Welcome to the Royal Philips first quarter 2016 results conference call on Monday the 25th of April 2016. During the introduction hosted by Mr. Frans van Houten, CEO, and Mr. Abhijit Bhattacharya, CFO, all participants will be on 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. Robin Jansen, Head of Investor Relations. Please go ahead, sir.
Thank you. Good morning, ladies and gentlemen. Welcome to Philips' first quarter fiscal year 2016 results conference call. I'm here with Frans van Houten, CEO, and Abhijit Bhattacharya, CFO. In a moment, Frans will take you through our strategic and financial highlights for the period. Abhijit will then provide more details on financial performance. After that, we will be happy to take your questions. Our press release and the related information slide deck were published at 7:00 A.M. CET this morning. Both documents are now available for download from our investor relations website. A full transcript of this conference call will be made available by tomorrow on our investor relations website. Before I turn over the call to Frans, I would like to remind you of the following three things.
First, starting this quarter, we publish our quarterly financial results under the new segment reporting structure, reflecting our strategic approach in the health technology market. The new reporting structure will enhance transparency and has no impact on total Philips financials. You can access prior period financials under this new segment reporting structure on our IR website in the financial reporting update section. Second, following the decision in 2014 to combine our Lumileds and automotive lighting businesses into a 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 under cash flow from discontinued operations.
Therefore, all commentary that will follow in terms of sales and earnings at both the total level as well as at the lighting segment level continues to exclude the performance related to the Lumileds and automotive lighting businesses. Finally, 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 now hand over the call to Frans.
Thanks, Robin. In the first quarter, we booked a solid 3% comparable sales growth and a significant 14% improvement in adjusted EBITDA, bolstered by several successful new product launches across the portfolio that in fact drove higher volume and better product mix. Overall performance improvement was also strongly supported by ongoing benefits from our Accelerate! program, despite challenging macroeconomic conditions in several markets. As Robin noted, we are now reporting based on six segments, four of which are part of our Health Tech portfolio, Personal Health, Diagnosis and Treatment, Connected Care and Health Informatics, and Health Tech other. Of course, Lighting and legacy items. This reporting better reflects the future relevant portfolio logic of our company. This morning, I will focus my remarks on our main operating segments, Personal Health, Diagnosis and Treatment, Connected Care and Health Informatics and, of course, Lighting.
We had 5% comparable sales growth in Health Tech in Q1 and many areas of strength throughout the Health Tech portfolio. Adjusted EBITDA improved by 50 basis points, even as we continue to invest significantly in high growth areas such as wearable patient monitoring solutions, digital pathology, and health informatics, all of which are important growth areas for the future. In Personal Health, comparable sales growth was 6% and the adjusted EBITDA margin improved by 130 basis points. We drove double-digit growth in Health and Wellness with continued double-digit growth in Oral Health Care, which was fueled by the recent introduction of the Philips Sonicare Essence in Greater China, which provides consumers with the high-quality brushing experience at affordable price points. Personal Care delivered high single-digit growth and Domestic Appliances, low single-digit growth.
Sleep and Respiratory Care achieved mid-single digit growth, driven in particular by Philips new Dream Family sleep therapy program, which we launched in Europe and in the United States. This Dream Family helps to improve the sleep therapy experience for people with obstructive sleep apnea. To date, more than 200,000 people are using the Dream Family in the United States since its introduction in the fourth quarter of 2015. We are now launching this in Japan. In Diagnosis and Treatment, the adjusted EBITDA improved by 80 basis points, driven by 5% top-line growth and savings from our productivity initiatives. This was partially offset by ongoing and anticipated investments to improve our quality management systems and by currency effects.
The production and shipment levels of the two major CT product lines in Cleveland are on track, and also the global CT production and shipment levels are by and large back on track, and the backlog has normalized. Since last quarter, we have brought one more product line into production, and now we have one more product line that needs to be put back in production mode in Cleveland. All in all, there's still remediation work to be done in Cleveland, explaining the associated elevated remediation spend that we will incur well into the second half of the year. As a result of all this, we continue to expect that the improvements will contribute around EUR 100 million to the adjusted EBITA in the second half of 2016, and EUR 75 million in 2017.
Within the Diagnosis and Treatment segment, image-guided therapy did particularly well in the first quarter, with double-digit growth in orders and sales, as well as an improved adjusted EBITA margin, supported, among others, by the growth in peripheral vascular diagnostics and therapy. This is a clear demonstration of the synergetic value that Volcano brings. After its first full year as part of Philips, the projected revenue synergies are ahead of plan, and total cost savings amount to close to EUR 40 million, which is substantially ahead of plan. Comparable sales in the Connected Care and Health Informatics segment increased by 9%, driven by double-digit growth in patient care and monitoring solutions and in high single-digit growth in health informatics. This strong growth performance helped to improve the adjusted EBITA margin by more than 3 percentage points.
