Royal Philips NV (PHG) François A. van Houten on Q1 2016 Results - Earnings Call Transcript

| About: Koninklijke Philips (PHG)

Royal Philips NV (NYSE:PHG)

Q1 2016 Earnings Call

April 25, 2016 4:00 am ET

Executives

Robin Jansen - Head-Investor Relations

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

Analysts

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

Ben E. Uglow - Morgan Stanley & Co. International Plc

David A. Vos - Barclays Capital Securities Ltd.

Peter Olofsen - Kepler Cheuvreux SA (Netherlands)

Philip H. Wilson - Redburn (Europe) Ltd.

Andrew Carter - RBC Europe Ltd. (Broker)

Graham Phillips - Jefferies International Ltd.

Ian Douglas-Pennant - UBS Ltd. (Broker)

Operator

Welcome to the Royal Phillips first quarter 2016 results conference call on Monday, April 25, 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. 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.

Robin Jansen - Head-Investor Relations

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 07:00 AM 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 published 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 of 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 segment level continues to exclude the performance related to the Lumileds and Automotive, Lighting businesses. Finally, when we refer to adjusted EBITA on this call, this represents EBITA excluding restructuring cost, acquisition-related charges and other charges and gains above €20 million.

With that, I would like to hand over the call to Frans.

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Thanks, Robin. In the first quarter, we booked a solid 3% comparable sales growth and a significant 14% improvement in adjusted EBITA, offset 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 HealthTech portfolio, Personal Health, Diagnosis & Treatment, Connected Care & Health Informatics and HealthTech Other, and then, of course, Lighting and Legacy Items. This reporting better reflects the future of relevant portfolio logic of our company.

This morning, I will focus my remarks on our main operating segments, Personal Health, Diagnosis & Treatment, Connected Care & Health Informatics, and of course, Lighting. We had 5% comparable sales growth in HealthTech in Q1, and many areas of strengths throughout the HealthTech portfolio. Adjusted EBITA 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 healthy informatics, all of which are important growth areas for the future.

In Personal Health, comparable sales growth of 6% and the adjusted EBITA margin improved by 130 basis points. We drove double-digit growth in Health & Wellness, with continued double-digit growth in Oral Healthcare 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 & 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 from 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 & Treatment, the adjusted EBITA 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 more 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 €100 million to the adjusted EBITA in the second half of 2016 and €75 million in 2017.

Within the Diagnosis & 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 €40 million, which is substantially ahead of plan.

Comparable sales in the Connected Care & Health Informatics segment increased by 9%, driven by double-digit growth in Patient Care & 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 three 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.

Now 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. And at the leading industry tradeshow 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 street lights 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 have 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 street light can be monitored, controlled, and managed remotely. Typically, this provides an 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. However, 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. As such, 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 up front that we are not in a position to provide much more detail on the separation during the Q&A session beyond what I've 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 we'll 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.

With that, let me now hand over the call to Abhijit to discuss our financial performance and market dynamics in more detail.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

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 HealthTech 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 the industry trends.

Geographically, comparable sales growth of 3% in the first quarter was equally driven by mature and growth geographies. HealthTech 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 HealthTech 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 & 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 HealthTech 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-growth 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-single-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 & Health Informatics and by mid-single-digits in Diagnosis & 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 in UK 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 EBITA 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 a 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 & Health Informatics, 80 basis points in Diagnosis & 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 €23 million from our overhead and End2End productivity programs, as year-on-year incremental cost savings of €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 €67 million of additional bill of materials savings year-on-year and then on top of the normal run rate savings of €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 point 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 €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-30%s.

Net financial expenses were up €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 €63 million lower than in the first quarter of 2015. The return on invested capital, which is calculated on a five-quarter math basis, was 6.9%. Excluding the total one-off charges of €345 million related to the pension liability to de-risking in the U.S. and UK in Q4 2015, the ROIC was 9.9%, which is about 1 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 €43 million, excluding an outflow of €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 €48 million.

By the end of the fourth quarter, we completed 82% of our three-year €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 single 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 anticorruption 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 market 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 15% of total Lighting sales, grew comparable sales by 27%. And our improvement programs continued 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 €200 million to €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 €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 €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 €80 million to €100 million at EBITA level in 2016. This expectation is in line with the 2016 guidance we gave for the former IG&S during the Q4 earnings call.

I would also like to remind you that in Q1 the profitability of our Sleep & 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.

