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Koninklijke Philips Electronics NV (NYSE:PHG)

Market Update Conference Call

December 03, 2012 7:00 am ET

Executives

Abhijit Bhattacharya - Executive Vice President of Investor Relations

Emmanuel Delay - Group Controller

Gabriël van de Luitgaarden - Head of Financial Risk and Pension Management

Ron H. Wirahadiraksa - Chief Financial Officer, Executive Vice-President and Member of Board of Management

Analysts

Andreas P. Willi - JP Morgan Chase & Co, Research Division

Martin Wilkie - Deutsche Bank AG, Research Division

Gael de Bray - Societe Generale Cross Asset Research

Fabian Smeets - ING Groep N.V., Research Division

Aaron Ibbotson - Goldman Sachs Group Inc., Research Division

William Mackie - Berenberg Bank, Research Division

Robin van den Broek - ABN AMRO Bank N.V., Research Division

Operator

Welcome to the Royal Philips Electronics Conference Call Regarding Financial Reporting-Related Matters on Monday, the 3rd of December 2012. [Operator Instructions] Please note that this call will be recorded and is available via webcast on the website of Royal Philips Electronics. I will now hand the conference over to Mr. Abhijit Bhattacharya, Head of Investor Relations. Please go ahead, sir.

Abhijit Bhattacharya

Good afternoon, ladies and gentlemen. Welcome to this conference call where we will give you an update on matters related to financial reporting for Royal Philips Electronics.

From last year, the Lighting and Consumer Lifestyle Capital Markets Day are held on 1 day in September, and hence, we provide this update through this call in December. I would also like to clarify that our fourth quarter earnings announcement will take place on the 29th of January, which is a Tuesday. As such, we will not provide any detail or take any questions that relate to our performance during the fourth quarter of this year.

We are here with Philips CFO, Ron Wirahadiraksa; our Group Controller, Emmanuel Delay; and Gabriël van de Luitgaarden, who is the Head of Financial Risk and Pension Management. In a moment, Emmanuel will take you through his presentation. After that, both Emmanuel and Ron will be pleased to take your questions.

Our press release and accompanying information slide deck were published at 8 a.m. CET this morning. Both documents are now available for download from our Investor Relations website. We will also make available a full transcript of this conference call on the Investor Relations website by tomorrow morning at the latest.

This is our Safe Harbor statement, contains important information, request you to please go through it. And with that, let me hand the call over to Emmanuel.

Emmanuel Delay

Thank you, Abhijit. Good afternoon, and welcome to all of you. Let me quickly run you through the agenda of topics that we would like to address today. We'll start with informing you about reporting changes applicable to 2013. We will then give you an update on the review of intangible assets that we have performed. This will be followed by an update on pensions, where we will update you on the current estimates for this year and compare it to what we had indicated in our last Annual Report. We will also provide you with insight into the impact of the adoption of IAS 19, revised from January 1, 2013, on our statements of income. Finally, we will give you an update on restructuring cost in Q4 2012 before moving on to take your questions.

Let's start with the reporting changes, which will be effective from 2013. Let me start with IFRS 10, which has a new definition of control that determines which entities are consolidated. IFRS 10 replaces the part of IAS 27 consolidated and separate financial statements related to consolidated financial statements. It also replaces SIC 12 consolidation special purpose entities. The revised definitions of control focuses on the need to have the following combination of factors: power, exposure to variable returns and the ability to use such power over the industry to affect the amount of the investors' returns.

The new standard includes guidance and control with less than half of the voting rights de facto control, participating and protective voting rights and agent-principle relationships. This new standard will be applicable from January 1, 2013. We have assessed the impact of the adoption of this new standard and concluded that it does not have any impact on the current scope of our consolidation. In other words, if we have not identified entities that need to be consolidated under the new standard that are currently not consolidated and of the entities that are currently consolidated, we have not identified any that should no longer be consolidated.