We continue to invest in organic growth opportunities as well as in partnerships that we expect will have great relevance for our existing and potential future customer base and therefore driving future growth and profitability. For example, we partnered with Hitachi Data Systems to introduce a next-generation vendor-neutral archive system. The Philips Vendor Neutral Archive is an open, universal data management solution in which medical images, documents, and potentially other clinically relevant data are archived in a standard format. It allows healthcare organizations to make many millions of images, often stored in legacy proprietary systems from multiple departments, rapidly available to virtually any clinician at any location within the hospital, no matter which information systems they use. In less than three seconds, clinicians have a complete and integrated view of an individual patient's medical condition over time, which helps, of course, to improve patient outcomes.
The Philips data management solution is run on our HealthSuite digital platform, an open, hybrid, on-premise, and cloud-based platform that enables the next generation of connected health and clinical information technology innovations. To demonstrate the strength of our pipeline of multiyear strategic partnerships, I'd like to call out another win that we forged in Q1. We signed a 15-year, $90 million agreement with Marin General Hospital for imaging systems, patient monitoring, and clinical informatics solutions. The collaboration includes technology, design, and informatics to develop new patient-centric hospital bed tower and ambulatory facilities. This partnership underscores Philips' ability to provide solutions for hospitals and health systems that are grappling with a fundamental market shift towards creating long-term patient value while also managing cost, complexity, and risk. Let's switch to lighting now.
We reported our sixth consecutive quarter of year-on-year operational improvement on the basis of a significant 27% growth in LED sales and improved cost productivity and product mix. In Q1, for the first time, LED lighting accounted for 50% of overall lighting sales. Largely as a result of our success in LED and its growing share of the overall lighting business, we continue to expect Philips Lighting to return to positive comparable sales growth in the course of 2016. Additionally, we would like to underline that our home business delivered double-digit growth for the second consecutive quarter, and professional in North America actually returned to positive growth in the quarter.
At the leading industry trade show called Light + Building, next to a full range of LED lamps and electronics, we showcased four of our most important connected LED lighting growth platforms for smart cities, smart retailing, smart offices, and smart homes. These growth platforms are our future. Today, I'd like to focus on one of these growth platforms, smart LED city street lighting solutions. Of over 300 million streetlights globally, actually less than 12% today are LED-based and less than 2% are connected. This offers a significant opportunity to increase the adoption of connected LED street lighting for smart cities. For example, we recently launched a partnership with Vodafone to implement CityTouch smart street lighting systems, which will be connected wirelessly, saving energy and making maintenance so much easier and efficient.
We also introduced Philips DigiStreet, our new range of LED street lighting luminaires, which include a plug-and-play upgrade option to wirelessly connect the luminaire to the Philips CityTouch street lighting management system. With this upgrade, the streetlight can be monitored, controlled, and managed remotely. Typically, this provides additional 30% energy saving on top of the 40% average saving achieved by switching to LED. Maintenance cost and time are also reduced as real-time information on the status of each light point is relayed to the operator who can troubleshoot remotely or schedule crews to a precise location. Let me now provide you with an update on the separation process. We continue to simultaneously prepare for either an IPO or a private sale of Philips Lighting.
With equity market sentiment improving compared to the first couple of months of the year, an IPO increasingly appears a more likely outcome, subject of course, to further market developments and other relevant circumstances. We have not yet concluded on all the proposals in the private sale process and continue to assess the attractiveness of this route compared to the IPO, both in terms of value and conditions, while taking into account the best interest of Philips and its stakeholders. We expect to update the market on conclusions and next steps shortly. I appreciate that you probably have a lot of burning questions on this topic, but I would like to state upfront that we are not in a position to provide much more detail on the separation during the Q&A session beyond what I have just shared with you.
With regards to Lumileds, I can say that we are engaging with third parties that have expressed interest in Lumileds and will provide more detail on this process when appropriate. Our outlook for 2016 remains unchanged as we continue to expect modest comparable sales growth and to build on our operational performance improvements. We expect earnings improvements in the year to be back-end loaded, taking into account ongoing macroeconomic headwinds and the phasing of cost and sales. Let me now hand over the call to Abhijit to discuss our financial performance and market dynamics in more detail.