Question-and-Answer Session

Operator

Thank you, sir. The first question comes from Mr. Max Yates from Credit Suisse. Please state your question.

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

Hi, good morning. Thank you. So 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?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

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 after things could go fairly fast.

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

Okay, thank you. And 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 fairly detailed understanding of the CFIUS process, is there any work you can do initially to try and understand their position on any bids from GO Scale for that business, and have you actually been in contact with CFIUS so far?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

I had my share of the CFIUS process last year. I can say that. I've been to Washington. But 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. And yes, 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. So 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.

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

So 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 seasonality of this business, the second half is normally stronger in the consumer business than the first half. Is there anything – 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?

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

This is Abhijit. No, 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 & Respiratory business because it had a dip compared to last year with the reimbursement cut. 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. But then, in the second half, margin should pick up. So I think that...

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

Okay.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

...that's how you should look at it.

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

Okay. But is the assumption that the consumer business did a 14% margin in Q1, is that correct?

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

No, I think – we are now reporting as Personal Health the whole portfolio and then 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. So, 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 whole structure and new structure. And as we try to simplify things in Philips, I think, this goes against that drive.

Max R. Yates - Credit Suisse Securities (Europe) Ltd.

Sure. I understand. Thank you very much.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

You're welcome.

Operator

The next question comes from Mr. Ben Uglow from Morgan Stanley. Please state your question, sir.

Ben E. Uglow - Morgan Stanley & Co. International Plc

Abhijit and Robin. So, my first question is I'd like to know how to think about the margin in Diagnosis & 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. And 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 fit in terms of its profitability?

And if I think about the old healthcare targets, which, admittedly, we're now going back to 2015, divisionally, we were considering 16% to 17% reported EBITA. Should Diagnosis & Treatment be in line with the old divisional target above or below? And 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 targets? So, that was question number one.

Question number two; 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?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

All right. Ben, let me start and 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 HealthTech by saying it should be in the mid-to-high teens EBITA in the longer term. And obviously, we stick to that overall goal. The old healthcare guidance, of course – also excluded the IG&S charges. Robin, I'm referring to Ben's reference to the old healthcare target that excluded, whereas my mid-to-high teens includes that IG&S charge. So, that is where we need to go. And then, the three segments, in fact, all should be able to achieve that target.

And at this time, I don't see the need to indicate which one will be above and below the average. The Diagnosis & Treatment portfolio has a strong set of product categories, where the Ultrasound and Image-Guided Therapy would be above average within that portfolio, and the old imaging modality slightly below that average. But D&T, overall, should be in line with the stated objective for HealthTech.

We start the year, of course, with – it's a seasonal business, so the first quarter would be below. We still have elevated cost levels related to the quality or regulatory efforts that we have throughout this segment. And, gradually, we will improve this business. Abhijit, do you want to add anything to...?

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

No. I think that's a fair – other than the – the only thing, Ben, you will see that the seasonality, particularly in Q4, is extreme for this business. So it's a bit, let's say, abnormal compared to even normally seasonal businesses and, therefore, you see Q1 coming in, let's say, pretty low.

Ben E. Uglow - Morgan Stanley & Co. International Plc

Okay. So, just on that point, Abhijit, the reminder that we get the €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 HealthTech guidance has been?

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

Yeah. So what we have said is that the second half of the year, we'll see most of the benefit of the €100 million of the Cleveland year-on-year. So 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 & Treatment alone by about 70 basis points, but I think for the second half with these improvements as well as the lowest quality costs 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.

Ben E. Uglow - Morgan Stanley & Co. International Plc

Okay, thank you.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

Coming to your question on patient monitoring, I think the answer is something in between. So we had, of course, good pickup in patient monitoring. Part of that was catch up or poor – weaker comparables. If you see, Q1 last year, we had a decline. So 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.

Ben E. Uglow - Morgan Stanley & Co. International Plc

That's helpful, thank you.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

Thanks, Ben.

Operator

Our next question comes from Mr. David Vos of Barclays. Please state your question, sir.

David A. Vos - Barclays Capital Securities Ltd.

Good morning, gentlemen. Thanks for taking my question. I also had a kind of a more general question on the Connected Care & Healthcare Informatics business and 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 still a little bit lower than what you reported in Q1 2014.

So I was just wondering if you could help us understand where your ambitions lie there. And 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 – thinking, for example, about Cerner where you see EBITA margins north of 30%, which is quite a long way north of where Philips is at the moment? That'd be very helpful. Thank you very much.

