Welcome to the Royal Philips Electronics Second Quarter Result 2012 Conference Call on Monday, 23rd of July, 2012. [Operator Instructions] Please note that this call will be recorded and is available by webcast on the website of Royal Philips Electronics. I will now hand the conference over to Mr. Abhijit Bhattacharya, Head of Investor Relations. Please go ahead, sir.

Good morning, ladies and gentlemen. Welcome to this conference call on the second quarter of 2012 for Royal Philips Electronics. I'm here with Philips' CEO, Frans van Houten; and our CFO, Ron Wirahadiraksa. In a moment, Frans will take you through his introductory remarks and provide an update on our performance. Ron will shed more light on the details of the financial performance during the quarter. After this, both Frans and Ron will be happy to take your questions. As usual, our press release and the accompanying information slide deck were published at 7 a.m. CET this morning. Both documents are now available for download from our Investor Relations website. We will also make available a full transcript of this conference call on the Investor Relations website by tomorrow morning at the latest. With that, let me hand over the call to Frans to start proceedings for the day. François van Houten: Thanks, Abhijit. Welcome, and thank you all for joining us today for our second quarter 2012 earnings conference call. The improved results in the second quarter are encouraging and important proof that our multiyear change and performance improvement program, Accelerate!, continues to positively impact our business. I am pleased with the response of our people and organization to this major and fundamental transformation of our company. In a relatively short period of time, we have started a large number of initiatives to redirect resources to those businesses and geographies that have strong growth and profit potential, and we have taken out cost in other areas. We have begun to rebuild our value chain to make it leaner, faster and more effective to speed up time to market, to use less working capital, and above all, to improve customer service. We are redefining our company culture to make it…

Thank you, Frans. Good morning, and welcome to all of you on the call. I will begin by giving you some color on the development in the markets we serve and then walk you through the financial performance for the second quarter. Let me start with Healthcare. In the U.S., we are seeing a steady market. Based on recent surveys, we believe that hospitals will increase their capital budgets this year moderately, although economic uncertainty may influence this in the second half of the year. The U.S. healthcare industry as a whole must deal with the implications of the Patient Protection and Affordable Care Act, which was recently upheld by the U.S. Supreme Court. Given the lack of clarity related to the implementation of this legislation, it means that market participants in the United States will have to deal with ongoing uncertainty for the foreseeable future. Once the implications of the medical device tax are established, we intend to mitigate the negative effects by actions through various stages of the value chain. We remain cautious on the European markets. Southern Europe continues to be very weak, and economic growth for the remaining part of Europe is subdued. The austerity measures undertaken in countries such as Italy, Spain and Greece continue to significantly affect public spending on healthcare. On a more positive note, the growth economies continue to show good momentum well into the second quarter, where demand is fueled by government and private spending. In Japan, which is our second largest market for the healthcare sector, recovery is happening at a steady pace. Overall, we maintain our outlook of 4% to 5% growth in the healthcare markets we serve and expect to outperform the markets going forward. For the consumer markets, in the mature geographies, we have seen an encouraging…

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

My question is on the cost savings, where you made further good progress in Q2. You seem to be a bit ahead of plan at least of the trajectory I had in my model. Should we expect to see upside to the EUR 400 million? Or is it just the planned savings coming through quicker?

Yes, Andreas. Thanks for the question. You're right. It looks slightly better like if you take the EUR 176 million by 2, you're at about EUR 340 million, EUR 350 million. So we are on the run rate to achieve the EUR 400 million. These things sometimes become a bit more lumpy. So for now, we will stay with the EUR 400 million.

And my follow-up question on foreign exchange. The -- with your business model, you buy in a lot of components. A lot of them are probably end products. Many of them may be quoted in dollars. With the continued weakness of the dollar, maybe you could give us some estimate on how that could impact your profitability going forward when you buy in products and sell them in Europe or other emerging markets where currencies are weak. And to what degree you're protected from hedging and for how long and how you can offset that with price increases.

