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Koninklijke Philips N.V. (PHG)

Q3 2018 Earnings Call· Mon, Oct 22, 2018

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Transcript

Operator

Operator

Welcome to the Royal Philips Third Quarter 2018 Results Conference Call on Monday, 22 of October, 2018. During the introduction hosted by Mr. Frans van Houten, CEO, and Mr. Abhijit Bhattacharya, CFO, all participants will be in a listen-only mode. After the instruction, there will be an opportunity to ask questions. [Operator Instructions] Please note that this call will be recorded and available by webcast on the website of Royal Philips. I will now hand the conference over to Mr. Pim Preesman, Head of Investor Relations.

Pim Preesman

Analyst

Thank you. And good morning, ladies and gentlemen. Welcome to Philips' third quarter 2018 results conference call. I'm here with our CEO, Frans van Houten, and our CFO, Abhijit Bhattacharya. On today's call, Frans will take you through our strategic and financial highlights for the period, Abhijit will then provide more detail on the financial performance and market dynamics. After that, we will take your questions. Our press release and related information slide deck were published at 7 AM 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 end of today on our website. I would like to remind you that Philips' shareholding in Signify, formerly Philips Lighting, is currently 18% of Signify's issued share capital. The stake is presented as an investment included in assets classified as held for sale in the financial statements of Royal Philips as from the end of November 2017. We provided you with guidance for the expected ethics [ph] translation combined with the consolidation and deconsolidation impact on sales during the respective quarter and for full year 2018. We will continue to do so this twice a quarter, once immediately after the results publications this morning and once during the last week of the quarter, both available on our IR website. Finally, as mentioned in the press release, adjusted EBITDA is defined as income from operations excluding amortization of acquired intangible assets, impairment of goodwill and other intangible assets, restructuring charges, acquisition-related costs and other significant items. Comparable growth for sales and orders are adjusted for currency and portfolio changes. With that, I would like to hand over to Frans.

Frans van Houten

Analyst · Bank of America. Please state your question

Thank you, Pim. And thank you all for joining us today. While I am pleased with the continued strong 11% order intake growth, operational improvements were partly offset by increased foreign exchange headwinds. This resulted in 40 basis points in adjusted EBITDA improvement on the back of 4% comparable sales growth. We continued good traction of the new products and solutions that we have recently introduced resulting in 15% order intake growth and 6% comparable sales growth for the Diagnosis & Treatment businesses. The Connected Care & Health Informatics businesses continue to deliver a solid 5% order intake growth. However, sales decreased 2%. Main reasons for a tough compare of 8% in the third quarter of last year and the low single digit growth in the patient monitoring market globally in 2018. I'm encouraged by the step up in sales growth over the Personal Health businesses compared to the first half of 2018. But the recovery was a bit slower than expected as good growth in our gross geographies was partially offset by lower growth in our mature geographies. Growth and operational improvements mainly drove the increase in adjusted EBITDA of 40 basis points, partly offset by increased foreign exchange headwinds, which had an adverse impact on adjusted EBITDA of approximately 60 basis points. All segments were negatively impacted. However, predominantly in Personal Health was approximately 80 basis points. During the quarter we continue to make good progress with our productivity programs. Let me expand on our strategic journey to leadership in health technology. Our value creation story is built on three key levers. First by creating value in our core businesses by gaining market share through deeper, more comprehensive customer partnerships, innovative solutions and pursuing growth by increasing geographic coverage. On this first lever innovation partnerships and increased geographic…

Abhijit Bhattacharya

Analyst · Goldman Sachs

Thank you, Frans and good morning to all of you on the call and the webcast. Let me start by providing some color on the third qua comparable sales growth of 4%. The diagnosis and treatment businesses delivered a 6% comparable sales growth with double-digit growth in ultrasound, high single digit growth in image-guided therapy and mid single digit growth in diagnostic imaging. We are very pleased to see the continued strong traction of these businesses, specifically in ultrasound where all the business segments of cardiovascular, OB/GYN, general imaging and point of care demonstrated double-digit sales growth. In the cardiovascular segment, we’ve introduced the EPIQ CVx ultrasound system which performed strongly since launch. Frans mentioned already the reasons for the 2% comparable sales decline in Connected Care & Health Informatics. This reflected mid single digit growth in therapeutic care, offset by low single digit decline in Healthcare Informatics and Monitoring Analytics. The Personal Health business delivered 4% comparable sales growth, driven by mid single digit growth in personal care and sleep and respiratory cares. In sleep and respiratory care following the successful launch of the DreamWear Full face mask at the end of the first quarter, we recorded another quarter of double-digit growth in the largest mask segment. Unfortunately currency headwinds, mainly in Turkey and Argentina, trade sanctions in Iran and supply chain disruptions due to adverse weather conditions like floods in Hong Kong and India impacted comparable sales growth negatively by about 80 basis points in Personal Health. Group sales in mature geographies increased by 2% on a comparable basis, low single digit growth in North America and other mature geographies and mid single digit growth in Western Europe. Sales increased by 9% on a comparable basis in our growth geographies, led by double-digit growth in Latin America, APAC…

Operator

Operator

Thank you, sir. [Operator Instructions] We’ll now take our first question from Mr. Patrick Wood from Bank of America. Please state your question.

