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Edited Transcript of PHIA.AS earnings conference call or presentation 10-Oct-19 7:30am GMT

Preliminary Q3 2019 Koninklijke Philips NV Earnings Call

Amsterdam Oct 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Koninklijke Philips NV earnings conference call or presentation Thursday, October 10, 2019 at 7:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Abhijit Bhattacharya

Koninklijke Philips N.V. - Executive VP, CFO & Member of the Board of Management

* François Adrianus van Houten

Koninklijke Philips N.V. - Chairman of the Board of Management & CEO

* Leandro Mazzoni

Koninklijke Philips N.V. - Head of IR

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Conference Call Participants

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* David James Adlington

JP Morgan Chase & Co, Research Division - Head of Medical Technology and Services Equity Research

* Hassan Al-Wakeel

Barclays Bank PLC, Research Division - Research Analyst

* Michael Klaus Jungling

Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst

* Patrick Andrew Robert Wood

BofA Merrill Lynch, Research Division - Director in Equity Research and Head of the EMEA MedTech & Services Team

* Scott Bardo

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Veronika Dubajova

Goldman Sachs Group Inc., Research Division - Equity Analyst

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Presentation

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Operator [1]

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Welcome to the Royal Philips update on the financial performance in Q3 2019 on Thursday, the 10th of October 2019. During the call hosted by Mr. Frans van Houten, CEO; and Mr. Abhijit Bhattacharya, CFO. (Operator Instructions) Please note that this call will be recorded and will be available on the Investor Relations website of Royal Philips.

I will now hand the conference over to Mr. Leandro Mazzoni, Head of Investor Relations.

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Leandro Mazzoni, Koninklijke Philips N.V. - Head of IR [2]

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Good morning, everyone, and thank you for joining our third quarter 2019 update call. I'm here with CEO, Frans van Houten; and CFO, Abhijit Bhattacharya.

After some remarks by Frans, there will be an opportunity to ask questions. Over to you, Frans.

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [3]

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Yes. Thank you, Leandro. Good morning, ladies and gentlemen. Thank you all for joining this call this morning. I'd like to provide some color on the update on the financial performance in the third quarter 2019 that was published earlier this morning on our website.

During this call, Abhijit and I will gladly take some questions. But in terms of the numbers, we need to restrict ourselves to the information contained in the press release for obvious disclosure reasons.

In the quarter, we continued to see good growth momentum across our businesses. Group sales are expected to amount to approximately EUR 4.7 billion, reflecting a strong 6% comparable sales growth with actually all businesses contributing.

I am pleased with the continued adjusted EBITA margin improvement in Diagnosis & Treatment and in the Personal Health businesses, which are in line with our expectations. It is disappointing that the margin in the Connected Care business is expected to decline by 4.5 percentage points to 11.3% of revenue in the quarter. The decline was due to increasing headwinds from tariffs, but related to that, a delay in the impact of the mitigating actions to offset those headwinds. We also saw factory undercoverage as production levels were lowered to reduce inventory and an adverse product mix impact.

As a result of this, and additionally, shortfall of around EUR 20 million of license income in the segment Other, group adjusted EBITA for the quarter is expected to be around EUR 583 million or 12.4% of sales, and that compares to 13.2% in the third quarter of 2018. I wish to underline that the fundamentals of the Connected Care business are strong. But we do need to acknowledge that the businesses are affected by headwinds and have several transformations underway that are impacting results in the short term.

I am going to stay very close to those businesses in the weeks and months to come to make sure that they deliver on the improvement actions that have already been rolled out. And as I mentioned, we saw a delay in the impact of these actions, but there are very good actions underway. So we will drive execution of these mitigating actions. And we also plan to elaborate further on the progress of these plans in due course and, in particular, of course, at the end of October call.

So let me conclude. As you know, since 2016, Philips has been on a consistent performance improvement trajectory. We have delivered 3 consecutive years of mid-single-digit comparable sales growth and at least 100 basis points of annual adjusted EBITA margin improvements. We expect the good growth momentum to continue. Given the overall significant headwinds and the current underperformance of the Connected Care businesses, we now expect the full year 2019 adjusted EBITA margin improvement for the Philips Group to be around 10 to 20 basis points. And if I look ahead to 2020, I can tell you that we expect to deliver 4% to 6% comparable sales growth and an adjusted EBITA margin improvement of around 100 basis points.