Yes. Well, actually, you've given kind of the answer in a way. So for this quarter, the ForEx impact was slightly positive. Of course, there's an impact in the sales line, which is offset by cost of sales and then we have the unwind of hedges that we take. And that brings me to the point that actually, through hedging, we have been ongoingly been able to mitigate the impact of ForEx hedges run out. In the meantime, of course, we configure our operating base as much as possible to cater for the economic exposure mitigation, and then the rest we will have to drive through price increases.

But are you getting price increases in places like Europe or Brazil to offset the higher sourcing costs? François van Houten: Andreas, this is Frans. If you look in particular at Consumer Lifestyle, then -- where the effect that you describe is applicable, then yes, we are repositioning some of our products to a slightly more elevated price level to compensate for the sourcing costs which are up. In Lighting, the situation is more complex. Yes, the euro is down, but we can also expect some raw material benefits to come through in the second quarter -- second half of the year. Also, raw materials, we take term contracts which protect us up as well as down on the short-term fluctuations. Overall, we want to continue to work on our gross margin and look for opportunities there.

The next question comes from Mark Troman from Bank of America Merrill Lynch.

First question on -- same question on the Healthcare. It sounds as though -- I could be wrong in interpreting this, but it sounds as though you're a little bit more cautious on the U.S. than maybe in prior quarters. Now, we noticed orders were down a little bit. Have you seen a change of situation in the U.S. or you're just highlighting more uncertainties? Perhaps a little bit of color on the -- what's going on in U.S. Healthcare. François van Houten: Yes, Mark, thank you. The tonality of how we talk about it on the U.S. is indeed a little bit more cautious. It sounds a bit paradoxical, because we see strong traction in the U.S. in the first half of the year with 7% growth. That's really great. We also have spoken to hospital directors, and they tell us about the need to invest. I guess for many hospitals, the Supreme Court announcement was not really earth shattering, as no matter what the outcome was, the need to take these patients in was there anyway. But the weaker order intake situation in the U.S. is something to pay attention to, and we cannot -- let's say the outlook is certainly not secure, and we need to be very vigilant.

Okay. And just one follow-up. I think during Q3 and Q4 and maybe even Q1 this year, you have the step up costs, which, correct me if I'm wrong, I think were around EUR 200 million I think what you called step up costs to kind of stimulate growth and I guess catch up on the plan that you wanted to implement. Do those costs stay in Philips? Or do they unwind over time? So in other words, as your fixed cost base presumably has increased by roughly EUR 200 million to help growth, does that EUR 200 million stay there? Or will that reduce over time? François van Houten: Mark, those costs are invested to accelerate growth, and I think some of the benefits we see was the 5% growth in Q2. If you look across the world, then there are many pockets of growth where we need to invest in order to realize growth, while, at the same time, we cut cost elsewhere. And so the decision last year to step up the cost was very much in reflection of the opportunities that we see, so you could reason as follows. Those costs are there to stay, but as a percentage of sales, over time, that will normalize. Moreover, at the same time, we cut cost in overhead areas and in markets where we grow less, and, of course, that also provides compensation. I guess I'll leave it at that.

The next question comes from Martin Wilkie from Deutsche Bank.

It's Martin from Deutsche Bank. Just a couple of questions on Lighting. You've given us some stats on the growth in LEDs and the implications that Lumileds sales are still falling year-on-year. I was wondering if you could let us know how much of that was the exit from backlighting and if you could give us some sense of the underlying growth trends inside Lumileds. And then related to that, the second question. I think you had mentioned previously you were looking to get Lumileds back to breakeven in Q4. Just generally, are we still on track to see that improvement by the end of the year?

Yes. Thank you for the question. It is indeed so that for Lumileds, it was mainly for the withdrawal from the backlighting. So that answers that part. On Lumileds being on track to breakeven for the second half of the year, yes, we are on track to do that.

And can you give us some sort of sense as to what amount of margin drag we're seeing from that loss making at the moment and, therefore, how we should think about that improving in the second half?