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

David, the ambition for Connected Care & Health Informatics is in the same order of magnitude as I've explained for HealthTech, so in the mid-to-high teens, and I don't make a distinction between the three reporting segments.

Now, what you need to realize that is in Connected Care & Health Informatics, there are sizeable 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. So overall, it is a segment that is heavily weighed down by those investments, which of course will pay off over time. And then, by the way the high growth that you see in that segment, of course, also reflects the fact that we are making new investments.

Then your point on peers; let say in the medium-term, we look to these mid to high teens EBITA. And that doesn't mean that there are no businesses that would be above-average and certainly I can have – we can look at Cerner and other companies' profitability margin, but at this time, we will strive to get to the mid-to-high teens.

David A. Vos - Barclays Capital Securities Ltd.

Okay, thank you very much. That's it from me.

Operator

Our next question comes from Mr. Peter Olofsen from Kepler Cheuvreux. Please state your question sir.

Peter Olofsen - Kepler Cheuvreux SA (Netherlands)

Good morning, first two questions on Lighting please. On the overhead and support functions within Lighting, now we have some of the former IDNs growth 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? And then, on the lamps side, conventional lamps; could you remind us what you expect to spend annually on the footprint adjustments in conventional lamps?

And then my final question relates to working capital. I think both Connected Care & Health Informatics as well as Lighting showed pretty nice improvements. You think these improvements are sustainable?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

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 year 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 enhancements year-on-year. The lamps' footprint reduction will be answered by Abhijit.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

I think we have said so far that conventional footprint was about 1.5% to 2% of sales. So you could say that for this year, roughly between €90 million to €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. So 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.

Peter Olofsen - Kepler Cheuvreux SA (Netherlands)

Okay, thank you.

Operator

Our next question comes from Mr. Phil Wilson of Redburn. Please state your question.

Philip H. Wilson - Redburn (Europe) Ltd.

Good morning, it's Phil from Redburn. Thanks for taking the questions. I'll do one at a time, if that's okay. Firstly, just looking at your guidance, 11% adjusted EBITA 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?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Hi, Phil. Frans here. 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 Diagnostic & Treatment being quite back-end loaded. So we will continue to make improvements through the year, and indeed, we have still quite a journey to make.

Philip H. Wilson - Redburn (Europe) Ltd.

Okay, thank you. On slide 46, you talk about how you expect the overall U.S. healthcare market to grow. It looks like you actually expect the Diagnosis & Treatment markets, the imaging market, to decline low single digits in 2016, which is different to what other peers I think are saying about the imaging market. Can you talk about what the drivers are behind the potential decline in the U.S. imaging market in 2016?

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

I think overall, we've said that we expect procedures to grow. 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, and that could be marginally offset with reimbursement cuts in the Diagnosis & Treatment area. But it's a very minimal decline, you could say more flattish than anything, and that's based on the current projections we have.

Philip H. Wilson - Redburn (Europe) Ltd.

Okay, thank you. And then finally, I see, as you said, Professional Lighting in North America return to growth. Can you give some help on what the margin currently is for PLS North America and where you think that can settle?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

No, Phil. We are not detailing out the margin in North America, but it is safe to assume that as we are back to growth, also our margins are improving.

Philip H. Wilson - Redburn (Europe) Ltd.

Is it profitable?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

We are not detailing out the margin, as I said.

Philip H. Wilson - Redburn (Europe) Ltd.

Okay, thank you very much.

Operator

Our next question comes from Mr. Andrew Carter of RBC. Please state your question, sir.

Andrew Carter - RBC Europe Ltd. (Broker)

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. So I was looking at page 44, and I apologize if I missed something in the prepared comments there. But I was wondering. I guess in particular North America and Western Europe, you seem to have been 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? And also I guess in terms of how important the different quarters are as you go through the year in terms of building up the order backlog as you go into the following year?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Sure. First of all, there is always unevenness in the orders, especially as we go to larger contracts. Having said that, in North America we grew orders mid-single digit. Do you want to...

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

In Q4 last year, we actually had very strong order intake in North America, very strong double digit. And as Frans mentioned, it is uneven. So for Q1, it was largely flat. But that's something we expected in line with what we call sometimes lumpy or uneven. But if you look at the rolling 12-month order intake, you see that for North America we are in pretty good territory because if you look at the 12-month rolling, you then don't get caught up in the quarter-by-quarter fluctuations. And 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, but 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 is pretty okay at this stage.

