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Koninklijke Philips Electronics (NYSE:PHG)

Q4 2006 Earnings Call

January 22, 2007 3:15 am ET

Executives:

Pierre-Jean Sivignon, Chief Financial Officer, Executive Vice President

Analysts:

Nicolas Gaudois, Deutsche Bank

Ben Adler, Morgan Stanley

Jonathan Crossfield, Merrill Lynch

Simon Schafer, Goldman Sachs

Didier Scemama, ABN AMRO

Jonathan Dutton, UBS

Sean Murphy, Nomura

Andreas Willi, JP Morgan

Luc Mouzon, BNP Paribas

Antoine Badel, Credit Suisse

(Alabomnay Asalo?), Lehman Brothers

Francois Meunier, Cazenove

Thomas Brenier, Societe Generale

Jan-Willem Berghuis, Kempen & Co

Niels de Zwart, Rabo Securities

Presentation

Operator

Thank you for holding, ladies and gentlemen, and welcome to the Royal Philips Electronics Q4 results 2006 call on Monday 22nd January, 2007. Operator instructions. I will now hand the conference over to Pierre-Jean Sivignon. Please go ahead, sir.

Pierre-Jean Sivignon, Chief Financial Officer, Executive Vice President

Ladies and gentlemen, let me first welcome you to this conference call for the Q4 results of 2006 for Royal Philips Electronics. I will make a few introductory remarks and then together with Gerard Kleisterlee, who is with me, we will open up the call for your questions.

The completion of Q4 allows us to look at our achievements against the targets we set for ourselves. The main conclusions we can draw are the following. We successfully achieved our average annual comparable sales growth target with 6%. We achieved our annual growth target in Medical, Lighting and DAP (Domestic Appliances and Personal Care) and CE (Consumer Electronics) was 5%. We are achieving our margin target in Medical. We did achieve our margin target in DAP. The underlying Lighting results in the quarter were higher than last year and we virtually achieved our annual margin target.

We are very pleased with Consumer Electronics being within a whisker of achieving its margin target in what was a very difficult year. We have almost completed the cleaning up of the activities in corporate investments and we are well set to achieve our 2007 EBITDA target of above 7.5%. As a consequence of all this and the increasingly changing nature of the company, we are substantially increasing our dividend from €0.44 per share to €0.60 per share.

Q4 was another successful step towards becoming a more profitable, higher growth company. Let me be more specific: the comparable growth for the company was 2% with most divisions achieving their targets. In fact, medical was up 7%. DAP was up 13% and Lighting up 7%. Those are our higher margin divisions. This means that we are growing in the right areas. This growth level supports our average annual target of 5-6%.

Consumer Electronics declined by 4% but grew in the areas of connected displays and peripheral accessories. The EBIT in the quarter was €665 million, or 8.2% of sales. EBITDA was 9.1% of sales and on a recurring basis was 1% of sales higher than one year ago. In Medical Systems, the comparable growth was 7%, which gives a growth of 7% for the whole year.

Equipment order intake, excluding the Belfast order as well as some cleaning up of the order book was practically flat in the quarter and achieved a 6% growth for the year. The margin in the quarter compared to one year ago increased in both absolute terms and percentage, as we had forecast. The record underlying performance is mainly due to all improvement actions that were set in motion some time ago.

In DAP, the excellent quarter has given us a 13% comparable growth which again more than supports our target of 7%. Very strong growth came in all product groups, and specifically in all health care and domestic appliances. Avent’s profitability was higher than expected due to some early action that we took. The underlying development of the margin was strong and allowed us to reach 16% EBIT margin for the year excluding CHS (Consumer Healthcare Solutions) was at the top end of our target range. In fact, the DAP annual EBIT was an all time record.

During the quarter, we did make substantial investments in advertising and publicity, which should benefit the growth beyond Q4.

Sales in CE on a comparable basis declined by 4%. However there was continuing growth in connected displays and peripheral and accessories. The margin in the quarter was 7.9% at CE which gives an annual EBIT of 3.9%, which is an excellent performance in a difficult year. We are expecting to achieve our EBITDA target for 2007 but expect the year to have a difficult start.

The Lighting sales growth was 7%, driven by Lumiled specifically and lamps as well. Lumiled growth was higher than the predicted 25%. The Lighting margin in virtually all product groups was strong. The exception was backlighting solutions where there was an inventory write down and a lower than expected ramp up. The main thing to say about other activities is that the cleaning up process is virtually complete, with few activities still to be disposed of.

As we mentioned at the end of 2005, we expect to complete these processes by the middle of 2007. In unallocated, we continued to add costs to become SOX compliant, but these costs will be substantially lower in 2007. Also in the quarter, there were substantial investments in the brand campaign, as we had broadcasted. I draw your attention to two charges in financial income and expenses, totaling €125 million for the impairment of our TPO shares and marking to market the TPV shares.