Well, last year, on a full year basis, 2010 to 2011, of the 600 basis points of Lighting down, we were -- 120 basis points was from Lumileds. So that gives you a sense on the impact that it has made, and we intend to bring that to at least breakeven in the second half of this year.

The next question comes from Ben Uglow from Morgan Stanley.

I wanted to head back to just the Healthcare. On the Healthcare side, Ron, could you give us a little bit more of an understanding of the margin improvement, which was quite significant? Obviously, there is normal seasonality between the first and second quarters. But what I was curious to understand was whether there was a mix effect as well from Patient Care & Clinical Informatics the growth that we were seeing there. So question number one, how much is mix impacting Healthcare margin? Question number two, I don't know whether this is for Frans or for Ron. Can you just give us a general sense on the Affordable Care Act, what part of that legislation directly sort of affects your businesses? Is it via reimbursements? Is it via excise taxes? Or is it a more general overall effect on demand for Healthcare? François van Houten: Let me start with the second one and then Ron picks up on the first question. So first of all, we are happy that there is a decision on the Affordable Healthcare Act, right. Having said that, it doesn't mean that everything [indiscernible] many of the provisions still need to be turned into operational effect, and that is where the details are still missing. For example, the excise tax levy on how it will be implemented and to what extent is unclear. We are awaiting further details on that. In speaking with the hospital directors, there is, to cater for a wider patient base, a need for investments. We see that higher investment level in the first half of 2012. There is a good chance that, that pattern will continue. At the same time, we are a bit concerned about slowing effects of the economy. And as we flagged the government are taking fewer -- giving fewer orders, all of these things amalgamate into a combined effect that makes us still cautious on the second half of the year and 2013. But overall, I think the Affordable Care Act should have, in the end, a positive effect.

On the margin question, it's not so much of a mix effect, maybe slightly. It's much more an effect of the increase that we have seen, the good growth in sales and managing cost very, very frugally. As you know, in Healthcare, we're ongoingly working on operational excellence, so that has contributed to the improved results.

So -- and obviously, I guess it's implied, but it's fair to assume that your Healthcare margin across all segments improved during the quarter. Is that a fair assumption?

Yes. By and large, that's correct.

The next question comes from Ludovic Debailleux from Natixis Securities.

Two questions, please. First of all, the growth economy grew by 11% in Q2, which is very positive considering the growing concern, especially in China. What do you see there for the coming quarters? And do you expect the business to slow down in this country, which -- and for you, which division would be the most at risk? That was question number one. And question number two, IG&S is better than expected at minus EUR 79 million. Do you confirm the minus EUR 300 million on a full year basis that you gave as an indication? François van Houten: Good momentum still in the growth economies, perhaps a little bit less than before but still good. We are outgrowing GDP in most growth markets, and I think it's a reflection of a couple of things. First of all, most markets, like China -- or for that matter, I was in Turkey and Russia a few weeks ago traveling. There's still a big demand to further step up healthcare. And those healthcare sectors, it is our conviction, will outperform GDP growth as a matter of course. So that certainly also applies to China, where the second- and third-tier cities still have a healthcare demand and where we also expect that, as part of managing the population, the government will continue to place emphasis on this. Then if I move to Lighting for a moment. The LED energy-efficient lighting is attractive as it slashes energy cost, and we also expect that to continue to be a priority sector for many markets across the world. Then the middle-income groups, the population in China that has been pretty good to our Consumer Lifestyle business, continues to buy. So we have not seen that significantly slow down. As a rule of thumb, in China, we expect to continue to grow at a rate of approximately 2x GDP for the group.

On your question on IG&S, yes, it was somewhat better. We reiterate our guidance for the year, EUR 300 million and, of course, we'll try to improve that somewhat.

