Koninklijke Philips N.V. (PHIA) Earnings Call Transcript & Summary

Welcome to the Royal Philips Second Quarter and Semiannual 2023 Results Conference Call on Monday, July 24, 2023. During the call, hosted by Mr. Roy Jakobs, CEO; and Mr. Abhijit Bhattacharya, CFO. [Operator Instructions] Please note that this call will be recorded, and a replay 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. Please go ahead, sir.

Hi, everyone. Welcome to Philips' Second Quarter and Half Year 2023 Results Webcast. I have here with me our CEO, Roy Jakobs, and our CFO, Abhijit Bhattacharya. The second quarter and half year press release and slide deck as well as the frequently asked questions and deck on the Respironics recall were published on our Investor Relations website this morning. The replay and full transcript of this webcast will be made available on the website as well. Before we start, I want to draw your attention to our safe harbor statement on screen. You will also find the statement in the presentation published on our Investor Relations website. In today's call, we will discuss our results as well as the progress on the actions we are taking across different areas to drive performance improvement. With that, I would like to hand over to Roy.

Thank you, Leandro. Good morning, everyone, and welcome. It's good to be with you. I want to start with the -- with the key highlights for this quarter. First, we delivered an improved operational performance with 9% comparable sales growth and improvements in profitability and operating cash flow. The improvements were across the company with all business segments and all regions contributing. These positive results are results from our ongoing actions to strengthen our execution. Secondly, we are making progress in executing our plan and on our 3 priorities: enhancing patient safety and quality, strengthening our supply chain reliability, which supported our performance in Q4 last year and the first half of this year and establishing a simplified, more agile operating model, supporting our productivity. Thirdly, resolving the Respironics recall for patients remains our highest priority. The vast majority of the sleep therapy devices are now within the hands of patients and care providers and the complete testing and analysis for sleep devices affected by the recall showed positive and reassuring results for patients. Looking ahead, based on our strong performance in the first half of the year, our order book and the ongoing actions to improve execution, we have raised the outlook for the full year 2023. Whilst acknowledging that uncertainties remain, we now expect mid-single-digit comparable sales growth and adjusted EBITDA margin at the upper end of the high single-digit range. Now on to the key financial highlights in the quarter. We had a strong comparable 9% sales growth. Diagnosis & Treatment grew 12%, Connected Care grew 6%, and I'm encouraged by the return to growth in Personal Health. Our adjusted EBITDA margin was 10.1%, a strong improvement of 490 basis points compared to Q2 2022. Operating cash saw an inflow of EUR 135 million, a step-up of EUR 440 million versus last year. Our order book increased 3% year-on-year, even after strong order book to sales conversion of the last 3 quarters. I'm confident that this order book will continue to support sales growth in the coming quarters. On the back of the high order intake in Q2 2022 and Q1 2023, comparable order intake declined 8% in the quarter. Excluding Russia, this would have been 4%. This confirms our earlier view that orders would be lumpy as we work hard to deliver order intake growth in the second half of the year. This is founded upon strong fundamentals of the markets in which we operate as they remain strong, and I'm very confident that our innovation portfolio is well positioned to help hospitals worldwide address their staffing shortages, enhance productivity and improve patient and staff experience. The order funnel remains healthy, and we see signs of improvement in cost inflation and staff shortages in hospitals compared to 2022. But we also continue to expect hospitals and health care systems in the U.S. and other mature geographies to exhibit cautious buying behavior in the short term, given the global macroeconomic conditions. During the second quarter, we achieved some key customer and innovation milestones. We signed a multiyear agreement with University of California Irvine Health to provide enterprise monitoring as a service, including informatic solutions to standardize, centralize and scale monitoring across the health system. 5 top hospitals in Shanghai with more than 10,000 beds installed Spectral CT 7500. We also expanded our leading image-guided therapy portfolio with the launch of Zenition 10, cost-effective mobile imaging system to guide high-volume routine surgery as well as complex orthopedic and trauma procedures. We introduced a cloud-based Philips HealthSuite Imaging PACS on Amazon Web Services, designed to enhance image access speed, reliability and data orchestration for clinicians across the imaging workflow. And in Personal Health, we launched a premium 7 Series Shaver in China in partnership with JD.com, which debuted as the #1 shaver on this online channel. With that, I would like to give the floor to Abhijit to take us through Q2 in more detail, after which I will come back on the progress on our execution priorities. Abhijit, please?