I'm sure that you have many questions, so we'll now open the line to try to answer as many as we can in the limited time available. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Veronika Dubajova from Goldman Sachs.

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Veronika Dubajova, Goldman Sachs Group Inc., Research Division - Equity Analyst [2]

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I'll keep it to one. I was hoping, Frans and Abhijit, you could comment on how you think -- sort of how you see the medium-term margin expectation for CC. Obviously, you had guided for 16% to 18% in the past. Is that still an achievable target and if it's the issue here or just that you're achieving that target later? Or should we be thinking about this business as generating a lower margin, not just in the short term, but more over the medium term?

And I guess related to that, just it sounds to me like a lot of the issues here are timing issues as opposed to fundamental issues. So if you can kind of comment on that, that would be helpful.

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [3]

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Yes. Veronika, thank you. The fundamentals of the Connected Care business are strong. The 2 main carriers of that belief are obviously Sleep & Respiratory Care and patient monitoring, Monitoring & Analytics. These are very strong businesses with very good margin structures and market shares. We have been and are investing in the business. That is, of course, pressing on the results.

Connected Care has many product categories. The headwinds are, therefore, more complex to mitigate because you need to go into many different products, components, set assemblies, factory locations. So that is one of the reasons why it takes longer to have these mitigating effects take full impact as opposed to, for example, a Personal Health where you have high-volume products. So if you fix one mitigating action on a tariff issue, then you get instantly the entire benefit on the entire volume, right. And so Connected Care, therefore, a more -- a broader business. The example of the factory loading, that's a temporary thing also right. So that will dissipate fairly quickly. The overall customer demand, we think is strong. It has been lumpy, but we continue to see a very strong funnel.

So overall, I'm absolutely convinced that the fundamental attractiveness of Connected Care is assured. I'm, of course, very much aware that we have now seen a couple of quarters of lesser performance. We were expecting an improvement in the third quarter. In fact, September also didn't work out as we had expected. So in that sense, we really need to be very close and make sure that we drive these actions, and that we materialize the improvement that has been targeted. And so both Abhijit, myself and Carla, we will all do that, and then we will see a gradual improvement over the next quarters, plural, into next year. And I'm convinced that we can get this business to strongly contribute to Philips overall. We, of course, are also still dealing with the consent decree, right. So there is a lot on the plate of management concurrently.

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Operator [4]

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We will now...

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Veronika Dubajova, Goldman Sachs Group Inc., Research Division - Equity Analyst [5]

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Abhijit -- that's fine. I'll take it offline

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Operator [6]

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The next question comes from Mr. David Adlington from JPMorgan Capital.

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David James Adlington, JP Morgan Chase & Co, Research Division - Head of Medical Technology and Services Equity Research [7]

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Yes, maybe just you could give us some help with Q4 because hit the reduced guidance, you're still going to have a pretty decent improvement. I think about sort of 80 basis points given the flat year-to-date performance and actually, you've got a pretty tough comp in the fourth quarter. So maybe you could just sort of help us the sort of trajectory, and what levers you can pull for that Q4 performance, please?

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [8]

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Yes. Of course you know that, always, our fourth quarter is significant, and we have always said 2019 will be back-end loaded. And in fact we expect, yes, a strong quarter in terms of revenue, but also several of these mitigating actions are expected to further kick in. We have done our -- yes, math and we feel that this is a plan that is well bridged to deliver the improvements so that we can get to the 10 to 20 basis points for the full year.

I'm looking to Abhijit, whether you want to provide some more technical color into it.

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Abhijit Bhattacharya, Koninklijke Philips N.V. - Executive VP, CFO & Member of the Board of Management [9]

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No. I think if you look overall, Frans, you mentioned that in your introduction, right, D&T and PH are on a good trajectory and, let's say one of the segments which has pulled us back. So I think overall, the trajectory will remain for the other 2. And if we are able to get some momentum back in Connected Care, I think driving an improvement in Q3 is still -- Q4, sorry, is very much on the cards. So I think we leave it at that for now.

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Operator [10]

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We will now take our next question from Michael Jungling from Morgan Stanley.