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

I have a couple of questions, actually. The first one relates to the margin in Healthcare, which looks exceptionally good for second quarter. But given the rise in inventories we've seen, is there a risk that you could start reducing the manufacturing level in the coming quarters and that this could weight down on margins? The second question I had is related to the distribution agreement you signed with Funai in North America. Do you think that distribution agreement could be expanded to a more complete license agreement and do you think there are other opportunities for this kind of agreement in other geographies as the year progresses? And maybe a final question on M&A. There were no acquisitions during the last 4 quarters. But with the turnaround progressing well, especially in Healthcare and Consumer, do you now feel more comfortable about M&A going forward? François van Houten: Let me take the second and the third question and then have Ron take the first one. We announced the distribution agreement with Funai. Basically, they take over the distribution of our products there. I don't immediately see similar deals elsewhere in the world. We did flag that we are studying alternate business models for Lifestyle Entertainment in order to create value. I'd like to underline that with all the measures we have taken already, Lifestyle Entertainment continues to be profitable despite the diminishing top line. And I think that's testimony to a good management team that is cutting cost but also bringing out some exciting new products like the docking stations. On M&A, you're right. We have consistently said that it's not our priority to do M&A. We are convinced about the unlocked potential that we have in the group, and therefore, organic growth and organic operational improvement execution is what we need to do. We don't close our eyes for M&A. If smaller deals pass by, then we can consider it, but our priority is operational execution and unlocking the full potential of the businesses that we have already. Ron, first question.

Yes. So on the Healthcare margin we're, of course, very pleased with what we have seen in the margin, mainly due to better growth and cost management. We -- and that is what I can tell you. We will reiterate our guidance for the midterm targets 2013 being 15% to 17% reported EBITA.

The next question comes from Martin Prozesky from Bernstein.

A few questions on Lighting, please. In terms of the U.S., the construction market, can you give us an update on how Professional Luminaires is doing in the U.S.? And then second question on fluorescent, just an update on kind of the stickiness of price increases from end of last year and how rare earth metal input costs are trending, please. François van Houten: Yes, the Professional Luminaire market in the U.S., we are looking for the data.

Martin, this is Abhijit. For Professional Luminaires, we were flattish to slightly up in North America, but overall, for Lighting, we had a strong quarter. As Ron mentioned, we had a high single-digit growth, so 9% growth for Lighting overall. So that's -- so overall, in the U.S., we've done well, but this quarter, Professional Luminaires growth was not as high as the earlier quarter. François van Houten: Then on the fluorescent, I think we have flagged in the past already that on the professional side, the price increases stick. While on the consumer side, also due to private label brands, this is under pressure. On the input side, we make use of term contracts on the rare earth sourcing, which protects us, of course, both for upsides and downsides. At the moment, the spot rates are slightly lower than our term contracts, so we are not seeing full benefit of the decline of rare earth markets through in our margins yet. And this will continue for a while, as they will run out later in the year only.

Then, just one follow-up on the outlook for Professional Luminaires in the U.S. I mean we're getting I think pretty conflicting signals about the strength of the construction recovery. What are you seeing in terms of your business? François van Houten: Well, we've looked at some of the competitors, and they actually are -- have done slightly better than us. So I'm not sure that we are fully benefiting from that uptick. We are taking measures to improve our performance in Lighting also in the United States. The construction indicators seem to trend downwards a little bit in the second half of the year, so maybe that is where, indeed, the hesitation also that you picked up on falls. But what you can also take from my own explanation is that I think we should be able to improve our own act across the world, but also in North America.

The next question comes from Olivier Esnou from Exane.

I have a question on the P&L. Actually, I was looking at the development of G&A in the quarter, which was quite down quarter-over-quarter and year-over-year. I was wondering if you could just give us a bit of a flavor on that number. Is it a new run rate you see here? Or was there some exceptional? And secondly, talking about the quarter development. Is there any meaningful trend during the quarter when you look at the monthly development in each of the division you can share with us? As we had the impression that things have materially slowed, is it the same for you? Or you've have seen an even development? François van Houten: Okay. Well, thank you for the questions. We generally do not comment on the actual trends within the quarter or month we communicate with you on the quarter. What I can say is that project business and big channels sales like in Healthcare, it could be somewhat lumpy at times. So there's not always much to say, whilst in Consumer, the trend is sometimes better readable. On your question on G&A, as I said, there was a EUR 25 million one gain -- onetime gain of prior service cost to a medical retiree plan. That's what I talked about. And there have been also some lower pension costs in a number of countries. And then overall, we also had savings from the efforts that we make in salaries, and that explains the much lower G&A.

