential evolution of orders. We see Europe trending down, and I noted that you seem to be guiding fairly cautiously around 2017 on European orders. Can you just give us a sense of what's going on there? Are you seeing a change in the market?
All right. That's quite a few questions. We'll try to answer them as good as we go. Good order growth in the third quarter for diagnostic imaging. Also good order growth for ultrasound. Within diagnostic imaging, the year-on-year comparison is a bit difficult because 2015 had a very strong order intake for CT, and therefore difficult to immediately replicate this year. This quarter, we saw strong performance in MR, for example, and in general X-ray. Overall, we are confident about diagnostic imaging. On ultrasound, the market had shifted a little bit away from the high-end cardiovascular area, where we are the market leader, into a more point-of-care ultrasound, let's say, the ultrasound machines. We have, in the meantime, been able to adjust our effort. As a consequence, we saw good order intake in the third quarter.
Even though the revenue was still lagging a bit, we see the correction already in the order intake, and therefore, going forward, we think that ultrasound will be in a better upward trend. Image-guided therapy continues to do well, both on the equipment and on the device side. Your questions around Europe, maybe I can first expand a little bit and look at the whole world. Last year we were concerned about China. In the meantime, China has recovered very nicely, both the market overall and then in particular, our performance within the market, leading to double-digit order intake and double-digit growth. We expect that to be sustainable for the foreseeable future. In the United States, we are growing slightly ahead of the market. The market we see as flat to low single digit, and we are growing faster than that.
Again, we would expect that to be sustainable near term. That leaves Europe, where the market is a bit more down. Some differences by country. Overall, the sentiment in Europe has been more subdued, with, on the one hand, Brexit uncertainty, but on the other hand, also various countries with local elections coming up, and budgets not expanding. If you realize that Europe is just 24% of our overall revenue base, we need to see it in that context.
Understood. One very quick follow-up. To get to flat orders, which you're guiding to year-over-year in the fourth quarter, we can see obviously from the chart that it's a very, very tough comp. Without wanting to put too many words into your mouth, we should assume that sequentially, things are still improving, correct?
I'm looking to my wise friend on my right hand here.
Sure. If you look also in the overall order book, the position of the order book is the strongest it has been in the last couple of years.
Okay.
I think the order book is in a fairly good shape.
Okay, thank you very much.
Thanks, Ben.
The next question comes from James Moore from Redburn. Please go ahead.
Yeah, good morning, everyone. Good morning, Frans, Abhijit. I have got one on orders and one on margins. Just on orders, I wonder if you could give us some flavor as to what the percentage growth was in China in the quarter. And when we talk about flat for the fourth quarter, I think if I am right, at the last quarter, you talked about the full year seeing 4% growth. And I thought you needed something like 9% growth in the second half to achieve that. And after eight in the third quarter, are you now a little less confident on orders, and what has driven that? That was the first question. Maybe we could touch on that first.
Okay. Yeah, James. Well, we don't detail out the exact number in China, but I've said double digit order intake growth, double digit revenue growth. We feel very confident about the performance path in China. Let's leave it at that. On the orders in July, we said first half was quite weak, and we expect a stronger second half. That is materializing, 8% in the third quarter, and also we expect a strong fourth quarter. It's just that on the comparable order intake growth number, compared to last year where we had a very strong increase, mathematically, that's more difficult. That doesn't take away from the fact that we do expect a solid order intake quarter in the year.
Okay. Switching to margin as a follow-up, if I could. I think you need 150, 200 basis points year-on-year increase in the fourth quarter without being overly precise, but I make it 180. I'm just trying to understand which division we should see as driving that year-on-year change the most.
We will see improvements in all three segments.
Okay. Just on CC&HI then, I see that you've run at sort of an 8% margin in the last couple of quarters. A little bit down this quarter, a little bit up last quarter. Last fourth quarter, it was 18. Are you saying you can go back to 18 or above 18 because you're going to reverse these timing issues in the third quarter?
Yeah. James, we are not going to give a specific number for CC&HI, but you've seen the trends of these businesses. Q4 are big quarters, and we expect another big quarter also for CC&HI.
Just so I understand, within CC&HI, was it that the HISS and the PHM margins came down, or was it all driven by PCMS?
No. There were two things which Frans mentioned earlier. One was the PCMS, let's say, revenues going down, which has a big impact because it's one of the higher margin business, but also step-ups in investments in PHM as well as the consolidation of Wellcentive. All together, that had an impact.