Now let's move to IAS 19 revised related to employee benefits. As mentioned during the 2011 call on Financial Reporting Related Matters, the revisions to IAS 19, as published on June 16, 2011, are effective for annual periods beginning on or after January 1, 2013. I will comment on 2 basic changes of IAS 19 revised. First, it eliminated the option to use the so-called corridor approach, by which actuarial gains and losses or cost of plan changes could be deferred. This part of the amendment does not affect Philips, because we were already compliant as we did not apply the corridor approach.

Second, IAS 19 revised introduces significant changes to the recognition and measurement of defined benefit pension expenses and their presentation in the statements of income. As previously explained, these changes have a material impact on Philips EBITA and net income. This impact will be further explained today in Slide 12.

The next section on Slide 7 summarizes the results of our review of intangible assets. As per our policy, we continuously monitor for impairment triggers of intangible assets. Regarding goodwill, so far in this quarter, no goodwill impairment has been identified for the businesses in Healthcare, Consumer Lifestyle and Lighting.

With respect to other intangible assets, as part of the rationalization of the go-to-market model for Professional Lighting Solutions in North America, we will discontinue the use of several active brands, which will result in impairment charges of capitalized brand names of approximately EUR 16 million in Q4 2012.

Let's now move to a more in-depth discussion of pensions, starting on Slide 9. 2012 has been another year of low interest rates, which particularly affected pension plans. The first half of 2012 saw interest rates going up slightly, which had a positive impact on our pension plans. However, early in Q3, the interest rates moved down on the back of the concerns of sovereign debt solutions in the Eurozone and the fiscal cliff in the U.S. This negatively impacted some of our plans.

Cash outflow for pensions in 2012 is forecasted to be EUR 31 million lower than our expectations at the start of the year. This is mainly due to lower contributions in the U.S., following a funding relief related to the Moving Ahead for Progress in the 21st Century Act, also known as MAP-21. Pension cost for 2012 is in line with our expectations and forecasts, with the exception of a onetime pass service cost gain in Q2 of EUR 25 million, due to planned changes in the U.S. retiree medical plan.

We would like to mention that Philips has arranged a buyout transactions for the retirees of its Swiss pension plan, representing approximately EUR 250 million of liabilities. The buyout is expected to be completed before the end of the year. The plan assets were sufficient to fund the buyout, so there is no cash impact -- cash flow impact, I'm sorry. The settlement result in the P&L under IFRS is expected to be close to 0. This buyout is consistent with Philips' derisking strategy for pensions, as it reduces the exposure to pension liabilities, with no cash impact for Philips.

Next, let's move to Slide 10, where we show an overview of the balance sheet positions for pensions based on market data as of October. First of all, I would like to remind everyone that markets will continue to move until the end of December, and this of course, may have an impact on the reported finance -- final balance sheet numbers for 2012. The Netherlands plan, which is our biggest pension plan, benefited on the asset side from contracting spreads on government debt in the Eurozone and higher equity markets. This was partly offset by the unfavorable effects of a lower interest rates on the liability side. The net impact is a small improvement in the funded status of the Netherlands plan of approximately EUR 200 million. With regard to other major plans, we would like to note that the plan in the U.K. maintained a stable surplus, while lower discount rates negatively affected both the unfunded German plan and the deficit of the U.S. plan.

The current IFRS balance sheet position, as of October 2012, reflects these movements. The combined funded status of all plans was a stable net deficit of about EUR 1.1 billion. But as the improvement in the surplus in the Netherlands plan is not recognized, the net balance sheet position has deteriorated by approximately EUR 130 million.

We would also like to highlight that the funded status will improve by around EUR 200 million in Q1 2013, due to the exclusion of accrued pension administration cost from the defined benefit obligations as required by IAS 19 revised. This exclusion from the DBO will have a positive impact on the funded status. The net balance sheet position, however, will not be affected as this change only affects our plans in surplus, and such surplus is not recognized on the balance sheet.