Thank you, Frans, and good morning to all of you on the call and webcast. In Q1 2016, we delivered 5% comparable sales growth in our Health Tech portfolio, 27% CSG in our LED lighting portfolio, and a decline in comparable sales of 20% in the conventional lighting portfolio, of which conventional lamps declined by 15%, which is in line with industry trends. Geographically, comparable sales growth of 3% in the first quarter was equally driven by mature and growth geographies. Health Tech sales in growth geographies grew by 9%, and the mature geographies delivered 3% growth. Lighting sales in growth geographies declined by mid-single digit, while the mature geographies increased by 1%, all on a comparable basis.
Comparable sales growth for Health Tech in the mature markets was largely driven by mid-single digit growth in North America and 3% comparable sales growth in Western Europe, which was partly offset by a slight decline in other mature geographies. All segments showed positive comparable sales growth in the mature geographies, with the highest growth rates delivered by Connected Care and Health Informatics and Personal Health. For lighting, comparable sales growth in the mature geographies was led by mid-single digit growth in North America, low single-digit growth in other mature geographies, partly offset by mid-single digit decline in Western Europe. In the growth geographies, comparable sales for Health Tech was driven by high single-digit growth in countries like China and India, and double-digit growth in countries like Poland, Russia, Mexico, Indonesia, Argentina, and others.
Segment-wise, all segments delivered comparable sales growth in the high single to double-digit growth range in the growth geographies. In lighting, the mid-single digit decline in comparable sales in growth geographies was mainly due to double-digit declines in Saudi Arabia and Brazil and low double-digit decline in China. Let's have a look at order intake now. On a currency comparable basis, order intake declined by 3% after a quarter with double-digit growth, which largely reflects the unevenness of order intake dynamics. Comparable orders declined by low single digit in Connected Care and Health Informatics and by mid-single digits in Diagnosis and Treatment. Geographically, we reported a low single-digit decline in comparable orders in our growth geographies, mainly as a result of China after a very strong order intake in Q4.
In North America and other mature geographies, order intake was by and large in line with Q1 2015, while Western Europe posted a high single-digit decline on the back of, among others, strong comparables with Q1 of last year, strong order intake in Q4 of last year, as well as challenging market conditions in the NHS and U.K. feeding through into significantly lower healthcare CapEx. In lighting, the LED portfolio delivered another strong quarter with 27% comparable sales growth and a significant year-on-year improvement of the adjusted EBITDA margin, most notably in LED lamps. Our LED-based portfolio now represents 50% of the lighting portfolio, compared to 39% in Q1 2015.
Notwithstanding the ongoing decline in conventional lighting, we further improved the high teens adjusted EBITA margins in conventional lamps delivered in Q1 2015, which is a clear demonstration of the success of Accelerate!, and most notably, our proactive and highly successful management of our conventional manufacturing footprint. We were also particularly pleased with the second quarter of double-digit growth in home and a return to positive comparable sales growth in PLS North America. Let me now switch to EBITA development in the quarter. Slide 33 of the presentation material that we posted on our website this morning provides an overview of the main drivers of adjusted EBITA when compared to the same period last year.
As you can see on the slide, the adjusted EBITA margin of 6.8% this quarter was 70 basis points higher than Q1 of last year, despite a stronger-than-anticipated negative currency translation effect of 70 basis points. This margin increase was driven by a margin improvement of 130 basis points in Personal Health, 310 basis points in connected care and health informatics, 80 basis points in Diagnosis and Treatment, and 60 basis points in Lighting. Our underlying operational performance therefore contributed 130 basis points to the EBITA margin in the first quarter as our Accelerate! program continues to improve operational performance and drive efficiencies.
More specifically, in the fifth bar, you see a net contribution of EUR 23 million from our overhead and end-to-end productivity programs, as year-on-year incremental cost savings of EUR 91 million were partly offset by higher non-manufacturing costs as a result of investments in emerging business areas, higher selling expenses, and negative currency effects in the quarter. Design for Excellence or DFX, which is aimed at reducing cost of goods sold, delivered EUR 67 million of additional bill of material savings year-on-year and are on top of the normal run rate savings of EUR 68 million. These cost savings more than offset the 110 basis points of wage inflation and negative price effect of 210 basis points in the quarter. Operational improvement of 130 basis points was partly offset by a 70 basis points negative impact from adverse currency swings in a number of emerging market currencies, most notably in Latin America.