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Michael Klaus Jungling, Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst [11]

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And my question is in relation to your order growth number for the quarter. I think you mentioned it is going to be flat. Could you please provide some color geographically where the weakness is coming from and perhaps also some color in what product categories you are seeing weakness in your order growth?

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Abhijit Bhattacharya, Koninklijke Philips N.V. - Executive VP, CFO & Member of the Board of Management [12]

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Michael, I think if you look at the order book growth, first is, of course last year, we had a very strong Q3. We had an 11% growth. I think the order momentum in our D&T and service-related businesses is still strong, so it's nicely in the 4% to 6% range. Connected Care was flattish. And so also actually we had in the informatics businesses a bit lower. From a geographic point of view, a couple of markets had, let's say reasonably large declines in Western Europe, which is not something that we are particularly concerned because we believe that those are shifts between quarters.

China was strong. So China, we expect to be in the double digit. So I think China being -- is more or less offset by negative growth in North America and Western Europe. I think that's how you should look at it.

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Michael Klaus Jungling, Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst [13]

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And Abhijit, North America, you said was positive or flat?

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Abhijit Bhattacharya, Koninklijke Philips N.V. - Executive VP, CFO & Member of the Board of Management [14]

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No, was a decline. So that decline in North America and Western Europe actually offset the growth in China. So China continues to remain strong and performing extremely well.

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Michael Klaus Jungling, Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst [15]

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So is there a risk here that maybe we're seeing a slowdown in the capital equipment market that is leading to a slowdown? Is that the sense that you're getting? Or is it just coincidence that Q3 is flat?

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [16]

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Yes, we have earlier talked about this and that we do, of course, see market headwinds. And I think I said that the North America market is a little bit less robust than last year, right. So where we saw maybe 4% growth last year in the U.S., now it's more 2%, 3%. Europe is largely flat, and China continues to grow strongly.

In terms of LTM order growth, we are at 5%. And year-to-date, slightly below that. If I look at our funnel of opportunities, it's very strong. And I reiterate what I've said before, I see no reason why we cannot maintain an order growth that substantiates the 4% to 6% revenue growth. And it is a bit lumpy. I expect that several of those opportunities in the funnel will materialize also in Q4. So let's not get hung up on 1 quarter of flat order growth. That I don't think is evidence of our overall change in the sentiment that we have, which helped a lot.

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Operator [17]

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We will now take our next question from Patrick Wood from Bank America Merrill Lynch.

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Patrick Andrew Robert Wood, BofA Merrill Lynch, Research Division - Director in Equity Research and Head of the EMEA MedTech & Services Team [18]

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Just the one. Just taking a step back, curious to see how this sort of came about in the sense of narrative. Obviously, the public commentary that you guys gave and the communication to us was still reasonably positive on the margin structure of the guidance up until very, very recently. So I'm just curious as to how it happened quite quickly that we came to a new view. Was it that internally, people were sat on bad news? Or was there a delay in the management information systems internally, sending the news upwards to you guys? How much control do you feel you have over the information being set up to you? I'm just curious for a little bit of color on that.

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [19]

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Sure, Patrick. Well, so we have seen increasing headwinds, right. And we have said courageously, we will mitigate many of those headwinds, and therefore, we have talked about a net impact of those headwinds. In fact, the gross impact of the headwinds have increased, and we continue to work very hard to mitigate it. Several of those actions take time to materialize.

In parallel, we have our productivity programs that we are also working on. In parallel, we are working on the consent decree efforts. Shifting factory footprints is a lot of work. Actually, adds costs rather than, in the near term, it reduces costs. So we had maybe a little bit too much optimism in how all these actions were coming together. And then yes, it did not completely pan out like that. And I don't mind to say that I was also more optimistic and then September materialized less, right. So that is not great. This is also why I said in my opening words, that we will be very close to this business to make sure that all those actions deliver. I don't see a difference in the fundamentals of the quality of the business. Therefore, I remain convinced that just by sheer focus and hard work, we will be able to deliver the improvements, even though, realistically, we are now starting CC from a lower base, and therefore, we now need to work on improvements from that base.

