Koninklijke Philips N.V. (NYSE:PHG) Q3 2023 Earnings Call Transcript

Koninklijke Philips N.V. (NYSE:PHG) Q3 2023 Earnings Call Transcript October 23, 2023

Koninklijke Philips N.V. beats earnings expectations. Reported EPS is $0.33, expectations were $0.18.

Operator: Welcome to the Royal Philips Third Quarter 2023 Results Conference Call on Monday, October 23, 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 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’s third quarter 2023 results webcast. I have here with me, our CEO, Roy Jakobs; and our CFO, Abhijit Bhattacharya. The press release and slide deck as well as the 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. I would like to hand over to Roy.

Roy Jakobs: Good morning, everyone, and welcome to the webcast. Before we go into the numbers, I want to say that our hearts go out to everyone affected by the terrible events ongoing in the Middle East. As of today, I’m thankful to report that all our colleagues based in the region are currently safe. Now starting the key highlights for Q3. We delivered another quarter of improved operational performance with strong 11% sales growth, doubling our profitability and strong cash flow. The improvements were across all business segments and all regions and the result of our ongoing actions to strengthen execution. We are making progress on all our three priorities: enhancing patient safety and quality; strengthening supply chain reliability; and establishing a simplified more agile operating model, supporting our productivity and our margins.

Completing the Respironics recall remains our highest priority with the remediation of the sleep therapy devices almost complete. We are in discussions with the FDA on the details of further testing. The litigation investigation by the US DoJ as well as the discussions on the proposed consent decree are ongoing without further updates to share. Based upon our improved performance, we are further raising the outlook for both sales and profitability for the full year 2023. Although recognizing uncertainties remain in increasingly volatile geopolitical environment. Our improved performance reinforces the confidence we have in delivering also the next two years of our three years plan to create value with sustainable impact. On to the financial highlights.

The strong comparable sales growth of 11% was driven by 14% growth in Diagnosis and Treatment, 10% growth in Connected Care, and 7% in Personal Health. Our adjusted EBITDA margin was 10.2%, a strong improvement of 540 basis points versus a year ago. Operating cash saw an inflow of EUR489 million, an increase of approximately EUR670 million versus last year. Order intake, which accounts for around 40% of Group sales was lower in the quarter, mainly due to the comparison base related to the exceptionally high orders in 2021 and 2022, substantially lower China, and longer order-to-delivery lead times. We continue to see hospital healthcare systems in the US and other mature geographies exhibit cautious buying behavior in the short term, and China is heavily impacted by the government-initiated anti-corruption measures.

But I look at the future with confidence. Our order book remains strong. The fundamentals of the markets in which we operate, as well as our order funnel are healthy, and our innovation portfolio is strategically positioned to help hospitals address their staffing shortages, enhance productivity, and improve patient outcomes. Let me qualify what I mean with a strong order book. The order book remains around 20% higher than in Q3 2021, when the global supply chain crisis started, and will continue to support revenue growth. At the same time, we are implementing the necessary actions to improve order intake by reducing lead times from order to delivery and leveraging our operating model change and our innovations. Based on the flow of orders that are in the pipeline and the visibility we have as of now, we expect to see sequential improvement in order intake in Q4, while there remain the uncertainty and the geopolitical volatility we have outlined.

Let me provide you with some of the key customer and innovation milestones during the quarter. We signed a 10-year over EUR100 million Enterprise Monitoring as a Service and Informatics agreement with one of the largest health systems in the US, covering 20 hospitals with over 3,000 beds. We expanded our leading Image Guided Therapy portfolio with the launch of the Mobile C-arm System 3000, which contains workflow-enhancing features to help alleviate staff shortages faced by many hospitals. We introduced our ambulatory monitoring offering in Japan, combining Philips ePatch Holter monitors with ECG analysis through AI and advanced algorithms. And in Personal Health, we launched Sonicare DiamondClean 7900 Series in China which debuted as the number one high-end toothbrush on Alibaba’s Tmall.

We celebrated 100 years of successful presence and collaboration in China, where we are known as Philipu, and have a leading position, a strong local team of over 7,000 employees, and an extensive footprint covering manufacturing, innovation, sales, and services. And with that, I would like to give the floor to Abhijit to take us through Q3 in more detail, after which I will come back with the progress on our execution priorities.

