Koninklijke Philips N.V. (NYSE:PHG) Q4 2022 Earnings Call Transcript

Koninklijke Philips N.V. (NYSE:PHG) Q4 2022 Earnings Call Transcript January 30, 2023

Operator: Welcome to the Royal Philips Q4 and Full Year 2022 Results and Creating Value with Sustainable Impact Conference Call on Monday, 30th of January 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 will 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 Phillips.

Leandro Mazzoni: Hi, everyone. Welcome to the Philips’ fourth quarter and full year 2022 results webcast. I am here with our CEO, Roy Jakobs, and our CFO, Abhijit Bhattacharya. We’re also joined today by Shez Partovi, Chief Strategy and Innovation Officer; Wim Appelo, Chief Operations Officer; and Francis Kim, Head of Quality. I would like to first go through the agenda for today’s webcast. We will start with a discussion of our fourth quarter and full year 2022 results. We will then talk about how we will create value with sustainable impact with presentations about our focused organic growth and scalable innovation strategy and our three execution priorities: Patient safety and quality, supply chain and operating model simplification.

We will wrap up with our value creation trajectory. We will have a session of around 70 minutes, followed by Q&A. The press release, slide deck and frequently asked questions on the Respironics recall were published on our Investor Relations website this morning. The replay and full transcript of this webcast will be 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. With that, I’ll hand over to Abhijit.

Abhijit Bhattacharya: Thanks, Leandro. Good morning, and welcome, everyone. Let me start with our group performance and profitability in the quarter. Comparable sales growth was just over 3%, driven by improved component supplies in particular, in hospital patient monitoring, Image-Guided Therapy and Ultrasound. We delivered growth of 5% for Diagnosis & Treatment and Connected Care businesses on a comparable basis, which was partly offset by a decline in Personal Health due to China and Russia. Although the component supply situation is improving, the situation remains challenging, as we anticipate gradual improvements during the year. Adjusted margin was 12%. We continue to see a significant component and wage inflation, which had a 370 basis points impact on our margin.

This was in part offset by our pricing and productivity actions, which contributed a further 260 basis points. As I’ve explained before, the positive impacts — positive pricing impacts on our health systems businesses, that is Diagnosis & Treatment and Connected Care, will be reflected in the profit and loss account during the second half of 2023. The adjusted EBITA margin was 11.3% in Diagnosis & Treatment, 12.6% in Connected Care and 17% in Personal Health in the fourth quarter. In the quarter, our operating cash flow was €540 million and free cash flow was €301 million. Accounts receivables increased in the quarter, driven by the strong sales in the month of December, which we expect to convert to cash in 2023. We won a further 35 new long-term strategic partnerships across our regions, bringing the total to close to 100 in 2022.

This is a core part of our growth strategy and improves the quality of our recurring revenues. Now, moving on to the segment highlights from this quarter. In Diagnosis & Treatment, comparable sales increased 5% in the quarter, driven by high single-digit growth in Ultrasound and Image-Guided Therapy. Order intake declined by 7% on the back of double-digit growth in 2021. The decline was due to the cancellation of a few orders with lower margins in order to improve our order book margin profile. In Connected Care, comparable sales increased by 5%, driven by strong double-digit growth in hospital patient monitoring. Order intake fell 10% due to the normalization of demand for COVID-19-related acute care products, but continued to run above pre-COVID levels.

We see a fundamental demand shift in adoption of our patient care management solutions and expanding market shares in Connected Care informatics and in the patient monitoring business. Finally, in Personal Health, comparable sales declined by 4%, with double-digit growth in North America and Western Europe, more than offset by double-digit decline in China and Russia. The impact of the COVID crisis significantly affected our sales in China in the quarter. Now, moving to our order book. Our order book coverage is significantly higher than in 2020 and 2021, in particular, in magnetic resonance imaging, which is 30% higher and in Image-Guided Therapy and Monitoring where coverage is around 20% higher. And in absolute terms, at the end of 2022, the order book was 30% higher than the end of 2020 and with the improving margin profile as we proactively canceled some low-margin orders that I just told you about.

