Koninklijke Philips N.V. (NYSE:PHG) Q2 2023 Earnings Call Transcript

Koninklijke Philips N.V. (NYSE:PHG) Q2 2023 Earnings Call Transcript July 24, 2023

Koninklijke Philips N.V. misses on earnings expectations. Reported EPS is $0.15 EPS, expectations were $0.23.

Operator: Welcome to the Royal Philips Second Quarter and Semi-annual 2023 Results Conference Call on Monday, July the 24th, 2023. During the call, hosted by Mr. Roy Jakobs, CEO, and Mr. Abhijit Bhattacharya, CFO, all participants will be in a listen-only mode. After the introduction, there’ll be an opportunity to ask questions. Please note that this call will be recorded and replay will be available on the Investor Relations website of Philips — of Royal Philips. I will now hand the conference over to Mr. Leandro Mazzoni, Head of Investor Relations. Please go ahead, sir.

Leandro Mazzoni: 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’re taking across different areas to drive performance improvement. With that, I would like to hand over to Roy.

Roy Jakobs: Thank you, Leandro. Good morning, everyone, and welcome. It’s good to be with you. I want to start with the five — or 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 three 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 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 EUR135 million, a step up of EUR440 million versus last year. Our order book increased 3% year-on-year, even after strong order book to sales conversion over the last three 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 will 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 healthcare systems in the US 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 multi-year agreement with University of California Irvine Health to provide enterprise monitoring as a service, including informatics solutions to standardize, centralize and scale monitoring across the health system.

Five top hospitals in Shanghai with more than 10,000 beds installed the Spectral CT 7500. We also expanded our leading Image Guided Therapy portfolio with the launch of Zenition 10, a cost-effective mobile imaging system to guide high volume routine surgery as well as complex orthopedic and trauma procedures. We introduced the 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 the premium 7 Series shaver in China, in partnership with JD.com, which debuted as the number one 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.

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Abhijit Bhattacharya: 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 profitably sequentially — the profitability sequentially was impacted by mix and cost raising. 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 and 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%.

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 3.6 times to 3.1 times adjusted EBITDA in the first six months of the year. Our productivity initiatives are on track and delivered savings of EUR237 million in the second quarter.

Operating model productivity savings amounted to EUR112 million, procurement savings were EUR57 million and other productivity programs delivered EUR68 million of savings. Adjusting items in the quarter included EUR161 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 till 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 three 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 remain 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 time 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 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.

Roy Jakobs: 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 1, 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 and investigation by the US 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, healthcare professionals and industry experts. 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] (ph) in the 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 de-risk 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 fellow colleagues for the 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 a 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 three priorities, enhance patient safety and quality, strengthen our supply chain reliability and establish 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.

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Q&A Session

Operator: [Operator Instructions] We will now go to your first question. And it comes from the line of Hassan Al-Wakeel from Barclays. Please go ahead.

Hassan Al-Wakeel: Good morning. Thank you for taking my questions. I have three, 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 two to three 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 US, 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.

Roy Jakobs: Thank you, Hassan. Let me start with taking your first question. So in terms of the guidance, and what it is, 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 speculate 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 on a strong Q1, strong Q2 and also 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 race 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 at quite a kind of dynamic macroeconomic environment. So that’s something that we keep on the back of our mind, so that we kind of also already 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 good 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, the answers in your first and second question.

Then in return to market out of US, 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 return to growth. So that’s something that we will see probably materialize further into second half. And we’ll keep you updated the moment that we have any further news there.

Hassan Al-Wakeel: 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?

Roy Jakobs: Hassan, as I 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 timeline on that. We want to get it, of course, resolved 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.