The translation impact of the devaluations in just Argentina and Egypt alone impacted the adjusted EBITA margin of HealthTech by 40 basis points and Lighting by 80 basis points. In the first quarter, the income tax expense was EUR 44 million higher than the same period last year due to tax charges resulting from activities related to the separation of the Lighting business. For 2016, we continue to expect the effective tax rate to be in the low 30s. Net financial expenses were up EUR 47 million in the quarter, which was largely driven by fair value adjustment of our stake in Corindus Vascular Robotics. Due to these two extraordinary charges, the net income in the first quarter was EUR 63 million lower than in the first quarter of 2015.
The return on invested capital, which is calculated on a five-quarter MAT basis, was 6.9%, excluding the total one-off charges of EUR 345 million related to the pension liability de-risking in the U.S. and U.K. in Q4 2015. The ROIC was 9.9%, which is about one percentage point above our WACC. Inventories as a percentage of sales declined by 260 basis points to 14.7% year on year. Excluding the negative currency translation effects, inventory as a percentage of sales were down 50 basis points year on year, driven by all operational segments. Free cash flow for the quarter amounted to an inflow of EUR 43 million, excluding an outflow of EUR 172 million as part of our pension liability de-risking initiatives in the U.S. that we announced in Q4 2015 and partly had to fund in Q1, and separation costs of EUR 48 million.
By the end of the fourth quarter, we completed 82% of our three-year, EUR 1.5 billion share buyback program, which we started in October 2013. Looking ahead, we remain, in general, concerned about ongoing macroeconomic headwinds and geopolitical uncertainty in a number of regions around the world, and in particular Latin America, parts of Middle East, China, and Russia. In the U.S., we expect the healthcare market to show flat to low double-digit growth in 2016, following a strong year in 2015. For 2016, we expect a relatively strong economy and growth in procedure volume to be partly offset by continued reimbursement reductions. Capital spending for hospitals is expected to be flat in 2016. The European healthcare market, coming off a slight growth in 2015, is expected to see flat to low single-digit growth in 2016.
We continue to see an uptick across Europe in multi-year solution-oriented deals, although cuts to public spending budgets have offset this growth driver. In China, headwinds related to government's anti-corruption measures, centralized tendering, and price erosion continued the overall slowdown across the healthcare market in 2015. We expect the Chinese healthcare market to stabilize in 2016 and grow modestly. Overall, and similar to 2015, we estimate the global healthcare market to be in the low single-digit range for 2016. In lighting, the global market is expected to grow in the low to mid single-digit range. The outlook for the overall U.S. lighting markets remains positive. The U.S. construction market is forecast to grow by 9% in 2016, of which non-residential construction is forecast to grow by 5% in 2016.
The Western European construction market is expected to see a continued recovery as year-on-year growth is forecast to increase by close to 3%, driven by a slight pickup in non-residential and residential construction spending. Nevertheless, overall sentiments and market expectations in Europe remain quite uncertain and vulnerable, so we remain cautious. The Chinese residential construction market remains weak but showed signs of improvement in the first quarter of 2016. While during 2015, floor space of construction started for residential buildings declined by 15%, it showed growth of 10% in the first two months of this year. Let me briefly summarize our financial performance in the first quarter before opening the lines for questions. Our HealthTech portfolio delivered 5% comparable sales growth, and the LED-based portfolio in lighting, which now constitutes 50% of total lighting sales, grew comparable sales by 27%.
Our improvement programs continue to drive operational performance across the segments in Q1. The separation of the lighting business remains well on track as we continue to simultaneously prepare for either an IPO or a private sale. Now that we have substantially progressed with the separation process, we expect separation costs for the full year of 2016 to be in the range of EUR 200 million-EUR 225 million. These costs represent the vast majority of what we expect to report in legacy items for the full year. For HealthTech other, we expect royalty income to decrease by approximately EUR 60 million in the first half of 2016, of which about half occurred in Q1, and the other half is expected to occur in Q2 due to the expiration of patents.
In addition, we expect to incur approximately EUR 50 million of restructuring costs and other incidental items in HealthTech other in 2016, which will be slightly offset by cost savings. As a result, we continue to expect a net cost of EUR 80 million-EUR 100 million at EBITDA level in 2016. This expectation is in line with the 2016 guidance we gave for the former IGNS during the Q4 earnings call. I would also like to remind you that in Q1, the profitability of our sleep and respiratory care business within personal health was negatively impacted by about 100 basis points as anticipated due to the change in the U.S. reimbursement for home ventilation, which we were able to partly offset by a strong performance of the recently introduced Dream Family sleep therapy program.