Abhijit Bhattacharya: Thanks, Roy. Good morning, everyone. Let’s begin by looking at the segment highlights for the quarter. In Diagnosis and Treatment, comparable sales increased 14% driven by double-digit growth across Diagnostic Imaging, Ultrasound, and Image Guided Therapy. Adjusted EBITA margin was 12.7%, an increase of 230 basis points, mainly driven by operational leverage, pricing, and productivity measures. Year-to-date adjusted EBITA margin for Diagnosis and Treatment was 12.1%, an increase of 380 basis points compared to the same period last year. Connected Care comparable sales increased by 10% driven by double-digit growth in Monitoring and mid-single-digit growth in Enterprise Informatics. Sleep and respiratory care sales were flattish.

In the quarter, we started gradually to serve new sleep therapy patients in several countries outside the US. Connected Care adjusted EBITA margin was 3.7% over 1,100 basis points improvement from last year, mainly driven by increased sales and productivity measures. Personal Health delivered a 7% comparable sales increase. This was driven by high single-digit growth in Personal Care and Oral Healthcare and included the positive impact of price increases. Comparable sales grew high single-digit in North America and in Growth geographies, mid-single digit in Western Europe, and low single digit in China. Overall, consumer sentiment remained subdued. Adjusted EBITA margin for Personal Health was 18.7%, an increase of 460 basis points, driven by operational leverage, pricing, and productivity measures.

The adjusted EBITA margin for the Group increased by 540 basis points to 10.2%. Wage and component price inflation came in at 250 basis points slightly better than a year ago. However, this was more than offset by 240 basis points from operational leverage and by our productivity and pricing actions, which contributed a further 540 basis points. We delivered significant improved cash flow with a free cash flow of EUR333 million in the quarter. This was driven by higher earnings and improved working capital management. We saw a sequential reduction in inventory volumes in the third quarter and we will see continued improvement in the coming quarter as well. Year-to-date free cash was an inflow of EUR454 million. This resulted in an improvement of our leverage from 3.6 times to 2.9 times on an adjusted EBITA to gross debt basis compared to the start of the year.

We’ve been very disciplined in cost management and our productivity initiatives have delivered savings of EUR258 million in the quarter. Operating model productivity savings were EUR142 million, procurement savings were EUR59 million, and other productivity programs delivered EUR57 million. Year-to-date, our productivity initiatives have delivered savings of EUR685 million. Moving to our order book, as Roy mentioned, it remains significantly higher than the period before the supply chain constraints kicked in. We expect the order book to remain strong and continue to support sales growth in the coming quarters. It’s very important to note that orders and order book account for around 40% of our revenue. The remaining 60% come from recurring revenue streams, such as services and consumables and book-to-bill businesses, and from the Personal Health business.

As you can see on the page on the screen, absolute levels of order intake remain healthy, but we see a steep increase in sales level year-to-date due to the enhanced order book to sales conversion following supply chain and execution improvements. Also important to note, order intake growth in Q3 2021 was 47%, which is why the comparison base is highly elevated. At the same time, as Roy just said, we continue to implement the necessary actions to improve order intake by reducing lead times and leveraging our innovations. In Diagnosis and Treatment comparable order intake declined low double-digit following high order intake in Q3 2022, significantly lower orders in China and Russia, as well as longer order-to-delivery lead times. In China, the lower orders are due to the impact of the recent government-imposed anti-corruption measures.

We have seen similar initiatives before which we support. This impacted short-term decision-making by hospitals as they work through the government measures, resulting in a substantially lower order intake year-on-year. Based on our previous experience, this is not expected to impact fundamental demand in the China market and our order funnel remains very active in the country. As explained in the last quarter, the Russia impact is due to the longer order lead time because of additional export control procedures that have been put in place recently. Order intake was mid-single digit lower year-on-year in Connected Care due to the tough comps in hospital patient monitoring after the expansion and renewal of the installed base in the last few years.

For context, Connected Care orders continue to run at absolute levels, double-digit higher than pre-COVID levels. Moving to capital allocation, in the third quarter, we issued EUR500 million of fixed note — fixed rate notes due in 2031, which were used to pay off the short-term debt. This has a debt-neutral effect, while further strengthening our debt maturity profile. During the quarter, we settled a number of forward purchase transactions entered into under the EUR1.5 billion share buyback program announced in 2021. Following further settlements in Q4 2023, we plan to cancel more than 15 million shares in December, which will result in a reduction of over 1.5% of the outstanding shares. As Roy mentioned, we have raised the full-year outlook to 6% to 7% comparable sales growth and an adjusted EBITA margin between 10% and 11% for the Group, while recognizing uncertainties remain in an increasingly volatile geopolitical environment.