Let's move now to pension cost and cash flow for 2012. Slide 11 shows the forecasted pension cost and cash flow for 2012. As a comparison, we have added the numbers we expected at the beginning of the year as disclosed in our 2011 Annual Report. In 2012, the pension cost is stable at EUR 135 million, excluding a EUR 25 million onetime pass service cost gain reported in the second quarter due to planned changes in the U.S. retiree medical plan. Pension cash outflow consists of contributions for defined benefit and defined contribution plans, as well as benefit payments for unfunded plans and healthcare claims in retiree medical plans. Please note that movements in financial markets have limited impact on the level of pension cash outflow during the year, because defined contributions and benefit payments are not linked to market movements, and defined benefit contributions are only moderately impacted by deficits at the start of the year. Contributions for deficits are generally smooth over a long period of time.

Pension cash flow for 2012 was positively affected by the extended funding relief in the U.S., which had a positive impact on cash flow of EUR 35 million compared to the expectations at the start of 2012. This year, the U.S. Government adopted the MAP-21 Act, under which the funding of deficits of retirement plans is extended into the future by using a 25-year smoothed regulatory discount curve. Effectively, this lowers the requirement for sponsoring companies to provide deficit funding in the coming years.

Let's move on to the outlook for pension cost and cash flow for 2013, as shown on Slide 12. The outlook for pension cost in 2013 shows the impact of IAS 19 revised, which becomes effective as of January 1. This impact was already discussed during our financial reporting update in December last year. At that time, the impact on EBITA was estimated at approximately EUR 260 million. The estimated impact is now EUR 25 million higher at EUR 283 million, due to lower discount rates.

In 2012, interest cost on the pension defined benefit obligations and the expected return on plan assets were part of the pension cost in EBITA. IAS 19 revised eliminated the credit for expected returns on plan assets and introduced the concept of net interest cost on the net defined liability, which Philips will report under financial income and expense from 2013. Under IAS 19 revised, service cost will continue to be recorded as pension cost in EBITA. The current estimate for net interest cost of EUR 86 million is marginally lower compared to our initial estimate of EUR 90 million, and this is entirely due to movements in discount rates.

Cash outflow for pensions in 2013 is estimated at EUR 580 million, which is approximately EUR 22 million lower than that of 2012. This is due to favorable changes in regulatory funding rules in the Netherlands and in the U.S. In the Netherlands, the introduction of the ultimate forward rate by the Dutch Central Bank has a positive impact on the regulatory funded status and the minimum required contributions. Please note that the numbers for 2013 will be finalized in January on the basis of a funded position and market levels as at the 31st of December 2012.

Let me now provide you with an update on the expected restructuring charges in Q4 2012, which is on Slide 14. As of November, our latest view for restructuring charges in Q4 2012 amounts to EUR 380 million, which is an increase of EUR 80 million compared to the guidance given in our Q3 2012 press release. Of this, the Lighting sector accounts for an increase of EUR 70 million. There are 2 main factors which cause an increase in the restructuring charges for Lighting, and they are as follows: Firstly, during our Q3 Results Conference Call, Frans van Houten, our CEO, had mentioned that we still had a lot of work to do in Philips Lighting North America and that the new management there is taking strong action. As part of those actions, we are integrating our commercial activities to enable a more focused go-to-market structure in Professional Lighting Solutions in North America.

Secondly, both Frans and Ron had mentioned that we need to improve our performance further in Consumer Luminaires, as our performance improvement was not yet in line with our plans. We're taking action to consolidate our warehouses and reduce overhead costs further for Consumer Luminaires in Europe, leading to an increase in the restructuring charges from what was earlier communicated. Then there is an increase in Healthcare of about EUR 10 million, which is due to an onerous contract liability related to the restructuring of certain activities.