We expect this negative headwind from the change in reimbursement to have a similar impact in Q2. For the full year 2016, our outlook remains unchanged as we continue to expect earnings improvement to be back-end loaded, taking into account ongoing macroeconomic headwinds and the phasing of costs and sales. With that, let me now open 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 the one on your telephone. If you wish to cancel this request, please press the star followed by the two. Would you please limit yourself to one question with a maximum of one follow-up? This will give more people the opportunity to ask questions. If you are using speaker equipment today, please lift the handset before making your selections. There will be a short pause while participants register for a question. The first question comes from Mr. Max Yates from Credit Suisse. Please state your question.
Hi. Good morning. Thank you. Yeah, my first question would just be around the IPO and the potential timeframe. Could you just give us a bit of guidance on, if we were to progress via that route, what the timeframe would be, when we should expect the IPO to be launched?
Hi. Good morning, Max. This is Frans. What we flagged in the release this morning is that we plan to take a decision shortly, meaning that at this time, we are still evaluating both tracks, with the various bids under study and the IPO preparation in full swing. As we then take a decision shortly, then thereafter, things could go fairly fast.
Okay. Thank you. Just one follow-up would be, obviously in the press around the bidding, GO Scale Capital have been rumored to be involved in the bidding process again. Given you now have a sort of fairly detailed understanding of the CFIUS process, is there any work you can do initially to try and understand their position on any bid from GO Scale for that business? Have you actually been in contact with CFIUS so far?
Yeah, I had my share of the CFIUS process last year. I can say that, I've been to Washington. In my understanding, it's a process that you can only do after you actually register a request with a specific transaction, and therefore, it's very difficult to have an anticipatory assessment done. Yeah, it's not easy to assess these kind of things. Maybe if I expand then on the question, obviously we will take various factors into account when deciding, value being one, deal certainty being one, and of course also aspects as what it means to the various stakeholders, and do we provide a good home for lighting. Therefore, it's not a purely binary evaluation, and we are in the middle of that process as we speak, and hope to conclude that shortly.
Sure. Just one final one would be on the Personal Health margin this quarter. If I try and back out what the old consumer business did in the quarter, it looks like it did around a 14% margin, and obviously when I look at sort of seasonality of this business, the second half is normally stronger in the consumer business than the first half. Am I firstly right with that consumer margin, and is there anything, particularly in the first quarter, that means that's unusually strong and we shouldn't see margin progression in that business through the rest of the year?
This is Abhijit. I think you're right. The margin progression through the year is, of course, second half loaded because we have stronger growth in the second half. The first quarter was partially impacted, as we said, with the sleep and respiratory business, because it had a dip compared to last year with the reimbursement cuts. If you remember, the reimbursement cuts started in Q3, so Q2 would be the last quarter where we will suffer, let's say, on a comparable basis. In the second half, margin should pick up. I think that
Okay
that's how you should look at it.
Okay. Is the assumption that the consumer business did a 14% margin in Q1, is that correct?
No. I think we are now reporting as Personal Health, the whole portfolio. I wouldn't like to go back to former reporting, and what it meant, because we've given all the comparables a few weeks back at the end of March. I think you have good trends to compare with. Otherwise, we are forever caught up in this discussion of what it was, as per the old structure and new structure. As we try to simplify things in Philips, I think this goes against that drive.
Sure. I understand. Thank you very much.
Welcome.
The next question comes from Mr. Ben Uglow from Morgan Stanley. Please state your question, sir.
Abhijit and Robin. My first question is, I'd like to know how to think about the margin in Diagnosis and Treatment, just conceptually. When I look at the margin for the first quarter, and obviously I understand that it's a low quarter and that we still may have some remediation impact, 2% feels quite low. What I'm trying to figure out is, what over time, I'm not necessarily saying in the next six months, but what over time, where should that division sit in terms of its profitability? If I think about the old healthcare targets, which admittedly we're now going back to 2015, divisionally, we were considering 16%-17% reported EBITA. Should Diagnosis and Treatment be in line with the old divisional targets above or below?
Is there anything in particular in the businesses, for example, a big difference between ultrasound and the advanced imaging? What would make that division be above or below the old margin target? That was question number 1. Question number 2, very briefly, patient monitoring had a very strong quarter, it was growing at 9%. Is that a catch-up effect? Is there a base effect, or could you just explain the sales growth there, please?
All right. Ben, let me start, then Abhijit will help me to provide more color where necessary. You refer to the guidance on healthcare. In fact, we gave directional guidance on all of Health Tech by saying it should be in the mid to high teens, EBITDA, in the longer term. Obviously, we stick to that overall goal. The old healthcare guidance, of course, also excluded the IGNS charges. Robin, I'm referring to Ben's reference to the old healthcare target that excluded it, whereas my mid to high teens include that IGNS charge. That is where we need to go. Then, the three segments, in fact, all should be able to achieve that target. At this time, I don't see the need to indicate which one will be above and below the average.