The net cash in the quarter was €2.2 billion compared to €3.4 billion at the end of Q3. This change was due to the payment of €993 million for Intermagnetics and €1.590 billion for the buyback program. During this quarter, the continued implementation of the share buyback program reduced the share count by 51.2 million shares. The result of this is a much lower level of issued shares which is now 1,142,800,000, out of which 35.9 million are held in the treasury to ensure no dilution from the option program.

The inventory percentage of 10.7% is 20bps lower than one year ago, including a reduction for lighting. We consider this an excellent performance for the whole company. There are still one or two areas where the inventory to sales ratio can be improved and we are continuing to work on this. The results from non-consolidated companies reflect the lower results of LG Philips LCD, where we anticipated that and again on the sale of the FEI shares.

This segment of our results has been substantially cleaned up and will be virtually only LG Philips in the coming quarters. We are very pleased to announce that we will propose to our shareholders to increase the dividend from €0.44 per share to €0.60. This increase reflects the fact that we are now becoming a higher margin, more predictable company and it is our intention to increase the dividend further in the future. With that I will now open the call for your questions.

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Questions-and-Answer Session

Operator

Operator instructions. The first question comes from Nicolas Gaudois from Deutsche Bank.

Q - Nicolas Gaudois, Deutsche Bank

First question would be on Consumer Electronics. Could you give us some idea of what licensing revenues were in the quarter and what is your view for 2007, whether we should expect to maybe regain momentum with potentially [Bruarie?] coming through, or essentially a more flattish environment?

A - Pierre-Jean Sivignon

I think, Nicolas, as we said in November, looking forward we would like to stop giving that split. First of all, I think it’s less and less relevant. I think we would like to guide, looking forward in an EBITDA manner, for that objective of 3% that we have given to ourselves. The short answer is the amount is not very substantially different from what it was last year, but I think we would like pretty much to go away from that and really group and consider CE as one package for next year.

Q - Nicolas Gaudois, Deutsche Bank

Fair enough. Could you maybe comment a big on the backlog adjustments you say in Medical, whether this was basically you know, one specific project or more widespread? If it was more widespread, maybe give us some color in terms of the regions and the type of modalities concerned. Thank you.

A - Pierre-Jean Sivignon

As far as the backlog, you are referring to the specific backlog adjustments of Medical?

Q - Nicolas Gaudois, Deutsche Bank

Correct – why you had flat orders net versus up 6% YoverY.

A - Pierre-Jean Sivignon

The backlog – we have two things there. One was indeed the fact that you remember that last year in Q4 we had a very strong push coming from the Belfast order and that’s why we eliminated that in comparables. Then we had in Q4 a little bit of a clean up of the portfolio, but that was less than – I would say it was about a percent impact. All in, when you actually include all of that incoming orders were slightly positive for the quarter like for like, comparing Q406 to Q405. That adjustment was, I would say, small.

Q - Nicolas Gaudois, Deutsche Bank

Okay, but if I remember well last year you excluded from your order comparisons this large NHS 10-year order, so I’m struggling to see how this is impacting you having slightly positive or flat net comparisons for orders.

A - Pierre-Jean Sivignon

We can take the specific numbers offline, Nicolas, but if you indeed exclude the Belfast order from last year, and if you take your order like for like, correcting for currency for this year, you will find that we are a touch up in reality YoverY for Q4 and up 6% for the year incoming orders like for like again correcting for currency for medical.

Operator

The next question comes from Mr Ben Adler from Morgan Stanley.

Q – Ben Adler, Morgan Stanley

A couple of questions. I guess the first one is just on the Medical business – in the last sort of six months, we’ve seen some very sizeable transactions go through medical. Siemens buying Bayer Diagnostics and GE buying Abbott Laboratories last week. You haven’t participated in these transactions in in-vitro diagnostics. I guess my question there is are you passing up on these opportunities because you’re not interested in in-vitro diagnostics, or is it because the prices being paid are too full for Philips at the moment?

A - Pierre-Jean Sivignon

Well I think a couple of comments. I think you will find that this industry is still heavily fragmented so it’s hard to reach conclusions on what’s going to happen. It is fragmented which means that there are still some decisions to be made and still some opportunities remaining. Now to the second part of your question which is whether it’s too rich for Philips at the moment. I would say we’ve always been very clear in the past and we’ve illustrated that with our acquisition. We have a disciplined approach to acquisitions and when the price isn’t right, when we can’t see the value for shareholders we are absolutely capable of staying away from those projects. I think I won’t comment on the particular transaction that GE just did and you are referring to, but certainly if we don’t feel the numbers work we will stay away from it.