Thanks, Roy. Good morning, everyone. Let's begin by looking at the segment highlights from the quarter. In Diagnosis & Treatment, comparable sales increased by 12%, driven by strong double-digit growth in ultrasound and image-guided therapy and mid-single-digit growth in Diagnostic Imaging. Adjusted EBITDA margin was 10.6%, an increase of 380 basis points over last year, mainly driven by operational leverage, a favorable mix and productivity measures. The profitability sequentially was impacted by mix and cost phasing. In the first half of the year, our adjusted EBITDA margin was 11.8% for Diagnosis & Treatment, an increase of 460 basis points compared to the same period last year. This, together with our productivity, pricing actions and order books gives us confidence for the coming quarters. Connected Care comparable sales increased by 6%, driven by double-digit growth in monitoring, partly offset by Sleep & Respiratory Care. Adjusted EBITDA margin was 7.5%, an increase of 570 basis points driven by productivity measures and a significant improvement in the profitability of monitoring. Personal Health returned to growth with 3% comparable sales increase, which is encouraging. Consumer demand remains subdued globally as we expected, but there is evidence of gradually improving sellout trends. Adjusted EBITDA margin was 13.4%, an increase of 100 basis points driven by pricing and productivity measures. Adjusted EBITDA margin for the group increased by 490 basis points to 10.1%. The wage and component price inflation came in at 260 basis points. However, this was more than offset by 150 basis points from operating leverage and by our productivity and pricing actions, which contributed a further 580 basis points. Additionally, the Q2 adjusted EBITDA included a positive impact from phasing of royalty income in line with the guidance we provided for the segment Other for the quarter. We continue to improve our cash flow with a significant year-on-year improvement. This has delivered an improvement of the leverage from 3.6% to 3.1 -- sorry, from 3.6x to 3.1x adjusted EBITDA in the first 6 months of the year. Our productivity initiatives are on track and delivered savings of EUR 237 million in quarter. Operating model productivity savings amounted to EUR 112 million, procurement savings were EUR 57 million and other productivity programs delivered EUR 68 million of savings. Adjusting items in the quarter included EUR 161 million of charges mainly related to accelerated execution of the workforce reduction plan with 6,600 role reductions to date out of the planned reductions of 7,000 roles for the year and 10,000 roles until 2025. Moving to our order book, which ended the second quarter, 3% higher compared to last year. It's worth noting that this is significantly higher compared to the period before the global supply chain constraints even after the strong order book to sales conversion over the last 3 quarters. Orders and order book are an important leading indicator for around 40% of our revenue. The remaining 60% comes from recurring revenues such as services and consumables from book-to-bill business and from Personal Health. As you can see at the bottom of the page, the absolute levels of order intake remained healthy, but we see a steep increase in sales level year-to-date due to enhanced order book to sales conversion following supply chain and execution improvements. In Diagnosis & Treatment comparable order intake declined 8% or minus 2%, excluding Russia. This follows the double-digit comparable order intake growth in Q1 2023 and a high order intake in Q2 of 2021 and 2022. Overall, order intake in Diagnosis & Treatment was mid-single-digit up, excluding Russia, following a mid-single-digit order intake growth in the first half of 2022. The Russia impact is due to longer lead times because of additional export control procedures in place since this quarter. Order intake declined 7% in Connected Care in the second quarter due to the tough comps in hospital patient monitoring after the expansion and renewal of the installed base during the period 2020 to 2022. For context, Connected Care orders continue to run at levels double-digit higher than pre-COVID, driven by fundamental demand shift in adoption of our patient care management solutions and expanding market shares. As Roy mentioned, we have raised the outlook for the full year 2023. While acknowledging that uncertainties remain, we now expect mid-single-digit comparable sales growth and an adjusted EBITDA margin at the upper end of the high single-digit range. We expect to carry the positive momentum into the second half of the year while facing tougher comparison base in the fourth quarter. The full year outlook for restructuring, acquisition-related and other charges remain in line with the guidance provided in January despite some shifts between the different cost buckets based on year-to-date results. With that, I'd like to hand it back to Roy.