Turning to our performance for the full year 2022. In 2022, results were impacted by operational and supply challenges, inflationary pressures, the COVID situation in China and the Russia-Ukraine war. As a result of these ongoing headwinds, comparable sales for the group declined by 3%, and our adjusted EBITA margin decreased to 7.4%. Component and wage inflation had a significant negative impact of 300 basis points, which are pricing and productivity measures only partly offset. We also saw a negative 390 basis point impact from the lower volume during the year. For the full year, Diagnosis & Treatment sales declined 1% with an adjusted EBITA margin of 8.4%. Connected Care sales was down 11%, mainly due to strong double-digit decline in Sleep & Respiratory Care.

The margin for Connected Care was 2.1% as it was impacted by Sleep & Respiratory Care. Excluding this impact, the margin for the year was 8.3%. Personal Health sales were flat with a margin of 14.8%. Excluding the impact of Russia, Personal Health sales grew by around 3% in 2022. We recorded a loss in our income from operations of €1.5 billion largely due to the previous disclosed €1.5 billion non-cash goodwill impairment for the Sleep & Respiratory Care business and the R&D impairment charges. In the full year, we had a free cash outflow of €961 million as a result of lower earnings, higher inventories and cash costs related to the Respironics recall. We will talk more about our actions to drive higher cash flow generation later in the presentation.

We will submit a proposal to the Annual General Meeting of Shareholders to maintain the dividend of €0.85 per share to be distributed in shares. Now, looking ahead, we expect to deliver mid-single-digit growth in Diagnosis & Treatment and Connected Care in 2023, supported by our strong order book. Slow consumer demand is expected to result in low single-digit growth in Personal Health. Our guidance of low single-digit growth at group level in the year reflects uncertainties in the external environment. Adjusted EBITA margin is expected to improve to high single digits this year, driven by productivity and pricing actions across businesses, partly offset by a 3% impact from component and cost inflation as well as additional investments in patient safety and quality and supply chain improvements.

We anticipate a slow start to the year as solid growth in Diagnosis & Treatment and Connected Care is offset by a decline in Personal Health in the first quarter. I would like to remind you that Personal Health grew 8% in Q1 2022, and we had the sales in Russia in the first quarter of last year. We aim to deliver a free cash inflow between €700 million to €900 million this year, driven by improved earnings and a lower inventory, partially offset by cash out related to restructuring charges resulting from further reduction of workforce announced this morning, which we will explain in more detail in a few moments. Please note that the 2023 guidance excludes the impact of the ongoing discussion on the proposed consent decree beyond current assumptions as well as ongoing litigation and the investigation by the U.S. Department of Justice related to the Respironics field action.

The current guidance assumes a compound sales growth rate of 10% for the Sleep & Respiratory Care business comparable sales for the period 2023 to 2025. Restructuring charges are expected to be around 300 basis points, driven by further workforce reduction that I just mentioned and the rightsizing of our Sleep & Respiratory Care businesses in 2023. Acquisition-related costs are expected to be around 50 basis points and Respironics field action running remediation cost between the 50 basis points and 70 basis points for the year. Financial income and expenses are expected to be a net cost of €270 million in 2023, excluding incidentals, if any. This is €70 million higher than in 2022 due to higher debt and interest rates as well as a fair value gain on the value of Philips’ minority participation of €30 million in 2022.

We expect an adjusted EBITA loss of around €70 million in the segment Other in 2023. At EBITA level, we expect a net cost of around €200 million for the full year in this segment. For Q1, we expect a net cost of around €45 million at the adjusted EBITA level and around €80 million at the EBITA level. With that, we will now move to our next section after a short video when Roy will present our plans on creating value with sustainable impact.

Roy Jakobs: Thank you, Abhijit, and thanks, everyone, for joining us this morning. I’m Roy Jakobs. And as you know, I was appointed as President and CEO of Philips last October. I’m honored to have been given the responsibility to lead Philips, and I look forward and commit to a transparent and constructive engagement with you and all our stakeholders. There is no denying, 2022 was a tough year here at Philips, and that is also reflected in the financial performance that Abhijit just presented. As you all get to know me better, you will see a few things. First, I’m a realist. And right now, it’s very important to lead with realism. I’m also a great believer in knowing where I want to go and having a clear plan to get there, a plan that people can understand and have confidence in.