Patrick Wood

Analyst · Bank of America. Please state your question

Thank you for taking my questions. I have two please. The first will be in the Personal Health side, have you seen any change from P&G on their competitive position, partly because the numbers that they put out were pretty strong. I'm trying to work out how to reconcile that with the oral care that you guys may have seen? And then the second one, just trying to get a sense of the order backlog. Structurally when would you expect some kind of a parity between the growth of the core D&T business and the order backlog. I know, you obviously give sense for how this translates into sales, but it seems we're getting a larger, larger backlog over time. I'm just trying to understand when that comes through into the core business? Thank you.

Frans van Houten

Analyst · Bank of America. Please state your question

Yeah, hi. Patrick this is Frans. Good Morning. Thank you for your questions. Indeed on Personal Health, we have pointed out in the past some aggressive discounting, especially in the North American market that we elected not to follow because we believe we have premium innovations deserve to hold their prices. And of course, we noted with interest the statements around increasing prices. I don't think that that apply to the third quarter. So it should be then more forward looking. That would be - that would be good. As I said we have not followed that kind of discounting ourselves. I think that should address your first question. And then on the order backlog, indeed we are actually at an all-time high order book for Diagnosis & Treatment, up several 100 million. Its elucidated on page 26 of the investor deck, where we give you an index order book development. We also see that the time between order and revenue recognition is trending up a little bit with many orders taking at least 9 months to get into revenue recognition and the hybrid operating rooms with the Azurion platform can even be longer than a year. Of course, that is then offset by ultrasound which is more fluid and faster to revenue. But overall, I think your implied message that you know, is there a little bit of a longer period of translation, that is indeed the case. And while I'm on the topic also for Connected Care & Health Informatics, we see such a longer period with larger contract takes longer to get to decisions. And then it takes time for the overall revenue to kick in. Now I will finish by saying that, you know, we have had double-digit order growth for D&T for the whole year now and we are well positioned to underpin our 2019 revenue. And currently we are already tracking at a year-to-date gross of 8%. So maybe that all helps.

Patrick Wood

Analyst · Bank of America. Please state your question

Helpful. Thank you for taking the questions.

Frans van Houten

Analyst · Bank of America. Please state your question

You're welcome. Next please?

Operator

Operator

The next question comes from Ms. Veronika Dubajova from Goldman Sachs.

Veronika Dubajova

Analyst · Goldman Sachs

Good morning, gentlemen and thank you for taking my questions. My first question is actually on the margin development in D&T. Looking at this quarter it seems to be tracking meaningfully below where you were right at the first half of the year. And so Abhijit I know you mentioned in the press release and in your prepared remarks that you had some growth focused spending. But can you maybe give us an insight on why the margin improvement wasn't as impressive this quarter in D&T? And then I have a follow up that I'll ask after that.

Abhijit Bhattacharya

Analyst · Goldman Sachs

I think two main reasons Veronika, you see with the growth of the equipment business that from a mixed perspective that has a slightly dampening effect. And secondly, you know, with the launch of the skew [ph] of new products quite a bit of the capitalized R&D now starts flowing into the P&L. So those are the two impacts that we've had. As well as we’ve had some FX impact which has impacted not as much as Personal Health, but still an impact for D&T, I think these would be the three main contributors.

Veronika Dubajova

Analyst · Goldman Sachs

Okay, Abhijit. And then as a follow up, I think you've always said that you need to deliver more than 100 basis points in D&T to make the guidance for the year on a full year basis. What's your degree of confidence in being able to deliver that, let's call IT 150 basis points in D&T on a full year basis?

Abhijit Bhattacharya

Analyst · Goldman Sachs

Actually what we had said was we need to deliver more than a 100 basis - much more than 100 basis points on DI in principle, and then, let's say, most of the businesses would deliver or the businesses will deliver in the 100 basis points range. I think the confidence still remains because as you’ve seen with the order book, there is still more growth to come in the coming quarters and then once the service revenue start kicking in, we will also see a meaningful improvement in the margins. So I think so far we are pretty much on track. And even if you look overall for the company, I mean, yes, we've had a big impact on currencies this quarter, but year-to-date we are I think 96 or thereabouts basis points improvement. So we are still close to the 100 basis points that we talked about on an average annual improvement.

Veronika Dubajova

Analyst · Goldman Sachs

That's great. Thank you very much.

Frans van Houten

Analyst · Goldman Sachs

Thanks, Veronika.

Operator

Operator

The next question comes from Mr. Ian Douglas-Pennant from UBS. Please state your questions sir.

Ian Douglas-Pennant

Analyst · UBS. Please state your questions sir

Yes, thanks very much. And so first on Personal Health, your – and two high margin business lines appear to be facing some reasonably long-term headwinds now for the past year or so. With this mix headwind in mind and assuming that continues, could you confirm whether you still believe your long-term guidance of high teens in these businesses is still valid and could that include 17%, which would suggest you've got no further margin upside from here? And the second question, which is very short, I'm having trouble knowing how to think about the cost that you booked in you HealthTech Other line going forward, should we kind of take the minus 10 that you are implying for Q4 and annualize that or I mean, just how should we think about 2019 onwards there?