Thanks, Abhijit. I would like to continue on the topic of the Respironics recall, which has been and remains our highest priority. To date, around 99% of the new replacement devices and repair kits have been produced. Over 4.5 million of the produced sleep devices are now in the hands of patients and home care providers, while the remediation of the affected ventilators is ongoing. Regarding the test and research program, Respironics has published complete testing and analysis for DreamStation One, DreamStation Go and System One sleep therapy devices in Q2, which showed positive and reassuring results for patients. We continue to work through the testing for ventilators. As previously discussed, the litigation investigation by the U.S. DOJ related to the Respironics field action as well as the discussions on the proposed consent decree are ongoing. We are also in continued dialogue with regulators across our key markets on how to service new patients going forward. I'm confident that our focused growth strategy for scalable innovation will further strengthen our businesses and results going forward. I would like to highlight some of the progress we have made in the quarter on our execution priorities. First, on patient safety and quality. Our new Patient Safety Advisory Board went live in the quarter, driving deeper engagement with patients, health care professionals and industry exports. We continue to add significant capabilities and talents across the businesses. For example, we appointed strong regulatory affairs and quality leaders to the newly formed Enterprise Informatics business. Patient safety quality reviews are fully embedded in the new performance management cadence, and we remain on track to deliver 45 production in a number of quality management systems this year, building on a 30% reduction by the end of last year. . With respect to supply chain, as of the second quarter, we have moved to customer-centric end-to-end teams closely aligned to the different businesses we operate. We continue to make progress to reduce materials and component risks although challenges remain. For example, we have accelerated the redesigns of components by completing 160 printed circuit boards compared to 56 as of the end of Q4 and we are on track to meet our target to derisk all our high-risk components by year-end. As you have seen in the results we have presented today, I'm pleased to see that the actions we have taken continue to positively impact our sales as well as our service levels. Finally, we are simplifying our operating model by putting prime accountability into the businesses supported by strong regions and lean functions. This also included the difficult but necessary reduction of our workforce by 10,000 roles globally by 2025. To date, we have reduced 6,600 roles, as mentioned by Abhijit. I want to express my gratitude to all my fellows colleagues for their dedication and commitment to deliver results as we create a more focused and agile organization. We are also strengthening our teams with new health tech talent adding seasoned leaders with deep domain expertise across businesses, regions and functions. Year-to-date, close to 300 talents with health-tech background joined our organization. Let me close out by repeating the key messages of the quarter. We delivered strong operational performance in Q2 with 9% comparable sales growth and improvements in profitability and operating cash flow. We are making progress in executing our plan and on our 3 priorities: enhance patient safety and quality, strengthen our supply chain reliability and establish a simplified, more agile operating model. Resolving the Respironics recall for patients remains our highest priority. And looking ahead, based on our strong performance in the first half of the year, our order book and the ongoing actions to improve execution, we have raised outlook for the full year 2023, acknowledging that uncertainties remain. I would like to thank you for joining the call, and we will now take your questions.

Thank you, sir. [Operator Instructions] We will now go to your first question, and it comes from the line of Hassan Al-Wakeel.

I have 3, please. Firstly, on the guidance upgrade, can we read anything into your consent decree assumptions that you've embedded into guidance? And whether they've changed at all over the last 2 to 3 months, is the delay driving any meaningful guidance benefit? And is it fair to assume that your central case is not a Respironics wide injunction? Secondly, and also on guidance, your new guidance implies a step down in growth in the second half and no real improvement in margins sequentially despite productivity and pricing benefits as well as higher absolute revenues in the second half. So what's driving your caution here? And then finally, could you talk about your return to market in CPAP outside of the U.S. and whether you're in discussions with regulators and what the process is here, do you expect to return to other markets in the second half of this year?

Thank you, Hassan. Let me start with taking your first question. So in terms of the guidance, and whether there's anything to read into the CD. So actually, we have not adjusted any CD assumptions as we are still in discussion on the CD and as we don't want to expect that on any outcome, we also have not touched any of the underlying CD assumptions. What we have looked at is the underlying improvement of our business. And as you have seen, based upon a strong Q1, strong Q2, and also the fact that the actions we are taking are yielding their results in terms of getting more supply to convert our order book that is strong as well as driving productivity that has been the reason why we kind of have upped the raise for the full year and of the guidance. We have also said that uncertainties remain. That's something that we have been saying from the beginning of the year. We are still living in a quite kind of dynamic macroeconomic environment. So that's something that we keep on the back of our minds, so that we kind of also are ready to kind of address any of those dynamics that could happen also in the second half. But we, of course, remain fully focused to carry the group momentum through into the second half but also do have some tougher comps that will kick in, especially in Q4 as that's at the moment that we turned back into growth last year. And that we have, of course, been able to pull through in Q1 and Q2. And that's, in essence, combining, I would say, added the answers in your first and second question. Then we turn to market out of U.S. So we are indeed in discussion with regulators as we are also now completing especially on the sleep side, the recall in many markets. We have made great progress there, and that then also leads to the subsequent discussions on how and when to turn to growth. So that's something that we will see probably materialize further into second half, and we'll keep you updated at the moment that we have any further news there.