Before we go to the Q&A session of this call, we would like to mention important publication and AGM dates in 2013. On the 29th of January, our fourth quarterly and annual results for the year 2012 will be published. Please note this is a Tuesday, since we normally publish our results on Monday. On the 25th of February, we will issue the Annual Report for 2012. On April 22nd, we will present the first quarter results for 2013. The Annual General Meeting of Shareholders will be held on May 3. On the 22nd of July, we will publish the second quarter and semiannual results. And finally, on the 21st of October, we will publish the third quarter results for 2013.

Let me now hand over the call back to Abhijit to moderate the Q&A session.

Abhijit Bhattacharya

Thanks, Emmanuel. The operator will now ask the questions to come in please.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Andreas Willi from JPMorgan.

Andreas P. Willi - JP Morgan Chase & Co, Research Division

The first question is on the discount rates used in your preliminary calculations for next year, if you could give us an indication of what you have used in the U.S., in the Netherlands, maybe in general, and how those compare to the -- and what reference rate you have used to determine those? And that will be the first question. And on the follow-up question, in terms of potentially providing funding, additional funding into the plan to reduce the deficit, is that something that's been reviewed as a measure, maybe also to improve earnings?

Emmanuel Delay

Okay. Since -- Andreas, since these questions are largely pension related, let me give the floor to Gabriel to take -- to give you the answer on that.

Gabriël van de Luitgaarden

Thank you, Abhijit. First of all on your question on discount rates, I can give you the discount rates that we've been using for this particular call, and for the Netherlands, that's a discount rate of 3.5%, for the U.S. discount rate [indiscernible]. On the second part of your question on funding and the relationship with earnings, under the old IAS 19 rules, increased funded status would have had an impact on our pensions through improved expected returns on plan assets. This is no longer the case under IAS 19 R. So additional funding that we provide for our plans has now [indiscernible].

Emmanuel Delay

Okay. Andreas, does that answer your question?

Andreas P. Willi - JP Morgan Chase & Co, Research Division

I could only understand a part of it. I missed the rate you used in the U.S. And also maybe you could give us what reference rate you have used in terms of, is that a local single A corporate rates seem to be even lower than that?

Gabriël van de Luitgaarden

Yes, using -- I can give you, again, the rates that we've been using so far. It's for the Netherlands, it's 3.5%, which is 0.4% down from December 31, 2011. The rate for the U.S. is 3.6%, which is 0.6% down from 31st December 2011. Our reference that we're using as a basis for this is coming from Towers Watson RATE:Link curves, and they are based on the universe of AA corporate bonds.

Operator

The next question comes from Martin Wilkie from Deutsche Bank.

Martin Wilkie - Deutsche Bank AG, Research Division

It's from Martin from Deutsche Bank. The first question was just on the EBITA impact to the pension cost. That EUR 283 million, should we expect that largely to be booked inside the innovation in group lying on the divisional income statement, or will that be allocated across Healthcare, Lighting, Consumer? If could you just give us some indication of where we see that step-up year-on-year? And the second question was just going back to the -- sorry, if you could do that one first, I'll come back with the pension question separately.

Abhijit Bhattacharya

Martin, this is Abhijit. Regarding the allocation, it's a bit complex because some of the cost that fits in IG&S also gets allocated to sectors through the DSUs, as well as through corporate charges that go. But directionally, the largest part of the charge will be in Healthcare, and then IG&S and then Lighting and then CL. So this is kind of the ranking, but to give precise figures at this time is a bit difficult.

Martin Wilkie - Deutsche Bank AG, Research Division

Okay, okay, so that's the order for...

Abhijit Bhattacharya

Yes.

Martin Wilkie - Deutsche Bank AG, Research Division

I'm sorry. Just coming back on my second question. It was more on the restructuring. You've also given an increased number for Q4. I mean is there any indication at this stage as to what we should expect in 2013 for the charges are not part of Accelerate! and some of these other restructuring charges for Lighting and so forth for next year?