Q – Ben Adler, Morgan Stanley

A follow up – obviously the fact that you haven’t done a major acquisition does improve your cash pile and your fire power in 2007. Could you just give us a sense if you continue not to find a decent acquisition or something that fits your criteria in medical and given the possibility of raising funds through the TSMC stake, or indeed LG Philips later in the year, would you be willing to consider a further increase in this €1.6 billion remaining share price buyback amount?

A - Pierre-Jean Sivignon

I think before we say we haven’t made any major acquisitions in Medical, I would like to temper that a little bit. I think in 2006 we actually announced or closed seven acquisitions. If you look back at the last 18 months we have actually reallocated the two acquisitions north of €4 billion and in that particular group there were four acquisitions which related to Medical or Healthcare. The fact we haven’t done a very large one – whatever that might mean - I just want to make sure that we keep in mind that we’ve gone the long way in the last 18 months down that path. Looking forward in terms of immediate cash outflow, we will indeed have the remaining of the €4 billion that we announced on the back of the semi transaction, and that is going to take place in the coming weeks. We have to also pay our dividends and pay for the recently announced acquisition which is called Partners in Lighting which we announced a couple of weeks ago and which will close in the early part of the year. This will use some of our cash. If I push it forward, if we were to have some additional capital to reallocate, it’s nothing new. We will use our three avenues, which you know well; which are acquisitions in Medical or else by the way, in buyback and in dividends. I think there’s nothing new there, that’s exactly what we’ve been doing for the last couple of years.

Operator

The next question comes from Jonathan Crossfield, Merrill Lynch.

Q - Jonathan Crossfield, Merrill Lynch

I had a question on the Lighting division where there seems to be some issues around the backlighting application. Can you talk about what the size of the opportunity is and when you expect it to ramp?

A - Pierre-Jean Sivignon

I think the size of the opportunity is a bit hard to read at the moment. It’s a new technology. I think decisions are being made by manufacturers so I think it’s a little bit hard. It’s one of the technologies which are new in Lighting. The other one as you know is LED. High end LCD is actually going if anything probably faster than we thought. We mentioned to you that Lumiled is actually growing faster than the 25% guidance we had given to you. LCD is probably a bit hard to read at the moment. As far as the particular quarter is concerned we had – and we disclosed it – an adjustment on the inventory and we are probably right now facing a slower ramp up than what we had initially anticipated. Don’t change the fundamentals of Lighting, but that is what I can tell you today on LCD.

Q - Jonathan Crossfield, Merrill Lynch

Just a quick follow up on Medical, your flat orders – can you comment at all about regional variations there? Were there any stronger or weaker areas?

A - Pierre-Jean Sivignon

What I can say, yes, I think in substance, if you remember historically this year we certainly had a strong history of strong growth in Asia. I would say that this year Asia was in the fourth quarter a bit lighter, but still making Asia grow strongly on the back of the first three quarters. I think the US did well in Q4 and maybe were a touch lighter in Europe. That would be in essence, I would say the temperature of the orders of Medical in Q4.

Operator

The next question comes from Simon Schafer, Goldman Sachs.

Q - Simon Schafer, Goldman Sachs

Thank you and good morning. I actually had a follow up question. I think you commented that Avent maybe was doing a little bit better than you expected. Can you elaborate on that a little bit, and is there anything else with reference to Lifeline that you can update on? I think you communicated the CHS segment was a little bit better than you thought?

A - Pierre-Jean Sivignon

I think on Avent it’s always a bit difficult to give numbers, because I mean we are talking weeks – barely months ever since we had Avent. I think you came up and when we talk to shareholders it certainly is relevant as well. You want an update on those acquisitions and that’s what we’re doing. That’s why very early in the game we are telling you that Avent did better and better means better than what we have given ourselves as an objective when we acquired Avent. Better means better profitability in that particular case. We’ll continue to update you on Avent. It’s more a relative signal that we are actually ahead of the objective we had given to ourselves. On Lifeline, I think we’ve been somewhat explicit in the press release. Lifeline is making progress and is also exceeding its numbers in terms of revenue. The number of people subscribing to Lifeline has continued to increase in Q4 and we made some progress there as well compared to the objective that we have given to ourselves. I think these particular two are going better than what we had anticipated and we will continue to update you on that. Your last question was related to consumer healthcare solutions. This is a group as you know which will be taken out of that and reclassed into our emerging new category as early as Q1 2007 and we’ll update you on that and in that particular one we are investing in order to create some businesses around Lifeline. I think there’s nothing there to report in particular. We are growing in that territory in both new products as well as potential acquisitions.

Q - Simon Schafer, Goldman Sachs

Understood. Maybe as a basic financial follow up question, on the tax rates – unusually low this quarter. Is there any change to your long-term operating targets for taxation then?