Frans van Houten

Analyst · UBS. Please state your questions sir

Hi, Ian, Frans here. On your first question, in fact, we have three high margin business lines in PH that are all fantastic. And I would not take the headwinds as structural. We continue to expect strong growth potential in all three. I mean, I'm referring to sleep and respiratory care, health and wellness and personal care and as businesses with very strong profit potential and growth potential. The guidance that we have given very much intact on profitability, and we will come back on that during the Capital Markets Day in two weeks. And we have seen already a step up in growth in – from second quarter to third quarter. Abhijit said that besides the headwinds on currency, we also have invested about 80 basis points more in advertising and promotion, that's also anticipating a strong fourth quarter. So yes, franchise intact, and we'll talk about it in two weeks. The other question will be handled by Abhijit.

Abhijit Bhattacharya

Analyst · UBS. Please state your questions sir

So maybe to disclose on the PH part, we are already if you look at last 12 months we are in the 17% to 19%. And if you look at this quarter even with the 4% growth we had, let’s say, 160 basis points, 80 on advertising, 80 on currency. So operationally the business is still in very good shape, so I think we are well within the guidance range for 2020 already, and therefore as this business grows the margins will improve. Yes, the HealthTech Other, to multiply by Q4 by 4 is not going to work. As you know Ian, it changes between quarter depending on how we get our license revenue, so we guide to the full year and we will do that again at the start of next year. But I am glad that so far we have been able to outperform the guidance for this year and we have brought quite a meaningful reduction year-on-year which will helps overall the results of the company.

Ian Douglas-Pennant

Analyst · UBS. Please state your questions sir

So on that, so there's no kind of regime shift this quarter. I mean, there's you know, there's no reason to think that Q3 is a run rate going forward, we should probably take the 2018 full year guidance as a reasonable way to…

Abhijit Bhattacharya

Analyst · UBS. Please state your questions sir

Exactly, yeah.

Ian Douglas-Pennant

Analyst · UBS. Please state your questions sir

Okay. Thank you.

Operator

Operator

The next question comes from Mr. Michael Jungling from Morgan Stanley. Please state your question sir.

Michael Jungling

Analyst · Morgan Stanley. Please state your question sir

Great, thank you. I have two questions, firstly, on HealthTech Other and then secondly on U.S., China tariffs. On HealthTech and Other, can you comment on why the environmental provision has been where the charge is lower? Have they been some changes in the negotiations with the state and federal governments in the U.S. And within HealthTech Other, can you comment on what the release and the provision actually is, there was no specific I think in the press release. And then on U.S., China tariffs, could you please clarify whether the 60 million that you mentioned refers to EBITA? And what is the gross impacts of the 60 million, because I think you mentioned net, so what is the gross amount before your own mitigation developments? Thank you.

Frans van Houten

Analyst · Morgan Stanley. Please state your question sir

Yeah, let me take the second question, while Abhijit prepares for the first question. The gross effect of the tariffs are higher, and w don't find it meaningful to only talk about a gross number, because the moment you take a mitigating action you actually make that impact disappear. And we have various levers to pull to mitigate the impact from duties. One is rearranging our supply chain. Of course, that is perhaps the easiest because we have manufacturing facilities in the United States in Europe and in Asia, about one third. We are already on a path to create so-called multimodality factories where we can manufacture stuff from other business units. We were already anticipating that we need to have regional representation in a world that is more polarizing. So in fact, you could say mentally we were prepared for this. Now it takes some time to effectuate, bringing some U.S. production into China and vice versa. We expect that to have a beneficial effect already during next year. Then we will try to raise prices where the competitive landscape would allow that. So if you are asking how much of the 60 million will we see in the topline, then that's not an easy question, because if we just rearrange the supply chain then actually you will not see a topline effect, if we raise prices it may have an upward effect on revenue, although at this moment we are not counting too much on price raises. And then finally the 60 million, yes, that's an EBITA impact, but that 60 million EBITA impact will be compensated by additional measures elsewhere in the company, all right, and we are stepping up our productivity measures and so that we will be able to still comfortably deliver 100 basis points next year. Abhijit?

Abhijit Bhattacharya

Analyst · Morgan Stanley. Please state your question sir

Yeah. On the environmental, I think this is nothing to do with change in regulation by any government or anything. We carry environmental provisions for sites that we have, which are discounted and basically with the discount rates on 5 year and 30 year long-term yields have gone up by 15 to 13 bps respectively and that's just calls for recalculation of the provisions which then gives you a bit of release. So these things happen every quarter a bit and this time we got a positive impact because last year we had a negative one and that's why the gap is so big.

Michael Jungling

Analyst · Morgan Stanley. Please state your question sir

Great. And then the other provision that you released…

Abhijit Bhattacharya

Analyst · Morgan Stanley. Please state your question sir

That was related to a tax claim that was on the company which we have got judgement that we don't have to pay anymore, so that was a benefit.

Michael Jungling

Analyst · Morgan Stanley. Please state your question sir

Great. And then finally on the on the tariffs, may I quickly clarify, and the impact from the U.S., China tariffs, will they be treated as an adjustment to your EBITA or will you absorb that in your adjusted EBITA as a normal course of doing business?

Abhijit Bhattacharya

Analyst · Morgan Stanley. Please state your question sir

We will adjust that, I mean, this is here to stay, its not a one-off item, so then you don’t adjust it out. So we will have to absorb that and find countermeasures.