Yes. I heard that. My question was more about margin, because I guess the revenues are going to be growing in HISS and PHM, I assume. Does increased investment mean a net negative picture to the margin?
That was what happened in Q3.
Okay. Thank you very much.
Yeah.
We all need to remember that with a big sales quarter ahead of us, the operating leverage in that quarter will be very, very strong.
Very clear. Thank you.
The next question comes from Gaël de Bray from Deutsche Bank. Please go ahead, sir.
Yes. Thank you very much. Good morning, everybody. My first question is on Cleveland. You apparently, if I understood correctly, you're now guiding for the contribution from Cleveland to be around EUR 80 million this year. That would be slightly short of the EUR 100 million guidance you had initially. Do you still expect to recap the EUR 20 million shortfall next year, which means that one should see the Cleveland contribution, on a year-on-year basis, at close to EUR 100 million again in 2017? That's question number one. Question number two is, again, on the innovation spending. Can I circle back on this research and development expenses, which obviously were very high this quarter, probably now standing close to, well, more than 100 basis points higher than two years ago.
It seems you're currently spending much more on R&D in your health tech operations than GE or Siemens, for example. Is there actually any way you could optimize the spending here rather than just wait for the revenue to come in? Thank you.
Yeah. Hi, Gaël, Frans here. Let's first talk about Cleveland. We had a strong contribution in the quarter on Cleveland, and for the full year, we still expect close to EUR 90 million profit improvement year-over-year. Well, that's a little bit shy of the EUR 100 million, but in the ballpark. Of course, next year, we expect to continue to improve, but I'm not detailing that at this moment. On innovation, the choice to step up R&D was a very conscious choice as we have pivoted, let's say, from a diversified holding into a focused health tech company. We see the market opportunities in the health technology market. We see that customers are asking for more integrated solutions whereby informatics play a big role.
We have put significant efforts to step up our healthcare informatics activities, our Philips HealthSuite cloud platform, connecting smart devices throughout the hospital enterprise, but also to patients at home. I think this is going to pay us dividends in the years to come. On your question whether we can right size in R&D, we think we are more or less at the right level with the EUR 1.65 billion of R&D in health tech. We expect to keep that more or less flat, while obviously always looking for productivity improvement opportunities, which means with a higher revenue going forward, there will be some operating leverage on the overall R&D line, with gradually the percentage coming down a little bit as a percentage of sales. Nevertheless, we are an innovation company. We are, in fact, proud of our, let's say, innovation portfolio.
We see that the innovations that we bring to the market are very well received by customers. I was in Germany three weeks ago and spoke with most of the large university hospitals and also chains like Helios and Asklepios, and they all like our strategy very much. They see that a more integrated technology offer is required to drive better patient outcomes and higher productivity for these hospitals. I dare say, we see the recognition that R&D investment is going in the right direction.
Thank you very much, Frans.
You're welcome.
The next question comes from David Vos from Barclays. Please go ahead, sir.
Good morning, Pim, and with you, Frans. Thanks for taking my question. Just one on the service business within Diagnosis & Treatment. I think we haven't discussed that for a while in terms of growth. Could you just comment on that, how that's ticking along? Then I have maybe a follow-up after.
I think that is ticking along well, not only in the Diagnosis & Treatment business, but also in CC and HI. We have launched a few initiatives to increase penetration there. I think overall the growth has been good and so also the profitability. We now look at it as integrated results, even internally, so that we drive, let's say, both the business and the service side to go to common improvement measures that has helped to take out certain duplication of costs, et cetera, and drive the business to, let's say, a good growth level as well.
I may want to add, sorry, David, I may want to add that we are launching more and more also value-added services such as consulting, design services, lean services. At the upcoming RSNA, we will talk about radiology solutions. All of that helps, of course, to move gradually the business towards a higher proportion of recurring revenue.
Yes, absolutely. Should we be thinking about something like high single digits in terms of growth rates there?
No, I think mid is still. Overall for service, mid single digit is a good range.
Okay, perfect. Just one housekeeping question. I appreciate it might be a little bit too early for it, but we'll be tying up our models here on our end before the Capital Markets Day. If you could just comment on what you expect for 2017 in terms of the healthcare other and legacy item lines, that would be very helpful.
David, I think we will wait for the end of the year. We always guide in Q1 or when we talk about the year-end results, we guide for next year. I think that's a better time.
Okay, perfect. Understood. Thank you.
The next question comes from Alok Khatri from Société Générale. Please go ahead.