That's helpful. Roy, I guess if I can just follow up on the CD. I mean you state that you're in advanced discussions and you have received drafts even in the recent months. Have your discussions with the FDA changed at all? And is it fair to assume that your central case, which you embed within guidance is not a Respironics wide injunction?

Hassan, as we said earlier, we do not speculate on the outcome of the CD as many variations are possible. I can continue to stress that we are in active dialogue with the FDA that remains ongoing. There's also no specific reason kind of -- for kind of further time line on that. We want to get it, of course, resolve as soon as possible as does the FDA with the patient interest in mind. But it also is fair to say that these are important and detailed discussions that are happening, and that's why kind of we continue to progress on those.

Perfect. And sorry, a final one, just to follow up on the margin commentary. Just given the strength in Q2 and the impact from workforce reduction, how far are we through that in terms of the realization of benefits? What should we expect for the remainder of the year?

Hassan, this is Abhijit. We've been moving at a pretty good pace in terms of our reduction of headcount. So we just said that we've done about 6,600 of the 7,000 planned for the year. So that should give us a benefit going into the second half. The original plan was roughly -- we had 3,000 last year, plan was 4,000 this year, evenly split through the quarter. So we are slightly ahead and are confident of making that plan. So I think that's where I would leave it.

We will now go to our next question. And your next question comes from the line of Veronika Dubajova from Citi.

I have 2, please. The first one is just going back to the guidance. I mean if I just look at the mid-single-digit growth guidance that you've given for the year against the delivery in the first half, it does imply pretty significant deceleration in growth sort of flat to low single-digit range. Just want to understand, is there anything that you're seeing at the moment that makes that a likely outcome? Are you just embedding a degree of conservatism. And if you can maybe talk through, I don't know, I know July is barely started, but just maybe comment on what you're seeing in the quarter to date against that guide, that would be helpful. And then my second question is on the order book momentum. And clearly, pretty significant deceleration here versus what you delivered the prior quarter. I appreciate there are some difficult comparisons in there. But -- just maybe curious to get your thoughts here. I mean, if I look across your performance and your peers' performance, we are clearly seeing some slowdown in order growth this year. Just kind of put it into context for us because at the outset of the year. I think everyone was pretty excited about China, that's growing pretty healthily from what we understand. So is this a problem in the U.S.? Is this a problem in Europe? Is it the problem somewhere else? Kind of what gives you the confidence that this can improve as you move into the back half of the year and that it can support that sort of mid-single-digit growth in the D&T and Connected Care businesses that most of us expect for 2024? I know there's a lot of moving parts there, but if you can just give us a little bit of that, that would be helpful.

Veronika, let me take the first part of the question. I think if you look to take a step back, we had planned for actually a back-end loaded year. We ultimately saw that the supply chain improvements came in earlier. And therefore, we have had a strong start to the year. As you've seen in the second quarter, our growth was a bit flattered also because of our royalty income so if you take that into account and look at the second half, we see good momentum going into the third quarter, but also you should remember that the fourth quarter, we are battling tougher comps. If you remember, last year in the fourth quarter, Health Systems businesses grew mid-single digit. So of course, therefore, the growth will be, let's say, the year-on-year growth in the fourth quarter would not be as strong as it has been for the first 2 quarters this year. So that's the color I can give you how we expect growth to play out for the remainder of the year. It's not that there is a specific issue or something that we want to signal at all. We need to just get through quarter-by-quarter the supply chain improvements have happened, but it's not over. So we are still working these through. And as we get through every quarter, hopefully, we are able to deliver in line with the commitment. Coming to the second question, maybe I hand it over to Roy.