The Diagnosis and Treatment portfolio has a strong set of product categories, where ultrasound and image-guided therapy would be above average within that portfolio and the old imaging modality is slightly below that average. Diagnosis and Treatment overall should be in line with the stated objective for Health Tech. We start the year, of course, it's a seasonal business, so the first quarter would be low. We still have elevated cost levels related to the quality or regulatory efforts that we have throughout this segment. Gradually, we will improve this business. Abhijit, do you want to add anything to this?
No, I think that's fair. Other than the only thing, Ben, you will see that the seasonality, particularly in Q4, is extreme for this business. It's a bit-
let's say, abnormal compared to even normally seasonal businesses, therefore you see Q1 coming in, let's say, pretty low.
Okay. Just on that point, Abhijit, the reminder that we get the EUR 100 million improvement from Cleveland in the second half of 2016, what we're effectively saying is by the second half of 2016, all of those effects should be out of the way, and we should be thinking about the margins in line or at least on track for what the Health Tech guidance has been.
Yeah. What we've said is that the second half of the year will see most of the benefit of the EUR 100 million of the Cleveland year-on-year. That should also push up margins in the second half, and that will give you a stronger year-on-year improvement than you will see in the first half of the year. Although Q1 improvement was still good, and we got hit by both currency, by quite a heavy extent in Diagnosis and Treatment alone by about 70 basis points. I think for the second half, with these improvements, as well as the lower quality cost and then a few things that we are doing with our manufacturing footprint in the medium term, we should be able to get the margins up.
Okay. Thank you.
I mean, to your question on patient monitoring, I think, the answer is something in between. We had, of course, good pickup in patient monitoring. Part of that was catch up or weaker comparables. If you see Q1 last year, we had a decline.
Therefore, I think the 10% growth is not something that you would look to extrapolate for the rest of the year, but we are pretty happy with how we've managed to catch up in this business in this quarter.
Okay. That's helpful. Thank you.
Thanks, Ben.
Our next question comes from Mr. David Vos of Barclays. Please state your question, sir.
Good morning, gentlemen. Thanks for taking my question. I also had a more general question on the Connected Care and Health Informatics business. It's very similar to Ben's question really. Margin improvement has been pretty good there, from 0.8% to almost 4%, but it's also a little bit lower than what you reported in Q1 2014. I was just wondering if you could help us understand where your ambitions lie there. Maybe as a kind of a second leg to that question, if you could frame your ambitions in the context of what we see your competitors in the healthcare informatics space do. I'm thinking, for example, about Cerner, where you see EBITDA margins north of 30%, which is quite a long way north of where Philips is at the moment. That would be very helpful. Thank you very much.
David, the ambition for Connected Care and Health Informatics is in the same order of magnitude as I've explained for Health Tech, so in the mid to high teens%. I don't make a distinction between the three reporting segments. Now, what you need to realize that is in Connected Care and Health Informatics, there are sizable investments, step-ups in R&D versus the first quarter of 2015. For example, investments in extending patient monitoring towards wearables, as well as investments in health informatics, among which our HealthSuite digital platform, and the extension and build-out of our consulting activities around healthcare transformatory services. Overall, it is a segment that is heavily weighed down by those investments, which, of course, will pay off over time. By the way, the high growth that you see in that segment, of course, also reflects the fact that we are making investments.
Your point on peers. Let's say in the medium term, we look to these mid to high teens EBITDA. That doesn't mean that there are not businesses that would be above average. Certainly, we can look at Cerner and other companies' profitability margin. At this time, we will strive to get to the mid to high teens%.
Okay. Thank you very much. That's it for me.
Our next question comes from Mr. Peter Olofsen from Kepler Cheuvreux. Please state your question, sir.
Good morning. First two questions on Lighting, please. On the overhead and support functions within Lighting, now with some of the former IGNS costs having been allocated there, do you think the cost structure is appropriate for the size of this business? Or do you see room for meaningful reduction in overhead and support costs in coming years? On the lamps side, conventional lamps, could you remind us what you expect to spend annually on the footprint adjustments in conventional lamps? My final question relates to working capital. I think both Connected Care and Health Informatics as well as Lighting show pretty nice improvements. You think these improvements are sustainable?
Okay. Thank you, Peter. We have done the separation, and it gives us the insight that we can further simplify over time. The overhead support functions can be expected to have further productivity enhancements over the next one to two years. In any case, as part of the plan for improving the Lighting profitability, we expect to be able to make significant productivity enhancements in the business as we strive for steady profit enhancement year-over-year. The lamps footprint reduction will be answered by Abhijit.