This is also why we have said, next year, we look at 100 basis points. And I, of course, very much realized that that's then from the lower base in 2019. And therefore, overall, it is a -- we are behind on our original plan to get to the 15% next year. So but overall, I think it's a realistic plan and we will deliver it.

Just to remind everybody in the call, in Q3, we had, of course, another setback, and that was the license income, right. The license income is lumpy, and we cannot always predict exactly when that comes in. That was EUR 20 million in the quarter that we missed. That is something that we think can come later. Now I'm not going to make promises here whether -- when exactly that is, but we do think that there's still upside there as well.

If I take a little bit of distance and put the scorecard up, then since 2016, we have been improving 100 bps per year. We said we will do an average of 100 bps. If you take a 4- or 5-year perspective including next year, right, and divide it by 5, you would actually get to an 80 to 90 bps average improvement, right. So in other words, this is, yes, a temporary setback, but we largely and are -- stay committed to deliver on that overall guidance over that longer time line. So of course, it's not -- I'm not happy with it, but we are entirely committed to make sure that we continue the very positive run that we have been having over the years.

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Abhijit Bhattacharya, Koninklijke Philips N.V. - Executive VP, CFO & Member of the Board of Management [20]

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And maybe just to comment...

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Patrick Andrew Robert Wood, BofA Merrill Lynch, Research Division - Director in Equity Research and Head of the EMEA MedTech & Services Team [21]

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Got you. But it sounds like a tough September and too many projects at once rather than -- system is now giving you the information you need or employees fast on bad news.

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [22]

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No, no, no. Our employees did not sit on bad news. But for example, take the factory on the loading, we drive hard on inventory reduction. Okay, maybe we should have been more realistic that, that comes as a consequence with an under coverage on that factory. No, so we'll take that on us.

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Abhijit Bhattacharya, Koninklijke Philips N.V. - Executive VP, CFO & Member of the Board of Management [23]

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Maybe just a clarification. I mentioned the order intake. Like I said, couple of countries in Western Europe had declined. However, also Asia Pacific, Japan also had declined. So that actually offset most of the gains in China. So it was not the whole of Western Europe, couple of markets in Western Europe although, overall, Western Europe was still low single-digit growth. But let's say, if you look at all the big negatives, then I would also add Asia Pacific and Japan to that list.

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Operator [24]

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We will now take our next question from Mr. Zach (sic) [Scott] Bardo from Berenberg.

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Scott Bardo, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [25]

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It's Scott Bardo from Berenberg. Yes, just a few questions, please, just so we can better disentangle the profitability contributors for Connected Care. It was always my thought that the Sleep & Respiratory business is quite high margin for the company, and now that's been encapsulated within Connected Care and growing somewhat above the group, I believe. The thought was that was going to confer some positive margin development for this division. But of course, in the first 9 months, we see about, I think around 350 basis points year-on-year contraction. So can you help us understand outside of Sleep & Respiratory, roughly the profitability profile of the previous business, are we kind of at a flat situation or very modestly profitable? And how much is this division being impaired by discretionary R&D investments, which are currently loss-making?

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [26]

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Scott, the Sleep & Respiratory Care business has a program in place to increase the direct-to-patient construct for which we are developing IT applications. So that is weighing additionally on the P&L.

Secondly, we have a mix change, actually started early in the year with higher Respiratory Care versus the Sleep business, which has a different margin profile. Much of the Sleep & Respiratory Care business is affected by the tariff headwinds, and there are a total of actions going on to redesign out certain suppliers and design in other suppliers so that we can offset these duties, but that also costs extra money. We have been setting up a new factory for masks. So there is quite a bit of burden on the Sleep & Respiratory Care business as a consequence of transformation programs that we think over time will pan out. So it's a very strong business as such. We think that this is much more a, yes, temporary situation than a permanent situation.

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Scott Bardo, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [27]

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Understood. And do you think, Frans, given that Connected Care has been somewhat muted growth for some time and a little disappointing on the margin front, are you convinced that the organization or Philips has the right management organizational structure for this division? Or is there things that need to be optimized to deliver its performance?

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [28]

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Well, we have actions in place to optimize the organization. And let's remember that one of the reasons we moved S&RC into Connected Care was to merge the hospital respiratory business with the out-of-hospital respiratory business in order to drive synergies. That is in play currently, that's being worked on.