Michael Jungling

Analyst · Morgan Stanley. Please state your question sir

Great. Thank you.

Operator

Operator

The next question comes from Ms. Yi-Dan Wang from Deutsche Bank. Please state your question, madam.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Thanks very much. I have two questions. So first of all on the FX, could you quantify the FX impact on your margins by business for the fourth quarter and 2019 based on current rates. And also a suggestion if I may, you already are very helpful in giving us the topline impact, but without you know, details of the – your currency exposure it's quite difficult for us to estimate the margin effects. So would you be able to do a similar exercise for us on the margins. And then, the second question relates to the slowdown in the D&T division. Yes, year-to-date, it's a very nice impressive number. But in the quarter ended September, things do seem to have slowed and it seems to be on the back of lower service revenue. So could you give us sort of the phasing of your service businesses and how we should think about trends going forward, whether this is just a one quarter effect or we should build in something that lasts slightly longer than that? Thank you.

Abhijit Bhattacharya

Analyst · Deutsche Bank. Please state your question, madam

On the FX, its very difficult to predict. I mean, you know what happened in Q3 also for instance, let's take a step back right, for developed market currencies either we have natural hedges or we have a hedging policy in place which has stood us in very good stead. So if you compare the FX impacts we've had with competitors it has been significantly lower than a lot of our competitors. So I think there we have done well. We do not hedge most of the emerging market currencies simply because the cost of carry is too high and therefore it doesn't make sense. And therefore unfortunately we are exposed for emerging markets currency changes and that is pretty unpredictable. So for us to predict what will happen going forward is difficult. If you say, I think the Brazilian real has dropped and then came back at the end of the quarter you know, so depending on how these currencies move we will either take pricing actions or other cost actions and that there is small lag between the currency moving so sharply and the actions that you can take and therefore you have a shorter term impact. We will have a bit of an impact in Q4. We expect that to be less than what is it in Q3, but its almost impossible for me to predict you now what will happen with the currencies. And then if you look at - the D&T to call it a slowdown in Q3 is I think a bit harsh you know, given the 6% growth in the market which is growing 3% to 5% at best with a strong order intake growth, I think these are phasing issues same thing that happen through the year. So there's lower service, yes. I mean, over time that will pick up, but…

Frans van Houten

Analyst · Deutsche Bank. Please state your question, madam

Also about the transformational growth into profit.

Abhijit Bhattacharya

Analyst · Deutsche Bank. Please state your question, madam

Yeah. So I think you know, as we go into next years with the service revenues also picking up on the basis of strong installed base growth you will see margins continuing to rise because we have to keep – go towards the 14% to 16% percent range in the next couple of years.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Okay. Sorry. My line chopped off, while you were commenting on last bit of the FX, so did you say that the FX impact for the fourth quarter will be less than the third quarter?

Abhijit Bhattacharya

Analyst · Deutsche Bank. Please state your question, madam

Yes, I did. But difficult for me to predict, no its just simply difficult because like I said we don't hedge on emerging market currencies. If they bounce back a little bit like we saw the Brazilian real bouncing back that will help us. We also seen that in a couple of currencies also emerging markets now given the increased volatility the cost of carry has not moved, as much as the increase in volatility. So on those currencies we can also take certain shorter term hedging measures, as well as pricing measures. So we think we can mitigate some of it in Q4. But there will be some headwinds in Q4 for sure.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

And your margin improvement target, is that on as reported basis or is that in constant currency...

Abhijit Bhattacharya

Analyst · Deutsche Bank. Please state your question, madam

No, that is as reported. So despite the hits that we get on currency, we have to compensate for those. So it's a tough target without taking out currency impact.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Okay. Thank you very much.

Frans van Houten

Analyst · Deutsche Bank. Please state your question, madam

Thank you.

Operator

Operator

The next question from Mr. Scott Bardo from Berenberg. Please state your question, sir.

Scott Bardo

Analyst · Berenberg. Please state your question, sir

Yeah. Thanks very much for taking my questions. So firstly on Personal Health, and given the slightly softer recovery in growth that you've seen in the third quarter, I wonder if you could add the comments about expectation for the full year, where I think you'd previously shared the view of mid-single-digit growth for that division. Is that still now attainable in your mind? And also, I'd just like to follow up a little bit on the messaging for margins for that division given the headwinds you face into next year. Is this just the underlying message that you don't expect much in the way of margin improvement to Personal Health in H1? Thanks very much.

Abhijit Bhattacharya

Analyst · Berenberg. Please state your question, sir

So if you look at the PH, yes, I think there was - there was some noise around whether we will be in the 5% range given where we ended Q3, especially the 80 basis points impact from currency trade restrictions, as well as the weather. We will be at the lower end of the mid single digit, so the mid single digit is 4% to 6%. We will be at the lower end of that range, but still within the 4% to 6% is what we expect. And regarding the margin improvement, yes, for the first half of next year we will have not only the FX headwinds, depending a bit on how currencies develop, but you will also have the headwinds on account of the tariffs and the mitigating actions would come more towards the second half in terms of actually impacting the P&L So therefore the year-on-year step of in the first half of the year will be lower.