Emmanuel Delay

I think for the non-accelerated Accelerate!-related charges, it's largely Lighting. As you just mentioned, it's to do with the industrial footprint rationalization. And there, we had given guidance in the Capital Markets Day in September, which will, I think, be between 1.6% and 1.9% on an average, between 2011 to 2014 with the peak this year of 3.5%. We are a bit above that because of certain additional actions we have taken. But I think the 1.6% to 1.9% average for the full year period is still a valid guidance on that.

Martin Wilkie - Deutsche Bank AG, Research Division

So this increased charge in Q4 shouldn't necessarily change our thinking about what would come in 2013 is sort of a -- it's not a bringing forward or anything like that?

Abhijit Bhattacharya

No, not a big move there. Because if you look at this year, and that is the bit of uncertainty around restructuring charges, if you look at the guidance we give every quarter and then the amounts that have been booked, you will find that we've been short because it depends on how the discussions with all the stakeholders go. And then you -- a lot of them kind of got pushed forward towards the end of the year. So if you look on the overall, it's a bit of an increase for the year, but not a very big number.

Operator

The next question comes from Gael de Bray from Société Générale.

Gael de Bray - Societe Generale Cross Asset Research

Could you tell us what to expect in terms of cash outflows relating to -- related to the restructuring actions you've taken so far? So I guess I'd like to know the numbers for this year and for next year as well. And the second question is, is there any remaining impact related to the Television transaction with TPV that we should be aware of for maybe Q4 or next year?

Ron H. Wirahadiraksa

This is Ron, thanks for the question. Usually, restructuring charges take 6 to 9 months to materialize. It depends a little bit on the success we're having with the various regulatory bodies, various councils, unions and what have you. But this is a good -- this is kind of a good rule of thumb, I would say. Of course, if you're looking for a number over the quarter, probably it's more, let's say, second-half weighted if you will look at the overall average that we have communicated on restructuring charges for Q4. And of course, we still have some running from charges we took earlier in the year. Your other...

Gael de Bray - Societe Generale Cross Asset Research

Was on the TPV.

Ron H. Wirahadiraksa

Yes, so on TPV impact, well, the Q3 results was such that the overall value of the equity stake was 0. But we did not guide further for the developments of TPV or any other thing developing over this quarter.

Operator

The next question comes from Fabian Smeets from ING Bank.

Fabian Smeets - ING Groep N.V., Research Division

Also for me, a question related to TPV. I think we saw some statements today that they are breakeven for 2012. I was wondering, could you again remind us where in the P&L you will report the royalty flows from the joint venture?

Abhijit Bhattacharya

Fabien, this is Abhijit. The royalty flows will be part of IG&S. So we have a line under IG&S, which talks about IP royalty income. And you will see that in that line from next year starting from Q2, because we receive royalty 1 year after the commencement of the JV.

Operator

The next question comes from Aaron Ibbotson from Goldman Sachs.

Aaron Ibbotson - Goldman Sachs Group Inc., Research Division

Two quick questions, if I may, one, which I doubt that you will answer. But have you identified any cost savings in related to this increased restructuring in Lighting? Or should we expect that, that sort of follows normal relationship between restructuring charges and savings? This is part from the write-down. And then I was just curious on this buyout of the retirees in your Swiss pension fund at no cash cost. Is there any further opportunity? Do you see the potential to do that somewhere else in your pension liability book? And how does it look, for instance, in the U.K.?

Abhijit Bhattacharya

Okay, let me take your first question first. Most of the Lighting restructuring in Q4 is related to industrial restructuring, so it doesn't really change the EUR 1.1 billion number. There is always a little bit, which moves from 1 quarter to the other, but the EUR 1.1 billion number stays as is.

Ron H. Wirahadiraksa

I think the question -- sorry to interrupt you, Abhijit. I think the question was on the savings, right?

Aaron Ibbotson - Goldman Sachs Group Inc., Research Division

Yes.