A - Pierre-Jean Sivignon

Yes. That is an excellent and important question. You will have seen basically a little bit of action in our tax line in Q4. I think you can talk to Alan offline to get more detail. The essence is three things are taking place. One being the impact of the lower statutory rate in the Netherlands, which of course is having an impact on our deferred tax assets. That’s one. We had a couple of negotiations that completed as well in Q4 with a couple of tax authorities. Thirdly there were some tax entries related to the second tranche of the booking of the results on the semiconductor transaction. Those three elements created a little bit of noise on that line for Q4 and it was a very low – on the look of it – effective tax rate. Looking forward, we had guided you in 2006 on something north of 30%. I think we had said 31-32%. In 2007, I would want to say probably between 25-30%. We will have to fine-tune it. We will get more precise later down the year, but between 25% and 30% is a good number. Definitely below 30% 2007 onward.

Operator

The next question comes from Didier Scemama from ABN Amro.

Q - Didier Scemama, ABN AMRO

I just wanted to ask you a couple of questions starting with the other activities. We did have an improvement, as you wind down the corporate investment line. I was just wondering – I mean, I know you’re changing accounting and you’re going to move some parts in here, but essentially for the equivalent line in 2007, what would be your best guess in terms of loss.

A - Pierre-Jean Sivignon

Well I think we guided you – it’s hard. Two things, Didier. First, I suggest you go back to the rather exhaustive presentation we made back in November. I think we took you down to the great details on what are the moving parts in and out of that category, which you know not only is changing but on top of that is being rechristened. That’s one. If you need more details, I would prefer to take that offline because it’s quite I would say specific, and I would say again most of the elements are in that presentation and in the slide attached to it. In terms of guidance for next year, which as I said again will be rechristened as you remember, other will now be called a different name, but the guidance we gave to you was €80 million for the year and if you look at the press release, I think we went as far as telling you that that €80 million will be more skewed to the early part of the year, so then you can more or less do kind of a tuning which will be progressive from Q1 to Q4.

Q - Didier Scemama, ABN AMRO

Can you comment on the reasons why the debt margins were really lower this quarter when it’s traditionally your best quarter?

A - Pierre-Jean Sivignon

Let me first react on the numbers for the year. 15.9, that’s actually very strong. We’ve always been extremely clear on the model of DAP – we’ve always said 15-16% and there is a reason for that. I would say Q4 is exactly the illustration of why we have to stick to our model. We basically invested in advertising and brand. You could say why? Well the answer is look at the growth. I think the growth on the year was 11%. The growth on the quarter was 13%. The guidance for next year is 7%. All that with a profitability of 15-16%, so I think, Didier, the trick there is I don’t think it’s a bad quarter. I think it’s a quarter where we are using absolutely our model. It’s very tempting to push it up. Now don’t forget another part of the element which is CHS. You know, when we comment on DAP on the face of things, until Q4, we have CHS which is part of the DAP numbers. If you go to the nitty gritty of the release, you have all the elements to exclude CHS. We’ve given you the numbers there and basically if you do your exact maths, DAP for the year excluding CHS is actually 16%. We are at the very high end of that EBIT guidance we have given to you.

Q - Didier Scemama, ABN AMRO

Final one. I mean, you’ve got about €10 billion shy of cash you know, locked in with TSM and LTM and so on. In addition to that, you probably have got enough room to add some debt, so your fire power is going to be probably in the region of €15 billion or more. Given that the additional buy backs may be limited going forward, and that you’ve already announced your intention to maybe not go after very expensive acquisitions, I mean, what are you going to do with all that money essentially on the balance sheet?

A - Pierre-Jean Sivignon

Okay. You talk about 10-15 looking forward. If you again look back at what we’ve done in the last 18 months, we have reallocated slightly shy of €10 billion between acquisition and buyback. Those numbers can go as you’ve seen in the last 18 months pretty fast. I think in terms of buyback, we have launched the last tranche which is part of the €4 billion. That tranche is specific because we are still trying to be absolutely tax efficient. We don’t know what will be the capacity of that vehicle. We are testing it and we’ve made a very detailed press release a couple of weeks ago giving you the details of how this will function and we’ll update the market of course on the progress we make there. So the capacity using that vehicle, if we were to decide to do more share buyback, the capacity on that vehicle is a question mark. As far as dividends are concerned, which is a second avenue, I think there we’ve said that it was in principle a more expensive avenue in terms of tax cuts. At the same time, I think we’ve made a very large move on the proposal we’ll make to our shareholders. I think €0.60, that’s a big sign. I’ll let you calculate the results and you will find that there is a coherence with the kind of stock we want to become now and with the whole history of the last couple of years in terms of portfolio management and lastly, as far as acquisitions are concerned, I think we are capable of making moves. We’ve been explicit on the strategy directions we want to go in and we will be continuing to watch and obviously do it if that makes sense. I think I can’t be much more explicit, Didier.