Scott Bardo

Analyst · Berenberg. Please state your question, sir

Understood. And just a point of clarification on group guidance, I appreciate you've reiterated your midterm expectation today. But I think, again, the group had commented that you expect to come comfortably within your topline guidance this year, and also within your 100 basis points margin expansion. And I just wonder, given the year-to-date topline development and slightly more burdensome currency, do you still expect to deliver your midterm framework this year?

Frans van Houten

Analyst · Berenberg. Please state your question, sir

Yes, absolutely. Frans, here. I can confirm that. I mean, year-to-date revenue growth is at 4.4% we expect to be comfortably in our range for the full year. We also believe that we are on track to deliver the 100 basis points for this year.

Operator

Operator

We’ll now take the next question from Mr. Max Yates from Credit Suisse. Please state your question, sir.

Max Yates

Analyst · Credit Suisse. Please state your question, sir

Thank you. Just my first question is around free cash flow. Obviously you have the guidance of €1 billion to €1.5 billion per year. Is there any reason when we look ahead to your sort of usual very strong Q4 that you shouldn't be entering into the I guess the lower end of this range this year. Or is there anything we should be aware of as we go into Q4 as to why it may be difficult to get in that range?

Abhijit Bhattacharya

Analyst · Credit Suisse. Please state your question, sir

No May, the plan is to be in that range. If you look at the last 12 months rolling cash flow we are in that range as well. We have had a bit of dip in Q3 because we had to move some inventory around and build some inventory as well lining up for some plant closures, as well as to let say, ship stuff to countries before the duties came into effect and we carry that at the end of Q3. The plan is to convert that to cash in Q4, so we should be okay. And also Q3 includes one-off pension contribution of €130 million. So if you take that out, I think we still have let’s say, €900 million or slightly less than that for the – for Q4 which we are planning to do.

Max Yates

Analyst · Credit Suisse. Please state your question, sir

Okay. And just a second one, obviously, within Personal Health, the Chinese - the China growth was double-digits, so relatively strong. But could you give us any sort of feel of how demand evolves through the quarter whether within September you were may be picking up sort of any weakness in China given trade tariffs. Obviously some weakness and potentially weakening signs in the economy and whether there was any sense, that was actually feeding through to underlying demand as we move through the quarter?

Frans van Houten

Analyst · Credit Suisse. Please state your question, sir

Hi, Max. Frans, here. We actually saw a pretty even quarter. So there is no telltales of weakening demand at all.

Max Yates

Analyst · Credit Suisse. Please state your question, sir

Okay. Thank you very much.

Operator

Operator

The next question comes from Mr. Julien Dormois from Exane. Please state your question, sir.

Julien Dormois

Analyst · Exane. Please state your question, sir

Hi, good morning, gentlemen. I have two questions. The first one would be on the CCHI division. I was just wondering what it would take to go back to the kind of mid single digit to high single digits growth guidance that you've given for the next few years. Is it just a matter of the defibrillator sales resuming in the U.S. or is there something that we should expect in the next few years? And the second question is actually on Diagnosis & Treatment, you will now be entering a period where you are going to face very tough comps from an organic growth perspective, so from Q4 onwards. So I know you have now very strong order book and you've indicated that it should flow through the sales. But I'm just wondering whether you are confident in maintaining kind of a mid single digits growth going forward in that business?

Frans van Houten

Analyst · Exane. Please state your question, sir

Hi, Julien. Let's first talk about CCHI, and order growth in 2017 was not strong and the market in 2018 is kind of flattish. Philips is 50% of the monitoring market in the United States. With a flattish market that has reduced our ability to grow. And nevertheless our order intake gross is around 5% in this third quarter, underlining the strengths of the innovation portfolio. And we know from our funnel analytics that we have many customers that are engaged with us on large projects. And now decision making in large hospitals has certainly not improved. There's quite some carefulness on the CapEx side. Moreover, some of these deals become subscription deals, like Jackson Health in Florida, which is a platform-as-a-service and therefore it will not come with a big spike in business. And so to round it off, I'm confident that CCHI can get back on a higher growth rate starting now, underpinned risk and higher order book, order growth already, but also let’s say, continuing next week, and next year. I'm sure we will talk about during Capital Markets Day and give you more color. On D&T, we are outperforming the market. We expect to continue to outperform the market in all three businesses in D&T. We have strong innovations that are well received. And we have been outgrowing the market by a factor, if not more than that. And so you can expect us even when the comp becomes more difficult to continue to outgrow the market. And then of course, this massive order book increase starts to become translated into higher revenue growth as well.

Julien Dormois

Analyst · Exane. Please state your question, sir

Okay. Thank you very much.

Operator

Operator

The next question comes from Ms. Lisa Clive from Bernstein. Please state your question, madam.

Lisa Clive

Analyst · Bernstein. Please state your question, madam

Hi. I have two sort of longer term questions. One, just thinking about these long-term partnerships that you're signing. Data analytics and artificial intelligence become a bigger theme in medical imaging and also patient monitoring, access to data is likely to be a notable competitive advantage. So what exactly are you doing to ensure access to data now and in the future? And I suppose, specifically I'm wondering whether in those various long-term partnerships that you've signed over the past several years. You have terms in those contracts around data sharing where you can use this patient information for R&D purposes?