Andrew Carter - RBC Europe Ltd. (Broker)

Thank you. Can I follow on just on Lumileds, please? I guess over the last several quarters the performance there, which obviously we can see a little bit of it, does look as though the performance there has been somewhat disappointing. Have you had to have a step-up in the restructuring measures and footprint measures and stuff in Lumileds? And if that's the case, how long is that going to take to execute on?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

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. We also have taken measures to improve the cost productivity. And these measures have typically taken effect in about six months, again, underpinning an improved second half of the year profitability. So 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, also of course, for general illumination applications. So, overall, I expect a good future for Lumileds.

Operator

Our final question comes from Mr. Graham Phillips of Jefferies. Please state your question, sir.

Graham Phillips - Jefferies International Ltd.

Good morning. My question is around Cleveland. You spoke about the €100 million improvement last year, and I think in the end, it was a slight decline. You're now saying €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 month's time?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Graham, we started out by remediating Cleveland factory itself in 2014 and 2015. And then we have extended the efforts to include our supplier base in supporting our suppliers with the right measures is a, you could say, a hand-holding effort that takes a considerable investment. And we are partly also transitioning the supplier base towards alternative suppliers. So all of that is proven to be a quite a bit of a project.

We do see light at the end of the tunnel. We're 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. So all in all, I say we are having the situation well in hand, albeit with cost levels that are higher than originally planned. But I intend to do this well, and so a bit extra cost is an acceptable price to pay. And then we expected the second half of the year to show stronger bottom-line results.

Graham Phillips - Jefferies International Ltd.

Okay, thank you. And 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? And if you did go for an IPO, what would the proceeds likely be used for afterwards?

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

We've 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 there's an IPO, of course, they'll 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 have for – 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, and then we will also consider M&A activities to boost the portfolio that we have in HealthTech. So that's the update that I can give you today.

Graham Phillips - Jefferies International Ltd.

And you prefer that rather in a simple spin than putting perhaps more debt into that business because you actually want the cash for these other proceeds.

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Yes, that's right.

Graham Phillips - Jefferies International Ltd.

Okay, thank you.

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

Correct.

Operator

We have an additional question over the telephone. It comes from Mr. Ian Douglas of UBS. Please state your question, sir.

Ian Douglas-Pennant - UBS Ltd. (Broker)

Hello. Thanks very much for squeezing me in. Again, most of my questions have been answered already. I just had one, last one on your working capital, and all of the lines there had declined materially this quarter. Is there some change in scope that we should be aware of or – and are you – is this a focus-reducing working capital at the moment, and if so how far could that go? Thank you.

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

I can give a compliment to my CFO, Abhijit, who has certainly made working capital a focus area, and I'll let him speak to how much further we can improve.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

Thank you, Frans, but this is – 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, and that's not only in inventories but also in our receivables and overdue. So we believe there is still some room to grow 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. And we are driving that hard every day.

Ian Douglas-Pennant - UBS Ltd. (Broker)

And then, 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?

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

So payables is directly a factor of what we are doing in terms of contracts that we have to pay. But partly, the lower payables is also due to the payment of the CRT fines as well as certain pension payments. So these are not let's say current trade payables which are going down. In fact, our DPO, as we call it, days payable outstanding, has been sweeping up slightly to the levels which we want it to be.

Ian Douglas-Pennant - UBS Ltd. (Broker)

Okay, great. So cash flow should be pretty good in the second half as well is the answer. Thanks very much.

Abhijit Bhattacharya - Chief Financial Officer, Executive Vice President & Director

We had pretty decent cash flow last year, and we are looking to build on that this year as well.

Ian Douglas-Pennant - UBS Ltd. (Broker)

Thank you.

Operator

Thank you. Mr. van Houten and Mr. Bhattacharya. There are no further questions. Please continue.

François A. van Houten - President, Chief Executive Officer & Chairman of the Board of Management and Executive Committee

All right, thank you, everybody. Let me give one elucidation because you may have noticed that there were less – fewer questions than usual. And in fact, a couple of good attendees were not speaking up, and 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. So at least, that is how I explain it, and time will tell exactly, of course, that. Thanks very much for attending, everybody. It was a pleasure and have a great day.

Operator

This concludes the Royal Philips first quarter 2016 results conference call on Monday, the 25 of April 2016. Thank you for participating. You may now disconnect.

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