As we had mentioned earlier, Q4 will have tougher comparison base as we delivered over 6% growth in Diagnosis and Treatment businesses and over 20% growth in hospital patient monitoring in Q4 of last year. Personal Health will continue to have healthy growth as well. This just reiterates how we saw the second half of the year unfolding. And I want to be clear that we’re not seeing, not flagging any different dynamics than what we’ve said before for the fourth quarter. As we had said before, the improvements in the supply chain front-end loaded growth for the year. With that, I would like to hand back to Roy.

Roy Jakobs: Thanks, Abhijit. I would like to continue with the topic of the Respironics recall. Globally, over 99% of the sleep therapy devices registrations that are complete and actionable have been remediated. The remediation of ventilators is ongoing. Based on the test results to date, Philips Respironics and third-party experts concluded that use of our sleep therapy devices is not expected to result in appreciable harm to health in patients. Following ongoing communications with the FDA, Philips Respironics has agreed to implement additional testing to supplement current testing data on PE-PUR foam. The FDA acknowledged that current testing is extensive and conducted with independent parties and expressed no concerns with its validity or objectivity.

They did ask for more testing to supplement it. Philips Respironics is in discussions with the FDA on the details of the further testing. Earlier this month, we received preliminary court approval for a settlement agreement to resolve all economic loss claims in the US MDL, for which we have recorded a provision of EUR575 million in the first quarter of this year. 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 without further updates to share. Now, 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. As part of strengthening our patient safety and quality culture, two weeks ago, we kicked off our company-wide timeout for the topic, where we spent a full day talking to all 70,000 employees worldwide about how we are moving forward with patient safety and quality, the progress we’ve made to date, and how we take it further.

Patient safety and quality reviews are fully integrated in the new business performance management cadence and we opened one of the largest Electromagnetic Compatibility labs in Europe, specialized in testing health technology. With respect to supply chain, we continue to make progress to reduce materials and component risks. For example, we have now completed around 70% of the redesigns of printed circuit boards. We are on track to meet our target, de-risk all our high-risk components by year-end. And as you’ve seen in the results today, I’m pleased to see that the actions we have been taking to date continue to have positive impact on our sales, as well as our service levels. We’re monitoring the situation in Israel closely as we have manufacturing and R&D activities in the country, but currently, business continuity is guaranteed.

Finally, our new operating model with prime accountability in the businesses went live in April this year and we have completed the realignment of the workforce roles and reporting lines. This included also the difficult, but necessary reduction of 7,500 roles to date out of the planned reduction of 10,000 roles by 2025. Let me close out by repeating the key messages of the quarter. We delivered another quarter of improved operational performance with strong sales growth, better profitability, and better cash flow. We are making progress on our three priorities. Enhance patient safety and quality, strengthen our supply chain reliability, and establish a simplified more agile operating model. Completing the Respironics recall for patients remains our highest priority.

And looking ahead, we have further raised the full-year outlook for both sales and profitability. Although recognizing that uncertainties remain in an increasingly volatile geopolitical environment. The progress we are making reinforces our confidence in delivering the next two years of our three years plan to create value with sustainable impact. 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: Thank you, sir. [Operator Instructions] Thank you. The first question comes from the line of Hassan Al-Wakeel from Barclays. Please go ahead.

Hassan Al-Wakeel: Hi. Good morning, and thank you for taking my questions. I have three, please. Firstly, can I start on orders given Q3 is down 9% and year-to-date orders are down 6%? How are you thinking about the current order backlog substantiating growth next year? Do you think you can still achieve mid-single-digit growth in 2024, in line with your mid-term growth guidance? And is end market demand changing at all? Secondly, can you talk about the strong profitability in D&T and your expectations for Q4, given this is typically a higher volume quarter? You already said that your 2025 target of low teens in terms of profitability and I wonder how you’re thinking about upside to the current 12% margin that you’ve done year-to-date over the next two years.

And then finally, can you talk about the FDA’s update on your testing and whether this to your mind changes the scope of the consent decree potentially, or drives any further delays here? What extra tests do you need to do, and how long will this take? And do you think this has any impact in terms of timing on the litigation process? Thank you.