Frans van Houten

Analyst · Bernstein. Please state your question, madam

Yeah, great question. We tried to collaborate as much as possible with our customers on learning from data. I would like to point out that we don't need to own the data in order to learn from data. In LSPs, there's very often also a research component in the contracts where we have certain focal points on advancing - advancing our platforms. Besides LSPs by the way, I'd like to point out that we have a great platform called IntelliSpace Discovery which is targeting research hospitals where we do an open platform play to have these hospitals collaborate on AI application development. This is going very, very well and we have already some 30 hospitals doing collaborative research in our IntelliSpace Discovery this year with the aim to unlock the power of data. So it's an exciting topic and I will review the program on Capital Markets Day to make sure that we talk enough to give you some more data points on how that's going.

Lisa Clive

Analyst · Bernstein. Please state your question, madam

Okay. And just a second topic, in the press release there was the mention of the IFR technology and becoming part of the European Society of Cardiology’s updated guidelines. Could you just give us an – some color on the outlook for that technology exit - amongst your existing customers? Do you have any idea how often they use IFR versus FFR. Where do you think penetration to get to in the next five years? And given the changes in the guidelines in Europe should that be a much faster growing market than the U.S. or other regions?

Frans van Houten

Analyst · Bernstein. Please state your question, madam

Look, we are optimistic about it. The level of detail that you now ask, I think extensive - exceeds the scope of this meeting. We have Bert Van Meurs, who is the leader of our Image-Guided Therapy business at the Capital Markets Day. So please, be my guest to grill him personally on these questions.

Lisa Clive

Analyst · Bernstein. Please state your question, madam

Fair enough. Thanks.

Operator

Operator

The next question comes from Mr. Wim Gille from ABN AMRO. Please state your question, sir.

Wim Gille

Analyst · ABN AMRO. Please state your question, sir

Yes, good morning. My first question will be on CCHI, the margin dropped by 190 basis points. And you also indicated FX had an impact in this division as well, but not as big as in Personal Health, so the FX impacts can only account for a small portion of that 190 basis points. Is the rest of the impacts purely a mix effect and can you walk me through how that works in terms of margins between the monitoring business and the rest? And my second question would be on the Brexit theme. You’ve given us great detail on how to model the U.S. trade implications. But can you give us a bit of a flare on what you expect to happen in case a hard Brexit comes closer?

Abhijit Bhattacharya

Analyst · ABN AMRO. Please state your question, sir

Let me take the first part Wim, so the decline is primarily a mix impact. There was an FX impact, but we don’t call that out as the big thing, but also the sales, lower sales, so this is a high margin business with relatively fixed cost base and therefore when you have topline decline that you now see in CCHI about 75% of sales come from patient monitoring and when that is slow as Frans mentioned market is kind of close to flat or marginally up, that's what hits the margin. So going forward, you know, once we are able to execute a few more of the monitoring sales, then we should see margins coming back pretty quickly.

Wim Gille

Analyst · ABN AMRO. Please state your question, sir

Okay.

Frans van Houten

Analyst · ABN AMRO. Please state your question, sir

Yes. Your second Wim on question on Brexit, as far as the European round table of industrial companies we have been extensively dialoguing with the UK government on consequences of Brexit. At Philips, we estimate impact on cost, especially due to higher administrative burden, potential duties and other cost factors to be in the high single digit impact on the goods flow. Put all Philips I would say that is still going to be relatively minor. So I don't think the takeaway should be that this is going to be influencing our global results, but it does potentially make manufacturing in the UK to less attractive. I've always advocated for a frictionless border, which should actually be a cost of union. And yes, I think we are all concerned with the lack of progress in that context. But I want to reiterate that you know, for the bigger Philips, we should not take away that this is going to influence our overall commitment on delivering a 100 basis point improvement next year.

Wim Gille

Analyst · ABN AMRO. Please state your question, sir

Thank you.

Operator

Operator

The next question comes from Mr. Mr. Danny van Doesburg from APG. Please state your questions, sir.

Danny van Doesburg

Analyst · APG. Please state your questions, sir

Yes, good morning. Two short questions. Maybe an update on Spectranetics, especially for European situation, where are we in the new product launches and sales? And second question is about research and development, happy to see that productivity of R&D is now as mentioned there's a concern or at least the target. But how would you define productivity and specially that you measure it to be up 40 to 60 bps going forward? Thank you.

Frans van Houten

Analyst · APG. Please state your questions, sir

Hi, Danny. Spectranetics is doing well. In the quarter we had strong growth. Also Europe is contributing to that growth. We had double-digit growth globally for Spectranetics. So I'm very positive about it. Then indeed R&D productivity is a theme, I mean, for a company like us who invest €1.8 billion annually in R&D, clearly becoming more data driven around R&D productivity is a natural direction. I can tell you that every R&D project run in the company is in a central database. It is and has a business case to it. We are tracking on timelines, on cost levels and on the business case, putting a minimum threshold of value creation in every R&D project. All of these efforts mean that less important projects will be filtered out. We are also able then to reduce overhead costs in the R&D organization. I mean, we have more than 50,000 [ph] people working in R&D. So you can also work on indirect costs there which we are doing. And then finally, in terms of talent management, we also find that some people are more productive than others and therefore we can also optimize on that front. So it's a very interesting source of productivity gains that perhaps historically we had left more to the lower levels to manage. But these days, we are also having it firmly adding it into our scope.