Yes. I think Veronika, thank you for the question. And on the order book, indeed. I think important a few parts to take together. First of all, as we highlighted, we have still been growing versus last year. So it's really important to recognize the strength of the order book that we have. And actually, we are still challenged to burn it down faster. So actually, that is one area that we also want to work through, and that's where this remaining focus on getting more supply to be able to deliver more of the products actually will help us to deliver also better to customers and then also take more orders into our order book. Secondly, there is indeed a certain lumpiness. I started the year with saying that this is not a business as usual here. Now I've been talking to many customers. I've been a few weeks ago, I went to China. China actually is coming back very strong, as you have seen. That started already in Q1. It continued in Q2. We actually see it continuing in Q3 and Q4. So we can expect, I think, a double-digit contribution out of China for this year, and that's great to see China coming back. We also saw now in Q2 that Personal Health came back into growth. That's also important momentum that we will continue into third and fourth quarter. But I also went to the U.S., and actually, I was there even last week, I've been talking to customers also there. And I must say that I've been encouraged by some of the signs that I'm seeing when talking to customers that there is some stabilization coming in and focus on challenges. . So whilst they are still challenged on it, actually, they seem to be finding resolutions. We're also helping them with that, with our technology and innovations. That's what we're also talking about. And also they're combating the inflation, I think, more effectively. So that's what I would also take into the second half where actually, I would expect that the order intake would see growth coming back into play, and that will then not only be growth of the absolute order book but also in order intake. And we will work hard for that across the globe. And that may be the last piece. I think what I was also happy about is that kind of you saw that our contribution into the growth delivery in this quarter came from all businesses and all regions which also means that there is no specific kind of part that is laying back or kind of is behind. So Personal Health was the one that we're still not as strong as we hoped for in the first kind of half. We knew it. We expected that. So now we hope to continue the growth momentum across all segments into the second half. So there is no, I would say, specific reason for caution or for kind of concern. But we remain at the same time, realistic that this is not a business as usual year and that our customers and also the world is working through the current inflation, the interest and the challenges that they are in the labor market.

And can I just ask a quick follow-on or just on the consent decree. I think before you had talked about you had hoped to get it resolved and settled in the first half of the year. I might have missed -- I didn't see a comment on the updated time line in the press release this morning. Do you have any thoughts on when we might see a resolution there?

No. I've not. So that's also why we did not put a time line in. So -- and I also don't want to further speculate on it. I think it's important to stress that also there, there's no specific reason that I would call out or any specific concern that this is indicating something. I think it only indicates that this has been worked through very diligently and at the same time, as I said earlier, there's a lot happening across the plate of both the FDA, but also on our side. So I think in both parties, we are putting all efforts into it to bring this to the best possible conclusion. Now the moment we will get any update on timing or conclusion, of course, we will come forward with it. But it's hard to put a specific time line on it. Also, when I said earlier in the year, I would hope for first half, indeed, that was my hope, but I also said it's not in our control. Yes, there's a lot to be worked through, and that's kind of what -- yes, we have seen materializing now.

We will now move to our next question, and the question comes from the line of Richard Felton from Goldman Sachs.

My first one is on Connected Care. So strong performance on the margin, which drove the beat at group level in Q2. But could you provide a little bit more color on the margin drivers within the division, please, specifically interested to know the impact from monitoring versus Sleep & Respiratory Care. And then were there any one-offs which drove strong performance in the quarter for monitoring? That's my first one. And then my follow-up also on Connected Care. Look, it looks like Sleep & Respiratory Care still had a fairly material revenue decline in Q2. Given the system sales, I think, were already 0 last year, could you provide a little bit of color on where those incremental declines are coming from, please?

Yes. So Richard, this is Abhijit. On Connected Care, as we mentioned also in the commentary upfront, is coming mainly from monitoring. We have had a -- it's a very profitable business and monitoring, as you would remember, last year was really hit by the component situation, I think we have had a 20-plus percent growth in the second quarter and then when you get operating leverage, of course, you get a big impact. Besides that, in Sleep & Respiratory Care, also, we had started in Q1 taking cost actions. So therefore, there, the profitability starts to improve. So I think overall, it's pretty much organic. So there are no real one-offs.

Maybe I can take the second one on the SRC side. So if you look to the SRC mix, actually, you see that the ventilation side was where we saw the decline. We're also still working through the remediation on that. So actually, that is Connected. But at the same time, if I look to masks, actually, we have seen masks coming back stronger, and that was a positive development in the quarter. So it's a mix issue where the ventilation is actually driving the decline, while mask is offsetting some of that. whilst we, of course, have the ongoing effect of the Sleep remediation in the sleep devices part of the business.

We will now go to our next question. And your next question comes from the line of David Adlington from JPMorgan.

Firstly, just on orders. You said you faced a tough comp, but I think it was only 1% last year and the year before that was down 15%. So I just wonder if you have some further call to use either by notable weakness either by product category or by region? Secondly, just on your one-off charges, it looks like you've shifted 100 basis points from restructuring to other quality-related charges in Connected Care. I just wondered what the reason for that change was, please?