Roy Jakobs: Thank you, Hassan. Let me take the first one to start off it. So, on the orders, you saw that we have presented the minus 9% in the quarter. I want to put that in context. So, as said by Abhijit, first of all, we have still a very strong order book, which is 20% higher than two years ago. That also is fueling our strong sales performance to date and four quarters of improved sales growth. Secondly, we have an improvement where we see that the order intake as we also mentioned earlier will come off in Q4, and also we expect that to continue in 2024, as the underlying fundamentals of the market and our positioning has not changed. But we’re coming off a very high comparable growth in Q3 in this year, where we had 47% growth two years ago.

So, the comparable base also played part. And then on top, we are kind of taking actions to continue to work on improved order intake. Therefore, I also mentioned that actually we are ahead of the first year of our three-year plan, and actually this have given us further confidence in also executing the second and third year of the plan that I presented in January. And as you know, we presented a plan in which we started with low-single-digit growth in year one, mid-single-digit growth in year two, and onwards. That’s where we also stick to as part of the execution of our plan. Last point I think to mention, which is important that the order intake as we report is impacting 40% of our total business, and that’s maybe a bit of a different profile that we have with some other companies because we have 20% of our total business coming off PH, which you saw coming back to strong growth.

Secondly, 40% is tied to services, but also software subscription revenue, and then the remaining 40% is on the CapEx business where this kind of effects here the current profile. So, that’s kind of what I would say about order intake. And then maybe Abhijit can take the D&T question on profitability.

Abhijit Bhattacharya: Yeah. Hi, Hassan. I think, as you rightly pointed out, you know, we are pretty pleased with the progress we’ve made on margins in D&T. That has been something that we have been constantly working on and in fact, even challenged on. Now the good news is that, you see it back in the numbers. Of course, Q4, we expect sequential improvement because that’s, let’s say, our biggest quarter. Regarding the overall guidance, I think, we are just into the first year. We have given a range. So, there is still the upside of the range to go to. So, we will look at that as we progress through the period. It’s a bit too early now to change anything on guidance.

Roy Jakobs: Let me take the third question on testing and how that relates to kind of the consent decree. So, let me be outright in saying that the testing track and the consent decree track are two separate tracks. So, they are not correlated. As I said, we are in continuous dialog on the consent decree, there is no further update to share. At the moment we have it, we will come forward. On testing, we are currently in active discussions with the FDA to kind of finalize what exact testing needs to be done. So, that actually we can supplement the current testing that we have and also there the moment we have that finalized and — we can come forward with further news, we will bring that of course to you as we have always been doing.

Hassan Al-Wakeel: That’s very helpful. Roy, if I could just follow up, I mean, do you — do you expect — you talked about an improvement in orders in Q4. Is that to say that you expect orders to be flat or up in Q4? And how should we be thinking about 2024?

Abhijit Bhattacharya: Yes. Hassan, let me take that. You know, we’ve said we expect sequential improvement. Now we also talked about the uncertainty, especially what you see in China, right? So, therefore, we don’t want to be very specific, but we are fairly confident to see good improvement in the fourth quarter.

Hassan Al-Wakeel: Very helpful. Thank you.

Abhijit Bhattacharya: Thank you.

Operator: Thank you. The next question comes from the line of David Adlington from JP Morgan. Please go ahead.

David Adlington: Good morning, guys. Thanks for the questions. Maybe just firstly on orders, again. Obviously, China, I just wondered if we could get your thoughts in terms of when we might be through the anti-corruption slowdown and when we might be through the other side, getting various different bits of commentary in terms of when we might be through that. And then secondly just on Personal Health, just wondered how much of that 7% growth was due to price and maybe get your thoughts on pricing going forward from here, please.

Roy Jakobs: Okay. Thank you, David. Let me take the first question on China. So, we had a very strong start of the year in China, as you have seen, right? We grew orders and revenue double-digit, and that was good momentum that we saw because of pan demand and also strong progress we made on our local for local portfolio. We also expect that to continue. Now, then indeed, there is this current short-term slowdown as hospitals work through the anti-corruption measures. It is a phasing issue, right? We don’t see any cancellations coming through. It’s hard to predict exactly when it will be fully worked through. We have seen this earlier as well. It took a few quarters. So, I think there will be some ongoing activity in the next few quarters that’s to be expected.