Secondly, many of the COPD patients originate out of the hospital and then become out-of-hospital patients. And we see a growing interest from the providers to have an integrated care platform for those patients. And while Sleep & Respiratory Care was part of Personal Health, we were not seeing a strong enough integration from the go-to-market on these propositions.

We have, during 2019, made several leadership changes in the businesses of Connected Care in order to strengthen the focus and effectiveness. So if I listen between the lines, are you questioning some of that? We have taken action already. Now we need to give these people some time to get their hands firmly on the business and on the right path. So we have not been sitting on our hands, I assure you, and we are very close to it.

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Scott Bardo, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [29]

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Understood. And perhaps last question. It sounds like there's obviously a lot of plates spinning and a lot of actions being taken some temporary burdens. But as we look into the next planning period for Philips, I understand you're due to communicate in H1 next year. I think consensus, the market had in a mindset that once you get to a 15% margin, further progression was possible, perhaps at a lower level than what we've seen historically from the company on the EBITA margin side. But could we expect, actually, given the slight underperformance of those targets when we get to the new planning period similar sort of outlook of 100 basis points, i.e., catch up from some of the shortfall that you see currently?

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [30]

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Well, this is then for discussion next year, but I think I've been -- and Abhijit have been consistently saying that, yes, beyond 2020, there is further improvements to be made. We benchmark every business versus competitors in best-in-class. And we know that Philips has a lot of room for improvement. In fact, there's now, let's say, if you take 2019 as a base, then there is more room for improvement than before. I don't want now to use this call to give you a perspective on how fast can we improve beyond 2020, but we will definitely talk about that and give guidance. And in previous calls, I've also said, it's not only in the adjusted EBITA that we will see improvement. But we will also see improvement in the reported EBITA because as transformations come to a close, then some of that transformation cost that is now adjusted out would no longer burden the reported EBITA. So hence, you could then see stronger reported EBITA expansion.

I would like to leave it at that because this call was really focused on delivering insights and color on the third quarter. I recognize the desire to go deeper and wider, but if it is okay with you, we will, let's say, get to a close now. And then I hope to welcome you in -- is there one more question? Okay, I'm getting signals from Leandro that there is one more question. So one more question, and then we'll wrap up.

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Operator [31]

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The last question comes from Hassan Al-Wakeel from Barclays.

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Hassan Al-Wakeel, Barclays Bank PLC, Research Division - Research Analyst [32]

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I have a couple, please. So firstly, you mentioned September wasn't as expected. Can you quantify this and perhaps mention how this compares to the rest of Q3 and your expectation -- relative to your expectations for Q4?

And secondly, if you could please talk through the adverse product mix and how you expect this to then pan out in Q4 onwards?

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François Adrianus van Houten, Koninklijke Philips N.V. - Chairman of the Board of Management & CEO [33]

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Hassan, well, if it's okay with you, I'm not going to exactly quantify September versus July and August, but we are very back-end loaded in every quarter, right. Now I'm sure that that's of our own doing. And our customers and us, we have this elaborate game going on to say, at the end of the quarter, we want to get to certain results. I see the same with competitors, but so we are very dependent on September. That also means that forecast that gets made in August is -- can be very much influenced by the realization in the last 2 weeks of September, right, and that makes it a little bit less reliable.

Let's say, normally, in Philips, we try to have enough mitigations or, let's say, compensating measures. But as you have more headwinds, let's say your compensating measures that you can work on become fewer, right, and then you are more exposed to a headwind. So I think that is a bit what all got together in -- at the end of the third quarter. Maybe we can come back on this topic at the end of October where we have more time, and also frankly, we have had more time to, let's say, prepare because we now went as fast as we could to the market after adding up the quarter results.

The adverse product mix, this has been now with us for 2 or 3 quarters, so I don't want to promise that, that will instantly change in Q4. But of course, it's very much on our radar screen to work on it. It's not that we don't want to sell the lower-margin products, but we especially need to focus on the higher-margin products and get the step-up there. So let us come back on that topic as well in the October call.

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Operator [34]

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This concludes the Royal Philips Update on Financial Performance in Q3 2019 on Thursday, the 10th of October 2019. Thank you for your participation. You may now disconnect.