Okay. So in terms of underlying trend for that, can you -- do you have an indication going forward? François van Houten: No, so it's as I said, there is 2 items here, clearly, that are somewhat of a one-off gain. Other than that, the structural component is the savings and the salaries that we've seen, which are also, I think, in the 20s of million.

The next question comes from Michael Hagmann from HSBC.

I was wondering about Healthcare. Obviously, the quarter was very strong in terms of sales and in terms of margin improvement. Now Deborah has been there for 3 months, and I was wondering if despite or because of that strong development, she has now started to question the strategy. Or if you -- and in your conversations with her, do you sense that changes are imminent in the strategy of Healthcare? Or will it just continue as before? François van Houten: I am pleased with how Deborah has taken over the business quite seamlessly, and her teams have rallied with her to -- behind the strategy that is in place, the strategy that she, as you remember, elucidated during Capital Markets Day, where she and her team clearly said it's a good strategy, but operational improvement and execution can also do better in Healthcare. So the Accelerate! program has -- gets also strong traction there. So overall, strong start. The whole team supports her, and we can expect that the Accelerate! program will also show benefits on the journey to the 15% to 17% EBITA that Ron already reiterated for 2013.

And no -- certainly no change to the strategy in Healthcare? François van Houten: Deborah already said during Capital Markets Day that she is fully behind the strategy and that it is a matter of execution. And so this is exactly what is going on.

The next question comes from William Mackie from Berenberg Bank.

I'd just like to come back to Lighting, if I could and ask as you look into the second half of the year, I think you've reiterated expectations of a continual improvement in operating profitability. Could you perhaps break out the constituents or the relevant importance of the constituents that will drive that step-up with regard to the prospects of a turnaround in Consumer Luminaries and Lumileds, plus improving pricing trends, plus the payback from the ongoing restructuring?

Yes. So thanks for the question. So if you look at the improved margin versus last year, then we can see that there is an improvement in the gross margin on the back of operational improvements and Accelerate! savings. As you know, Lightning is very well underway to implement the Accelerate! program, which is still somewhat dampened by the negative variance we still have for now between Lumileds and Consumer Luminaries compared to Q2 of last year. So that explains why the margin, in effect, actually is the same, 650 basis points. Also, for Lighting, so as you know, we want to break even in both Consumer Luminaires and Lumileds second half of this year, which will -- if you compare with last year, the combined impact of the 2 I just mentioned on the call, 120 basis points for Lumileds. It was 130 for consumer Lumileds. So that would improve the margin compared to last year by 250 basis points on a run rate basis, if you will. So we're working hard to make that happen, to work on other improvements. And for now, we'll stay with the guidance that we have given already for 2013 of 8% to 10% reported EBITA for Lighting.

That's great. As a follow-up then, perhaps could you give an indication of the benefits from pricing effects in the lamps and Electronics business that you enjoyed in the second quarter? François van Houten: There's no big changes, really, in the second quarter versus the first quarter. I already, earlier in the call, spoke about the fluorescent situation. On LED, the LED prices in the Professional Luminaires are actually better than the conventional luminaires, which I find logical, because it's a better value proposition. And in the LED lamps area, thanks to the reengineering of the End2End value chain, we see that LED lamps are benefiting from a slightly better gross margin and certainly, a better bottom line than before. So that is good news, but those are not market trends but much more what we are able to implement as operational improvements.

Super. If you'll excuse me one last moment, which was with regard to the step-up that you've highlighted, the EUR 200 million increased investment for growth within the Accelerate! program, are we coming close to the normalization of the run rate of investment now, i.e. should we expect an incremental headwind from further R&D and promotional spend and the like? Or is that now at a neutral or declining level relative to sales?