Operator

The next question comes from Jonathan Dutton from UBS.

Q – Jonathan Dutton, UBS

Thanks very much. Just a couple of questions from me. I wondered if you could give us an update on Medquest and also the outlook for Medquest in 2007. Secondly on the LCD TV front, when do you think the current inventories will be normalized? Also, whether we might expect some slightly disappointing lighting margins with continued inventories on backlighting in Q1 of this year?

A - Pierre-Jean Sivignon

I think on Medquest there is not much to say at this point. We’re working hard to make the accounts current, so we are still making progress there and still working on that. On the numbers, basically I think close to break even, so nothing specific to report to you there in terms of the activities. Your second question was on the LCD backlighting – I think the only thing I can say is that we have no – I guess your question relates to lighting then, correct?

Q – Jonathan Dutton, UBS

Yes.

A - Pierre-Jean Sivignon

We have no inventory exposure there on 2007 moving forward, so I think we’ve taken care of our inventory exposure in Q4. I missed what was your last question?

Q – Jonathan Dutton, UBS

That question encompassed it, but I wondered if I might add one follow up question. In terms of the medical order intake, which was flat YoverY, I just wondered if you could give us a bit of color on that, whether there was any split between services and equipment orders during the quarter?

A - Pierre-Jean Sivignon

As you know, that’s where are a bit different from some of our competitors. We’ve always been very clear. We only comment on the up portion, which is hardware, so the numbers we’re giving to you – that 6% growth for the year and flattish up for the quarter – corrected for currency, this is strictly for the hardware/informatics backlog. I think those are the numbers. We don’t give any more numbers. The comment by region, I think I answered it in an earlier question.

Operator

The next question comes from Sean Murphy, Nomura.

Q - Sean Murphy, Nomura

It’s a question on lighting. There’s a comment in detail that the sales growth in lumineres appears much higher than the sales growth in lamps. I’m wondering what more detail on this is, what’s going on in this market.

A - Pierre-Jean Sivignon

I think in Lighting, both lamps and lumineres went well in Q4 and if anything had a good year. I wouldn’t draw any particular conclusions there. I think that the important things on lumineres – and maybe I should dwell on that – the important things on luminere is the fact that with the acquisition of Partners in Lighting which is the Belgian company which is as you know very much present in the domain of consumer luminere, it is certainly a particular domain in which we would focus more, both in terms of disclosure and in terms of related weight in your complete portfolio of lighting in the quarter to come. Besides that, I would say both lamps and lumineres did well in Q4.

Operator

The next question comes from Andreas Willi, JP Morgan.

Q - Andreas Willi, JP Morgan

Good morning – my question is on cash flow. You mentioned in the press release that you had some reclassifications there, but overall the cash flow in Q4 looks weaker than I had expected. If you maybe could go a bit in detail on that and what you expect in Q1 and going forward?

A - Pierre-Jean Sivignon

Okay. I think on cash flow it is true that our cash flow is a bit difficult to read. Essentially for two reasons – we had one reclassification which was on the back of the semiconductor transactions. I think if you basically take it offline with Alan, Alan will guide you there because I hate to be too specific on the phone. I would say in essence there were two elements which need to be disclosed on the phone right now. One was a reclass which was related to semiconductors taking some of the inflow from our operating cash flow this quarter and reclassifying to actually discontinued operation. The other element was an increase of working capital which was I would say on the back of one or growth and B, our prepaid balances in our balance sheet. I would say all in all if you correct for those two elements our operating cash flow for the year and for the quarter was I would say pretty much in line with what you were expecting and what we had guided you on. Looking forward, I think the profile of our cash flow with the new perimeter should be in line corrected of incidentals and corrected of the semiconductor reclass which had impacted us in 2006, which would be pretty much in line with what we’ve seen in 2006.

Q - Andreas Willi, JP Morgan

A quick follow up question on the regional growth – you touched on that in a few previous comments, but I was surprised to see much weaker growth in developing countries than in developed countries, particularly Asia down 10%, Latin America only 1% growth. Maybe you could give us some more details there on whether that has prompted you to look also at your emerging market strategy, or it’s just a weak quarter.

A - Pierre-Jean Sivignon

I think the situation is a bit blurred by Consumer Electronics. I think if you were to see the numbers with the three other product divisions consolidated you would see that the picture is quite different. Let me take one example, which would be domestic appliances. Domestic appliances on the back of its 13% growth in Q4 grew in every single region. Just to give you an idea, Medical as well had a strong growth in Q4 so I would say this perception of a slower all-in Asia growth in Q4 was essentially on the back of Consumer Electronics.

Operator

The next question is from Luc Mouzon, BNP Paribas.