Hi. Thanks for taking my questions. Alok Katre from Soc Gen. Well, one follow-up in terms of the order intake. It seems that the catch-up on Diagnosis & Treatment is a bit slower than what we would expect, given how much there was a bit of a decline in the previous quarters. Maybe you could just explain perhaps what's going on in there. Is there any particular modality that's holding back this sort of catch-up effect? That was the first question in terms of follow-up. Then just on the cash flow side, if you could probably just give some sense of working capital. Obviously, you've been cutting it for several quarters now. Just how much more juice is there remaining on the working capital side? Is there any internal sort of target for this over the next few quarters? Thanks.
Hi, Alok. Frans here. In D&T, we saw 6% order growth in the quarter, especially driven by IGT and ultrasound. To compare on diagnostic imaging was more difficult. Nevertheless, we expect that the D&T order intake growth can continue to be solid. As, let's say, the effects of Cleveland start to go away. How to say this? It will become more even in the comparison, therefore, less concerning to you. We feel strongly that with the innovations in that area, the earlier discussion on ultrasound, that we are in a good spot.
We had a tough year-on-year comparison also for Q3. We had high single-digit growth last year in Q3 in Diagnosis & Treatment. I think overall, the order book is in pretty good shape. Your second question on working capital, I think we will, let's say when we talk about longer term, we will probably give you some indication when we are in London next week. I think overall, improvements for the last two years have been pretty substantial, but we still believe that there is more efficiency which we can get in our overall working capital. There is still some more juice left, Alok.
Right. Fair enough. I'll wait for the CMD then. Thanks.
Yeah.
Once again, if you would like to ask a question, please press the star followed by the 1 on your telephone. To cancel this request, please press star followed by 2. The last question comes from Jonathan Mounsey from Exane BNP Paribas. Please go ahead, sir.
Hi, yes. Good morning. Thanks for taking my questions. A couple of questions. Just on Diagnosis & Treatment, could you give us an update in terms of the FDA and where you are with them? Is an end in sight in terms of their involvement in Cleveland? Then in terms of Personal Health, obviously from Q2 this year, we had a step-up in organic growth. I'm just wondering, by the time we get to Q2 next year, is basically the last three quarters of next year, are they very difficult comps? What's the product pipeline like to offset that? Can we expect strong mid-single-digit growth next year? Is it going to be difficult given how strong it's been back end of this year?
Hi, Jonathan. Frans here. Well, with the FDA, I feel that we are making very good progress on the quality and the compliance side. We've had, across the world, many inspections, and let's say the rate of observations has improved significantly. In Cleveland, we have not yet seen the FDA come back in. That's understandable because the arrangement was that every quarter we will have a so-called third-party audit, doing the work for the FDA, right? That's kind of an understanding, and that report is then sent to the FDA so they know exactly how we are performing in Cleveland. We feel confident about that. Nevertheless, the chapter is not yet closed off, and I think that was your specific question, right? We continue to invest quite a bit of money in further making the whole quality management system more robust.
Also working with our suppliers, because that was part of the problem, as you recall from the July discussion. We also see suppliers respond very well to our involvement to improve quality and compliance. Overall, on the right path, I would say. Then on personal health. I see no reason why the growth rate of personal health would change on average. We are in a solid mid to high single digit, and we see good demand for our innovations. Earlier this morning, I was, I think, interviewed by a journalist, and I said that the uptake of, for example, oral care products in China is going very, very well. We have worked diligently on supporting dental professionals, the dentists, in recommending to consumers to use Philips Sonicare toothbrushes.
As a consequence, we have seen really solid high double-digit growth already for many quarters, and we expect that to continue. This falls in the area of geographical adjacencies that I think we talked about earlier at Capital Markets Days. It's a strategy that works very well, and we expect that to continue.
Just one more part on that FDA comment then. Is it right to understand then that in terms of the third-party audit process coming to an end, is there a set of things you can do that basically means if you meet that, then it ends? Or is it entirely up to the FDA to decide when that third-party audit process ends?
Yeah, in the end, it is at the discretion of the FDA to decide when they want to do their own audit. I cannot predict exactly when that will happen.
Understood. Thank you very much.
Okay, very good.
Thank you, Mr. van Houten and Mr. Bhattacharya. That was the last question. Please continue.
All right. Well, I'd like to thank everybody for attending this conference. Great, 10 very good sets of questions, which we certainly enjoyed responding to, and we hope that we will see all of you at our Capital Markets Day on the 4th of November in London. Thanks, and have a great day.
This concludes the Royal Philips third quarter 2016 results conference call on Monday, the 24th of October, 2016. Thank you for participating. You may now disconnect.