Ron H. Wirahadiraksa

So we had communicated at the Capital Markets Day was about EUR 165 million of savings pertaining to the Lighting industrial footprint restructuring. So the additional charges we took now are not so much related to industrial footprint. It's more related to overhead reduction, warehouse consolidation and other areas that we are restructuring in the PLS in North America.

Aaron Ibbotson - Goldman Sachs Group Inc., Research Division

But -- sorry to interrupt. But that sounds to me that, that would result in some savings as well. I mean it's not write-downs, so these are cash charges?

Abhijit Bhattacharya

Yes, part of it is write-down, so we've disclosed earlier the EUR 16 million planned write-down. There are some inventory write-downs related to the correction of the brand. And you will get, maybe some more savings in the industrial footprint, but it's not a very major amount different from the overall EUR 165 million that Ron just mentioned.

Ron H. Wirahadiraksa

On your question...

Operator

Next question comes from William Mackie from Berenberg Bank.

Ron H. Wirahadiraksa

Sorry, excuse me. There was still another outstanding question we hadn't answered. So go ahead, Gabriël.

Gabriël van de Luitgaarden

Yes, thank you, Ron. On your question regarding buyouts and future buyout opportunities for other plans, I can only give you a general response to the sense that buyouts are just one of the tools that we use for derisking our pensions. If the price is right and a plan has substantial assets to fund a buyout, we continuously look at those buyout opportunities. But there may be also other tools to achieve the same goal, such as buy-ins and other ways of derisking ourselves. But we continue to look at buyout opportunities also in the U.K.

Abhijit Bhattacharya

Okay. Let's move to the next question from Will.

William Mackie - Berenberg Bank, Research Division

It relates to the restructuring charge, the additional restructuring charge that you've announced today. To what extent should we now see that you've captured within the provisions you're taking, all of the work to be done in North America or in PLS and within European CL, or will some of these additional efforts and actions spill into 2013 as well?

Ron H. Wirahadiraksa

Well, I think the way we have approached this is do a very rigorous job in looking at PLS and Consumer Luminaires and some related charges. This is part of an extended scope, certainly in Consumer Luminaires, where we already were working on improvement. I can assure that in PLS, it was on the results of quite rigorous study we did. Of course, should other measures prevail, that could lead to some more restructuring. But right now, this is the scope that we have in the plan, and we think it's the right plan to have.

Operator

The next question comes from Robin van den Broek from ABN AMRO.

Robin van den Broek - ABN AMRO Bank N.V., Research Division

In doing your IAS 19 assessment, I was wondering if you have changed any other assumptions compared to end of last year?

Abhijit Bhattacharya

Okay, let me give that question to Gabriël.

Gabriël van de Luitgaarden

No, we haven't changed any assumptions, no.

Abhijit Bhattacharya

So these changes are the changes in the interest rates as Gabriel mentioned earlier.

Operator

This is the last question, and it's a follow-up question from Aaron Ibbotson.

Aaron Ibbotson - Goldman Sachs Group Inc., Research Division

I'm really sorry, I'm not sure if I'm allowed to ask a follow-up, but I'll try. It was actually one on the pension, and that was on the gross liabilities. I'm not sure if you have given that. But if you have the net balance sheet liability, but I was just wondering if you can update us on what the gross liabilities were, for that matter, assets have done this year?

Abhijit Bhattacharya

Okay, let me give that to Gabriël then.

Gabriël van de Luitgaarden

Thank you, Abhijit. The gross liabilities at the end of 2011 is -- it was EUR 22.4 billion; end of October, EUR 23.8 billion.

Operator

Thank you. Mr. Wirahadiraksa and Mr. Delay, there are no further questions. Please continue.

Emmanuel Delay

All right. Well, thank you very much for being on this call. We hope this was insightful for you. Thank you for asking the questions, and we look forward to seeing you at our next event.

Operator

This concludes the Royal Philips Electronics Conference Call Regarding Financial Reporting-Related Matters on Monday, the 3rd of December 2012. Thank you for participating. You may now disconnect.

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