Q - Luc Mouzon, BNP Paribas

Just to come back on your comments about the difficult start in full year 2007 in Consumer Electronics, I just wanted to get a bit more flavor right here. Do you stick with your 3% EBITDA guidance for the full year, and is there any opportunity or any action that you would be implementing in the first half to guarantee or get some kind of risk pulled down a bit on that case?

A - Pierre-Jean Sivignon

I think on CE, as you know, CE is obviously as perceived by you always the riskiest part of the portfolio. If you remember before we talk about 2007, a word on 2006: I think you remember if you look at CE backwards, we had a year where the tough quarter was actually Q2 and that’s when we told you we’d be slightly shy of 4%, which was our guidance, but we told you at the same time the action on CE is really taking place in Q4. If you look back at 2006, that’s exactly what has happened. We’ve just closed 2006 for you. We ended up with a strong Q4 and actually made 3.9% which is I think indeed slightly shy of the 4% we had guided you on. Looking forward, 2007 is the same kind of situation. When you enter the year you always do with a bit of anxiety but our model is there and we count on it to confirm the guidance of 3% EBITDA and we explained to you how those two things are linked. To be even more specific on the beginning of the year, the specific actions we have to do, I would say one would be to basically take care of the phone transaction. I think that is something that we need to address. That’s a very important element. We announced that we were working on it. We said in the press release that we can’t announced that the deal is closed but we are working on it and it’s important to close that transaction for our numbers. I think the other thing which is crucial is certainly absolute discipline with our model and our inventory in particular in the domain of connective displays. We did well there in Q4. The pressure will be certainly there as usual at the beginning of the year in Q1 on the back of the selling seasons, and I think it will all be about model and discipline in Q1.

Q - Luc Mouzon, BNP Paribas

Just a brief follow up, could you guide us for the capex for the group in full year 2007, and would you expect the free cash from operations to be higher in 2007 than in 2006, basically?

A - Pierre-Jean Sivignon

Capex, I think we had said in earlier conversations 650. I think we would like to stand by that number. In terms of free cash flow, I think the free cash flow should be a touch stronger, basically, in 2007 versus 2006 on the back of obviously this extra profitability that we need to deliver to you in order to make the 7.5% EBITDA.

Operator

The next question comes from Antoine Badel, Credit Suisse.

Q - Antoine Badel, Credit Suisse

Good morning. Where do you see opportunities for further value creation in the next year or two? Because your divisions are now executing very well, you’re nearing the end of your divestiture program, you’ve got a buyback, you’ve upped the dividend. What more should investors look forward to?

A - Pierre-Jean Sivignon

Well I think it’s not a static gain. I mean, before I talk about cash reallocation, let’s talk about first the existing businesses. First, if I talk about revenue I mean if you indeed grow a portfolio which has a kind of profitability we have guided you on and if that actually grows at 5–6% which is our guidance, you would see that you absolutely right there create value. The second element is in terms of EBIT margin. I think we’ve guided you at least for medical, even though medical has progressed between one and two full points in 2006 as we had promised to you. We’ve guided you basically on a continued improvement of Medical in 2007 versus 2006. I would say the second elements of the answer is continued improvement at basically Medical. The third element is the mix. Obviously we are guiding you on growth at three of the divisions. We’re not guiding you on growth at CE. CE grew at 5% in 2006 but you saw that the overall number was 6%, which means that the stronger growth division grew faster than CE. That’s another element of value creation and last week you had the acquisition. We’ve acquired – we’ve announced or acquired seven businesses in 2006 and we certainly expect that those particular businesses will deliver some value. Finally, I will say a word about cost control. We’ve announced that we would obviously cut our expenses to the tune of €75 million basically on the full year basis at corporate and geography and we expect that to deliver value as well.

Operator

Your next question comes from (Alabomnay Asalo?) from Lehman Brothers.

Q – (Alabomnay Asalo?), Lehman Brothers

I just have a quick question on inflation – sort of a macro level question. Your guidance for 2007 in DAP in particular, with concerns rising around the world regarding inflation in some of the developed countries, how has this been factored into your guidance for 2007, particularly in DAP and maybe on Consumer Electronics as well?

A - Pierre-Jean Sivignon

I think it’s hard for me to comment on inflation. You know, because this question in the world right now is quite hybrid, and if anything right now the trend in a number of countries on the back of lower energy prices and the utilities price and commodities price, if anything they seem to be a bit of a cool down, so it’s hard for me to comment on you and you are probably a better judge than I am. As far as we are concerned, I think our best protection in terms of inflation is our global presence. You talk about DAP – let me say the good news about DAP is not only that it made its numbers in terms of model, I was saying that it did due the 16% EBIT excluding CHS looking at the clean DAP numbers. I would say the almost equally important point of this quarter is that DAP grew in every single part of the world. I think in terms of edging, your best protection is to be present everywhere in order not to be over exposed to a part of the world where you could indeed have some inflation risk. It’s hard for me to be much more explicit but I think probably DAP is a better, naturally hedged portfolio at the end of 2006 than it was at the end of 2005, having grown everywhere during that particular year.