Yeah, I think we have said so far, the conventional footprint was about 1.5%-2% of sales. You could say for this year, roughly between EUR 90 million-EUR 100 million would be the range. Regarding your question on the working capital, that clearly we believe is sustainable, and we have some runway there to go as well. Clearly we are working on that. You see now that for the second quarter, you see our inventory levels also coming down, and that is something we will continue to drive in the coming quarters.
Okay, thank you.
Our next question comes from Mr. Phil Wilson of Redburn. Please state your question.
Yes, good morning. It is Phil from Redburn. Thanks for taking the questions. I will do one at a time, if that is okay. Firstly, just looking at your guidance for the 11% adjusted EBITDA margin, which you appear to have stuck to, that looks quite a challenge, given the first quarter. To what extent do you need a macro-based second half growth recovery to achieve this, versus your internal measures of savings and Cleveland coming back?
Yeah. Hi, Phil. Frans here. Well, we have said it is going to be around the 11%, so of course that has a bandwidth around it. We believe that there is a lot of self-help improvement possible. We've already talked on Ben's question on Diagnosis and Treatment being quite backend loaded. We'll continue to make improvements through the year. Indeed, we have still quite a journey to make
Okay, thank you. On slide 46, you talk about how you expect the overall U.S. healthcare market to grow, but it looks like you actually expect the Diagnosis and Treatment market, so the imaging market, to decline low single digits in 2016, which is different to what other peers, I think, are saying for the imaging market. Can you talk about what the drivers are behind the potential decline in the U.S. imaging market in 2016?
Yeah, I think, overall, we've said that we expect procedures to go, but with cuts in reimbursement, it could be flat to slight growth in the market. You see that for patient care monitoring and health informatics, we see a bit of growth. That could be marginally offset with reimbursement cut in the Diagnosis and Treatment area. It's a very minimal decline, you could say, more flattish than anything, and that's based on the current projections we have.
Okay, thank you. Then finally, I see, as you said, professional lighting in North America returned to growth. Can you give some help on what the margin currently is for PLS North America and where you think that can settle?
No, Phil, we are not detailing out the margin in North America. It is safe to assume that as we are back to growth, also our margins are improving.
Is it profitable?
We are not detailing out the margin, Phil.
Okay, thank you very much.
Yes.
Our next question comes from Mr. Andrew Carter of RBC. Please state your question, sir.
Yes, good morning. I wonder if you could just help us understand a little bit what's going on in terms of the quarterly order intake at HealthTech. I was looking at page 44, and I apologize if I missed something in the prepared comments there. I was wondering, I guess in particular, North America and Western Europe do seem to have been, or flat to down, having been on a much improving trajectory over the last couple of quarters. Could you give us a bit of a feel as to what's going on there, whether any of it relates to comp effects? Also, I guess, in terms of how important the different quarters are as we go through the year in terms of building up the order backlog as you go into the following year.
Sure. First of all, there's always unevenness in the orders, especially as we go to larger contracts. Right? Having said that, in North America, we grew orders mid-single.
Mid-single.
Mid-single digit. You want to?
Yeah. In Q4 last year, we actually had very strong order intake in North America, very strong double digit. As Frans mentioned, it is uneven. For Q1, it was largely flat. That's something we expected, in line with what we call sometimes lumpy or uneven. If you look at the rolling 12 months order intake, you see that for North America, we are in pretty good territory, because if you look at the 12 months rolling, you then don't get caught up in the quarter-by-quarter fluctuations. Therefore, our recovery in North America is pretty good. Similarly, for Europe, as we called out when I was giving you the details, we had a very strong Q1 last year, so the comparables are tough.
We had an even stronger Q4, which of course, therefore meant that the backlog of orders coming in the first quarter this year was a little bit lower. Regarding this year, we are actually pretty happy with our order book and commitments that we have, which is why we have guided that the second half of the year would be stronger than the first half in terms of profitability as well, because we see our, let's say, order book coverage for the second half as pretty okay at this stage.
Thank you. Can I just do a follow-on just on Lumileds, please? I guess over the last several quarters, the performance there, which obviously we can only see a little bit of, but it does look as though the performance there has been somewhat disappointing. Have you had to have a step-up in restructuring measures and footprint measures and stuff in Lumileds? If that's the case, how long is that going to take to execute on?