Danny van Doesburg

Analyst · APG. Please state your questions, sir

But on Spectranetics Frans, is it already selling in most of the European countries today or is it still some countries left on…

Frans van Houten

Analyst · APG. Please state your questions, sir

Sorry, I misunderstood your question, Danny. Yes, the Spectranetic products are being sold in all European countries and that also contributing to the higher growth. I mean, in fact, due to the discontinuation of the drug-coated balloon extra reimbursement in the United States, the revenue growth there was a bit on a pressure. But let's say the growth elsewhere in the world has picked up, all together being able to do double-digit growth for Spectranetics in Q3, it's just a testimony of the traction that we are having. And so I hope that helps your...

Danny van Doesburg

Analyst · APG. Please state your questions, sir

Yeah, sure. Thanks. Thank you, sir.

Operator

Operator

We have a follow up question from Mr. Veronika Dubajova from Goldman Sachs. Please state your question, madam.

Veronika Dubajova

Analyst · Goldman Sachs. Please state your question, madam

Great. Thank you for squeezing me. And I just had one more follow up on the Personal Health slowdown this quarter. And I'm curious, Frans, Abhijit, if you can talk a little bit about where you see respiratory in the fourth quarter and into ’19? It's historically been a business that was pretty consistent in terms of growth. So I'm a little surprised by the magnitude of the slowdown that you've seen and what you're putting into place to try to accelerate that growth? Thank you.

Frans van Houten

Analyst · Goldman Sachs. Please state your question, madam

I think the sleep and respiratory franchise is strong. International markets continue to grow double-digit. In United States, we have seen a little bit more lumpiness due to in relation to large customer orders. I would say there is nothing structural to be concerned about. The franchise is intact and we expect also next year strong growth. Perhaps on the back of this question, happy to report that our endeavors to step up mask sales is going well. This, of course, always the difference between our competitor and us is that they had more mask sales and we had more system sales. Therefore extremely pleasing that we are growing double-digit on the mask side with our Dream series masks. And yes, as I said, I see no reason to change our outlook on the sleep and respiratory care business.

Veronika Dubajova

Analyst · Goldman Sachs. Please state your question, madam

That's great. Thank you very much.

Frans van Houten

Analyst · Goldman Sachs. Please state your question, madam

You’re welcome.

Operator

Operator

We have a question from Mr. Ian Douglas-Pennant from UBS. Please state your question, sir.

Ian Douglas-Pennant

Analyst · UBS. Please state your question, sir

Thank you. I shall be very quick, they’re small questions. Could you and I'm sorry if I missed it, could you give us the Health & Wellness in domestic appliances revenue growth rate numbers for the quarter or just an indication of where they were. And secondly, a request on currency in the past you have declined to give us any indication of what the currency impact might be on margins. . And then, of course, this quarter it's a major driver of the disappointments. I mean, could you just reconsider doing that in the future because, evidently, you do have an idea of what impact you would have, so just some - just some kind of guidance that you could circulate will be helpful even if you don't have it at hand now?

Abhijit Bhattacharya

Analyst · UBS. Please state your question, sir

Ian, thanks. A couple of things. So DA growth was also mid single digit and Health & Wellness was flat for the quarter. So that answers your first question. On the FX guidance, you know, it is close to an impossibility to do because if I had guided you are the start of Q3, I wouldn't have known what exchange rate movements have happened in the quarter. So yes, we could appear to be very intelligent at the beginning of the quarter and give guidance and then change it later on. So that’s simply an area which I - I'm sorry, but I don't want to get into because we just don't know what will happen. And like I said, the worry is less on the developed market currencies and the exposure is on the emerging market side. So that part we just have to unfortunately keep open.

Ian Douglas-Pennant

Analyst · UBS. Please state your question, sir

I'll follow-up with IR. I've got some ideas about how you could deal with that?

Abhijit Bhattacharya

Analyst · UBS. Please state your question, sir

Okay. Always open to your guidance. Thank you.

Operator

Operator

We have a follow up question Ms. Yi-Dan Wang from Deutsche Bank. Please state your question, madam.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Okay. Thanks very much. So a quick follow up and I've got a couple of others. So on the FX, you already do it for the revenue, so – and that's based on spot rates. So it would really be helpful if you could do it on a margin, too, on the same rationale. And then on CCHI previously you said that you were happy to – well, you were on track to deliver around the mid single digit growth for ‘18. That seems unlikely to occur. So just wondering what has changed. Has the time it takes for your customers to accept the technologies lengthened even further or has something else occurred? And then for the D&T margins you commented on growth investment. So just wondering you know, how much of the margin, I suppose shortfall is due to additional investments that you are placing or how we should think about that going forward, given the large number of new products that you have going on currently?

Frans van Houten

Analyst · Bank of America. Please state your question

So on the FX guidance I think you repeat Ian's request. We'll have a chat with a couple of you to see if there is a way to give you some idea. But like I said, you know, that’s very volatile area and giving any kind of definitive guidance as it doesn't work, but I'm happy to listen and talk to you after this. Regarding CCHI, could you repeat the question because you talked about…

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Earlier in the year you commented that you were happy - you were expecting around mid single digit growth for that business, Its going to be very backend loaded, so looking at the performance of the business year-to-date, it doesn't seem that you’re getting there, and if you tell me you still will get there? Yes.