Q – (Alabomnay Asalo?), Lehman Brothers

In terms of acquisitions going forward, should we expect a somewhat quieter period in DAP also in particular as you work on fully integrating the businesses that you acquired in 2006.

A - Pierre-Jean Sivignon

No, I don’t think you should do that. I think we’ve done seven. I mean, in an earlier question I was asked will you do anything massive and I was saying we haven’t done anything massive whatever massive means. We’ve done actually seven of I would say human sized. Are we going to be less active? I think no. We need to continue to grow Philips. You know the territories we will be looking at and if there are opportunities there we will be looking at that in a disciplined manner. But you know, it’s always hard to give numbers because the one domain where you don’t want to give budgets and certitude is certainly in the domain of acquisitions. I think you have to be practical and deliver when indeed it makes sense, but those things are very hard to anticipate. Are we working hard on it? Definitely.

Operator

The next question is from Francois Meunier, Cazenove.

Q - Francois Meunier, Cazenove

Just a follow up on Consumer Electronics in Q1. You said your inventories were controlled, but what about the inventories in the retail channels?

A - Pierre-Jean Sivignon

I think on the LCD side – all inventory as we’ve told you is actually the lowest ever in Consumer Electronics in general and including LCD television. I think that what we hear is that indeed there is a bit of pricing pressure, but as far as the channels are concerned on inventory, what we hear is that they are clean.

Q - Francois Meunier, Cazenove

Will the mix be woven in Q4? I understand that Ambilight was quite strong and that the margins in Ambilight are higher than for normal LCD TVs. It’s going to hurt in Q1?

A - Pierre-Jean Sivignon

Well in Q4, we had two stronger engines and the rest were weaker. The strong engines were indeed connective display, which includes Ambilight, and the other territory which worked and supported us was peripheral and accessories. In Q1 next year, we would hope that the other territories would start helping us, but again basically it’s hard to comment. I think the beauty is to have four engines and to be overall in a situation where that combined with our model enables us to have a year delivering on the 3% EBITDA. That’s why I am always uncomfortable commenting on the revenue. I prefer to really comment on the margin for the year. That’s really our mantra on that activity.

Q - Francois Meunier, Cazenove

But for Q1 you expect to have something worse than Q1 last year?

A - Pierre-Jean Sivignon

It’s hard to say. It’s really hard to say at the moment. The year just started. I think what we felt we had to tell you is in the press release. I can’t tell you much more than what we put in the press release. I think you know as much as I do at this point.

Operator

The next question comes from Thomas Brenier, Societe Generale.

Q - Thomas Brenier, Societe Generale

I’d like to come back onto the Medical systems division and this order intake. Just as a follow up to the very first question on this call, you mentioned a number: 6% growth. Is that for the backlog corrected for currency and excluding special items I would say? Then my question would be we’ve seen the growth of the backlog of the order intake deteriorating in the past two or three quarters. How does it help supporting the guidance for growth that you have in 2007? That’s kind of a back up question. What’s the average delivery date that you have in your backlog?

A - Pierre-Jean Sivignon

Let me take them one by one. First of all, the 6%, your definition of the 6% is correct. To do the 6%, you have to exclude the Belfast order which was booked in Q4 2005. So if you correct for that and for the impact of currency, the growth of incoming orders YoverY was indeed 6%. I think that’s your first question. Your second question was how do you basically reconcile the deceleration of the incoming orders with the guidance on revenue growth for next year? I think the answer is if you look back at the growth of incoming orders per quarter, and take not only this year and take the last three years, you will see that there is a lot of volatility quarter to quarter. So to look at the growth of revenue for 2007 from now, I think you need to look at how strong our existing backlog is in this year 2007. There, having looked at it in detail, we feel good about the guidance on the 6% growth that we gave to you on the back of that backlog at the end of the year. As far as your last question, which is what is the delivery, I would say how many months of backlog for modality do we have? I think that’s the way I understand your question. The answer is it’s very difficult to answer that, because it varies tremendously between modalities. You have modalities where it’s almost being delivered out of inventory and you would have modalities where it’s a much longer lead time for the more complex modalities like for instance MR or NukeMed. It’s very difficult to give you an average number. I actually don’t have it.

Q - Thomas Brenier, Societe Generale

What would be the maximum number?

A - Pierre-Jean Sivignon

I would say it could go up to three years? Some of these budgets which are being given on some of those hospitals are really mid-term plan. It’s really, really… I think what you need to keep in your mind is that we have a strong backlog. Let me just add one thing – we very often got the reverse questions in the previous quarter - how can you actually reconcile the very strong growth of your incoming orders with the fact that your revenue only grows by 6%. I think we are in a way on this particular quarter a bit on the other side of that question, which is why we are comfortable in telling you we have a backlog to go into Q1 and Q2.