Yeah. That's good analytics, Andrew. Indeed, the Lumileds performance had been under pressure over a couple of quarters. We expect it to go up in the second half of this year. We make that statement on the basis of a good order book for the Lumileds products. These measures typically take an effect in about 6 months. Again, underpinning a improved second half of the year profitability. We believe that we will come through this period. It's a good business. We have great design-ins with various mobile platforms for flash applications and also, of course, for general illumination applications. Overall, I expect a good future for Lumileds.
Our final question comes from Mr. Graham Phillips of Jefferies. Please state your question, sir.
Yes, good morning. My question is around Cleveland. You spoke about the EUR 100 million improvement last year, and I think in the end, it was a slight decline. You are now saying EUR 100 million improvement in the second half. Why did we slip last year? What more has to be done to get this improvement from just a little over two months' time?
Graham, we started out by remediating Cleveland Factory itself in 2014 and 2015. Then we have extended the efforts to include our supplier base. Supporting our suppliers with the right measures is, you could say, a hand-holding effort that takes a considerable investment. We are partly also transitioning the supplier base towards alternative suppliers. All of that has proven to be quite a bit of a project. We do see light at the end of the tunnel. We are very pleased with how the manufacturing is going. Production levels are back to normal. We have just introduced another product line that was still outstanding. There is now only one small product line to go. We have started to ship our IQon Spectral CT in several countries.
All in all, I'd say we are having the situation well in hand, albeit with cost levels that are higher than originally planned. I intend to do this well, and so a bit extra cost is an acceptable price to pay. We expect the second half of the year to show stronger bottom-line results.
Okay, thank you. The one follow-up is around the lighting IPO. Have you looked at the cost alternatives between IPO or an asset sale to the firm? If you did go for an IPO, what would the proceeds likely be used for afterwards?
Yeah. We have looked at all the various options, and at this time are comparing a private sale versus an IPO. The proceeds will be used Well, first of all, the proceeds need to come in, and if it is an IPO, of course, they come in in a phased manner. The proceeds will be likely used in a blended form, partly to pay off existing debt. For example, the debt that we used for Volcano acquisition. Partly for additional pension liability reduction that we've already communicated before, that we would still do later this year. Partly, we have a share buyback program to finish this year. Then, we will also consider M&A activities to boost the portfolio that we have in Health Tech. That's the update that I can give you today.
You prefer that rather than a simple spin, and putting perhaps more debt into that business, because you actually want the cash for these other proceeds?
Yeah, that's right.
Okay. Thank you.
Correct.
We have an additional question over the telephone. Comes from Mr. Ian Douglas of UBS. Please state your question, sir.
Oh, thanks very much for squeezing me in at the end. Most of my questions have been answered already. I just had one last one on your working capital. All of the lines there declined materially this quarter. Is there some change of scope that we should be aware of, or is this a focus, reducing working capital at the moment? If so, how far could that go? Thank you.
I can give a compliment to my CFO, Abhijit, who has certainly made working capital a focus area. I'll let him speak to how much further we can improve.
Thank you, Frans. We had a fair amount of cash blocked in this. We've been working for the last couple of quarters to see a tangible improvement. You see that across the board. That's not only in inventories, but also in our receivables and overdue. We believe there's still some room to go. At this stage, I'm not specifically guiding how much, but clearly there is still some more improvement which is possible for the rest of the year. We are driving that hard every day.
Obviously a lot of that's been offset by decline in payables year-over-year. Is that just an accident of timing? Should we expect to increase that back again?
Yeah. The payables is directly a factor of what we are doing in terms of contracts that we have to pay. Partly, the lower payables is also due to the payment of the CRT fines as well as certain pension payments. These are not, let's say, current trade payables which are going down. In fact, our DPO, as we call it, days payable outstanding, is creeping up slightly to the levels which we want it to be.
Okay, great. Cash flow should be pretty good in the second half as well then, by the sounds of it. Thanks very much.
We had a pretty decent cash flow last year, and we are looking to build on that this year as well.
Thank you.
Thank you, Mr. van Houten and Mr. Bhattacharya. There are no further questions. Please continue.
Thank you, everybody. Let me give one elucidation because you may have noticed that there were fewer questions than usual. In fact, a couple of good attendees were not speaking up. That is a reflection of the fact that a number of the analysts that cover Philips have currently suspended their active coverage, as the institutions that they work for are involved in the preparation for a potential IPO. At least that is how I explain it, and time will tell exactly, of course. Thanks very much for attending, everybody. It was a pleasure, and have a great day.
This concludes the Royal Philips First Quarter 2016 Results Conference Call on Monday, the 25th of April, 2016. Thank you for participating. You may now disconnect.