Frans van Houten

Analyst · Bank of America. Please state your question

So if you look at the first three quarters it becomes close to impossible to get there, so let us not – so I think there we will be clearly lower in terms of growth. And regarding the growth investments in D&T as I mentioned earlier, its largely R&D resource, capitalized which now flows through the P&L. So I think and most of our product launches have been done. So those costs are coming in as we speak. So I don't expect the further step up of those costs in the quarters going ahead.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Okay. On the CCHI, was really what has changed that you won’t get to middle single digit, has the time to for your customers to you know, to take the product…

Frans van Houten

Analyst · Bank of America. Please state your question

Yeah…

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Is that taking even longer?

Frans van Houten

Analyst · Bank of America. Please state your question

No, no. I mean, we have indeed in the past referred to custom orders taking longer to get to revenue as a, let’s say argument, why for example a quarter was a bit lower and than it flowed into next quarter. What we haven't really talked about so much is that CCHI also has a book and bill business, more flow business for monitors and consumables and so on. Overall, we see the whole monitoring market in the United States as flat with no growth basically and we are 50% of that market, which means that the overall - the overall growth rate of CCHI has a setback when it comes to our ability to deliver on our targets. The big orders continue to come and there continues to be a strong interest, but it is not the only source of growth possible. And therefore the overall market sentiment has also given a slower environment. And we have not been losing market share in CCHI. I'm very confident about that. And when I speak with - and Carla Kriwet, when speak with hospitals C-suite, this continues a very interesting area for them and therefore I do expect the market to recover. And if any signal is giving confidence, it is the order intake in the third quarter which for the second quarter in a row now is at mid single digit. And that means we are starting to rebuild order book for - to underpin next year's growth.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

But has the market actually deteriorated quite significantly in the third quarter because last quarter you were relatively confident about achieving that mid single digit growth based on your - the order funnel that you mentioned?

Frans van Houten

Analyst · Bank of America. Please state your question

If I recall last quarter we spoke at lengths about the imaging market, where we are growing double-digits. And I think I acknowledge that the imaging market was growing around 4%. And I - in hindsight, I think I perhaps have not been clear enough that the sign – the telltales of the connected care and monitoring markets being at that time at a flat to low single digit growth rate seems to be continuing, all right, and perhaps we were a bit more optimistic that it would already recover, but it hasn't yet. So it's still flat.

Yi-Dan Wang

Analyst · Deutsche Bank. Please state your question, madam

Thank you.

Frans van Houten

Analyst · Bank of America. Please state your question

You're welcome.

Operator

Operator

The last question comes from Mr. Scott Bardo from Berenberg. Please state your question, sir.

Scott Bardo

Analyst · Berenberg. Please state your question, sir

Thanks for the follow up, real quick. You mentioned that the - from Cleveland is slightly underway in Q1 2019. And it is my understanding that that's supposed to be an H2 '18 event. So I just wonder if you could confirm that it's a little bit delayed and perhaps going through some explanations why. Also, just please a follow-up on Abhijit's description of the slightly softer margin in D&T. I think you mentioned that it was due to mix effects. Could you square that a little bit with the strong growth that you've seen in Ultrasound and in interventional, which I thought were slightly higher-margin businesses? Thank you.

Frans van Houten

Analyst · Berenberg. Please state your question, sir

Yeah. Hi, Scott. Yeah, Cleveland I think we have talked about closing the last line by the end of the year. We have some remaining inventory of components that we would like to burn off and therefore we see that continuing into Q1. That's the most efficient way for us to deal with what is in the warehouse. And I don't see it as a structural slip as such. Then the margin, I think through the call we have had a couple of times that we talked about it, on the one hand you referred to, or you have high equipment sales growth then you get a mix shift because equipment has lower profitability than service. And it will take some time for the service revenue to catch up with the equipment revenue growth because first year you are always in warranty period. The equipment growth rate was north of 6% in the quarter, service growth rate was I think around 2%. Just to elucidate the mix shift there. Besides that Abhijit mentioned, that you get the flow down of our R&D depreciation, that capitalized R&D into the P&L. And you're right, we see strong growth of ultrasound that does have a higher profitability. So altogether, I'm not worried about our ability to bring D&T to the mid teens over time. I mean, that is our commitment. We can dissect it on a quarter basis in great detail. But what matters is that D&T will get to the mid teens and that is what I am confirming here today.

Scott Bardo

Analyst · Berenberg. Please state your question, sir

Very good. Thanks, Frans.

Frans van Houten

Analyst · Berenberg. Please state your question, sir

All right. You're welcome.

Frans van Houten

Analyst · Berenberg. Please state your question, sir

All right. I think we at the end of the call. I appreciate everybody's questions, great questions. And if there's any message that I want to leave with you is this that, I am very conscious of the reaction today, but our conviction here at the table is just that we have a great company with many levers pointing in the right direction and we stay entirely committed to our guidance of on-growth and profitability improvement. And I hope that we’ll have some credibility with you guy’s.

Operator

Operator

This concludes the Royal Philips third quarter 2018 results conference call on Monday, 22nd of October, 2018. Thank you for participating. You may now disconnect.