Q - Thomas Brenier, Societe Generale

That’s very helpful, thank you. A very, very last one: the 6% growth for 2007 – how would you split that between market trends and market share gains?

A - Pierre-Jean Sivignon

I can’t – you’re on Medical? On Medical, I can only give you two numbers and I will stick to them because I think if anything they are confirmed by what we heard recently. The guidance on the revenue growth for Philips I have given to you, there is no change there. What we know and what we understand is that the growth of the equipment market, the so-called emerging market, we say is still 4-5%. I think that number gets confirmed time after time. That’s what we would like to stick to. The balance between the two is actually IT and hopefully us continuing to take a little bit of market share.

Operator

The next question comes from Jan-Willem Berghuis, Kempen & Co.

Q - Jan-Willem Berghuis, Kempen & Co

A small question on the amortization line for 2007. Can you give guidance on it and whether it’s changed over the last few quarters given all the acquisitions and maybe slightly on Medical, I think a lot of the questions are about the growth rate in orders. I think last year you grew 15% excluding this Belfast order in terms of order intake. Isn’t the comparison base extremely strong?

A - Pierre-Jean Sivignon

Okay. I think on the last question, I think I answered it. What you’re saying is exactly correct, which is in line with what I had just mentioned in the previous answer. I think your point is totally correct. On the amortization, I think the amortization of next year, you can probably I would say annualize what has happened in Q4. I think that will give you a pretty good approximation of what will be 2007. We are already in 2007.

Operator

The next question comes from Niels de Zwart, Rabo Securities.

Q - Niels de Zwart, Rabo Securities

Good morning. My questions were all answered, but your press release mentions that your pension cost for continuing operations will be climbing by €50 million. Does that mean that your overall pension charges have decreased by that amount, or is there something else to lead to that for discontinued operations? Secondly could you maybe update us on the funded status of your pension fund, which was minus €304 million at the end of last year?

A - Pierre-Jean Sivignon

Okay. I think the guidance on pensions is exactly what you said. It’s an overall reduction on the cost of pensions for next year so that is something which basically is to be taken care of. We had already more or less included the number in our EBITDA guidance for the year. We had not disclosed the amount to you back in November, because it’s a calculation which only can be finalized on the very last day of the year as you know, for a number of reasons. I would say that that element is already factored in our 7.5% EBITDA guidance for next year. In terms of the impact of funding, it’s hard for me to say. I think if you give us a couple more weeks, we will be a bit more explicit on the back of the annual report, because we are just done with the actuaries calculations which are still taking place at the moment so I would prefer to give you a fully educated answer in a couple of weeks on the back of the annual report.

Q - Niels de Zwart, Rabo Securities

A follow up if I may, on the targeted capital structure, you always mention that you look for a maximum gearing in your balance sheet of 30%. Now your portfolio has changed after the sale of semiconductors. Would you feel comfortable by potentially leveraging up your balance sheet a bit more?

A - Pierre-Jean Sivignon

I think 30% was something we said some time ago. I think what I’ve mentioned in the later calls, I’ve related it to our ratings and our rating as you know today is A, and I said we would have some comfort on that basis to go down one notch. Then based on the cash flows, because as you know all this in terms of ultimate leverage capability has to be basically – you have to factor the recurring cash flow to make that calculation. Based on the cash flow that we foresee and the kind of rating constraint that I just mentioned to you, yes we would absolutely be prepared and ready to leverage our balance sheet, which we do consider as not fully efficient today.

Operator

The last question is a follow up from Didier Scemama from ABN AMRO.

Q - Didier Scemama, ABN AMRO

Regarding the TSMC stake, I believe your lock-up has now expired. There’s been some speculations in Asia that TSMC might be prepared to acquire at least a portion of that stake. Would you mind commenting on that?

A - Pierre-Jean Sivignon

Didier, as the professional you are you know I would never comment on that. We will never, we have never and we will never comment on rumors. I think the only thing I can say is that we are absolutely standing by what we said. We talked about disposal of stakes. We talked about a responsible and efficient way of doing it. The only way to do that is by precisely not commenting on rumors and doing what we have to do. You know, the lock-up has expired and we are working on those things, but I really can’t comment on any of that.

Q - Didier Scemama, ABN AMRO

The nature of the question would be would you be prepared to sell that to a third party?

A - Pierre-Jean Sivignon

We are prepared to look at any way that is efficient and responsible, Didier, as far as TSMC is concerned.

Operator

That was the last question, sir. There are no further questions. Please continue. This concludes the Royal Philips Electronics Q4 results 2006 call on Monday 22nd January 2007. Thank you for participating, you may now disconnect.

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