I think you have seen let's say all those step-ups being done already. I don't see immediately extraordinary further step-ups taking place. We will continue to adjust our cost base to where the growth opportunities are. In other words, if Russia grows, then we will expand our organization there. And if South Europe declines, we will reduce our organization there. So these shifts will take place as a matter of normal course. Overall, the message I'd like to leave with you is that in Philips, we need to and can further drive productivity, right. And then the need for the EUR 200 million last year was because we did not want to do it sequentially. In other words, we did not first want to drive productivity and then say, "Oh, but now we are shrinking, and now, we need to grow." So we needed to do both at the same time. That has, I think, helped us to grow. Overall, we are still the case of self-help. We can still drive productivity further and get more bang for the buck in R&D, in sales. The story still holds.

The next question comes from Andrew Carter from Royal Bank of Canada.

Most of my questions have actually been covered, but if I could just ask a couple of small ones, then that would be helpful. The first one was just in terms of the restructuring benefit that was secured in the second quarter. Could you tell us what the year-on-year benefit was there? The second one was just relating to the Healthcare and the equipment orders that you gave us the trends on. Could you remind us what the geographical split of your equipment orders has been most recently? And then finally, just on Lighting and Consumer Luminaries, the -- obviously, there's a seasonality to that business, and I understand that you're looking to win market share back. Should we start to see that in the next quarter? Or is it phased through the second half?

So the cost run rate compared to the last year, as we have said, cumulatively we're now at EUR 176 million. So as said in the earlier question on this part, if you multiplied it by 2, to a little over EUR 340 million. So we're well underway to achieve the EUR 400 million. So for now, compared like for like, it's EUR 176 million cumulatively, yes. That includes somewhat of an impact of Q1. Then in Healthcare, the geographical order intake, it's roughly the same as sales, because the order book is also split like that. François van Houten: And then lighting consumer?

Yes. Lighting Consumer Luminaries in the next quarter, well, we're not guiding for the next quarter. What I can tell is that we're working hard to make this breakeven. It's another effort to win back customers. This is a listings business, so we need to work harder on getting listings back in Luminaires. That is currently underway. François van Houten: I mean, I think his question was about when in the year. So I think the way to look at it is that it's going to take us a lot of effort, and it will be quite late in the year.

[Operator Instructions] We have a follow-up question from Andreas Willi from JPMorgan.

The follow-up question is on cash flow and their payables, receivables. A few number -- a few companies that have reported recently have shown a weaker working capital performance, because sometimes, they have to pay earlier, but certainly, they get paid later. And the number of companies mentioned distributors and mentioned Asia as a region of concern. Maybe you could tell us what you see in the market in terms of customers paying on time.

Yes. So by and large, customers are paying on time. Of course, there is some more difficulty at Southern Europe where, on that, we have, as part of our standard operating procedures, quite strong payables and receivables management. The question on free cash flow, there was, oddly speaking, like Q1, also Q2, the quarter ended in a weekend. So that has caused somewhat of a let's say distorted insight in a way, if you will. We like to look at to the year-to-date number of free cash flow, which is actually above EUR 400 million and which is, year-to-date, an improvement of about EUR 1.3 billion over last year. So we're very happy with that. As you know, last year, we have increased our payables discipline, so we adhere to that. There was a major setback in mainly the first quarter of last year, so we don't have that anymore. We're pleased with the progress in the free cash flow, Andreas. François van Houten: All right. Thanks, Ron. Thanks, Andreas. I've gotten the signal that there are no further questions in the queue. And therefore, I'd like to close this call but not before thanking you for your tracking us and confidence. I continue to reiterate that we have, in Philips, a large unlocked potential and that we are well on our journey to our midterm targets and that it is primarily a case of self-help. Second quarter was a good proof that we are on the right path. And I'm thankful to all the employees who are embracing the Accelerate! program and putting their shoulders underneath this quite big task. Thank you for that, and we'll talk to you soon.

This concludes the Royal Philips Electronics Second Quarter Results 2012 Conference Call on Monday, 23rd of July, 2012. Thank you for participating. You may now disconnect.