Right now, Philips needs a clear strategy and a clear plan focused on execution. And thirdly, you will see, I like to take on a challenge. Right now, I could not be more excited about the future of this company as we not only face down the tough challenges, but also face up to the enormous opportunities for all of us at Philips. And I’m very passionate about working in a company that serves patients and people. Like many of you, I’ve been a patient. For several years, at a young age, I experienced first-hand the importance of good health and good health care. I understand the need to improve the outcomes for patients, and that’s a huge motivator for me. Since taking up the role in October, I’ve spent every minute, exposing, examining and exploring our challenges and opportunities.

To tackle these challenges and opportunities, Philips must change. And making that change is what excites me and will demand all my realism, my energy and my passion. Before I take you through what we will do, I wanted to share an insight from my first 107 days. I’ve been part of this organization for a number of years. However, now, in the role of CEO, I can see things from a different perspective. I can see all the moving parts, what works, what needs to be changed, what we are not doing and what we have to stop doing, what makes a difference, and what’s actually sucking energy and power out of the organization. So, if we are to live up to our purpose, to make a difference to the lives of billions of people, a purpose that motivates all of us at Philips and especially me, then we have to take firm actions, make changes and improve performance urgently.

We have to regroup. We look at what we do and renew for our future of value creation and sustainable impact. Philips has been refocused with a business portfolio that operates in attractive, growing health tech segments. We have built leading positions in the majority of these segments with deep customer relationships, a purpose, a trusted and valuable brand, leading innovations and a strong ESG DNA. But the reality is we have not taken advantage of these strengths. Why? Because we have not executed well. And today, we face multiple challenges as a result. We have to deal with the Respironics recall. We have not lived up to our customers and your expectations in recent years. So, we must change and we must change now. Today, we will bring you through a plan that will address our operational challenges and drive progressive value creation through strategy, focused organic growth with people and patient-centric innovation at skill to get maximum value out of our business segments, creating value with sustainable impact.

There is no magic bullet here. Execution will be the key driver with three priorities: first, patient safety and quality; second, supply chain reliability; and third, a simplified, more agile operating model. This will be supported by a culture of accountability and empowerment and strengthened health technology talent and capabilities. This all means making deliberate choices about how we are organized, our size, where accountability lies and what our priorities are. Taking these steps will result in progressive growth in revenue and margins. Let’s now go deeper into the elements of our plan. As I said, we operate in growing market segments where attractive margins provide a foundation for sustainable value creation. This market is going through fundamental shifts, and we are well positioned to capture the opportunities this offers.

Demand for care is growing, costs are increasing and massive staff shortages exist. This drives greater demand for improved outcomes, productivity improvements, care outside of the hospital and for insights from growing health data. We also see increasing consumer demand in the area of health and care. The opportunities are clear. And, we have significant strengths to build on. Over 70% of our sales comes from Number 1 or Number 2 positions in their segments. We have leading innovation hardware, software and services in the hospital and in the home. We are the preferred strategic and innovation partner for many customers to provide imaging, therapy and monitoring solutions. 40% of our revenue is recurring. And we have the largest multi-vendor enterprise informatics business in the industry.

As I mentioned, we are all very clear about the need to address recent performance shortages, including the recall, driven by a lack of focus on strategy implementation, a technology-driven innovation model and poor execution. Now, let’s go through how we will drive change in each of those areas. In recent years, we have transformed our portfolio to become a leading health technology company with strong positions across Diagnosis & Treatment, Connected Care and Personal Health. We have market-leading capabilities, integrating platforms, informatics and services, but we are not extracting as much value out of these segments as we could. When you look across our core businesses, the opportunity for focused organic growth is crystal clear. But we need to change how we manage these businesses in order to realize these opportunities and maximize their value.

We must make choices, shifting from spreading our resources too thinly over too wide of a portfolio towards a sharper focus on what it takes to create growth and value in our segments and markets. In each segment, we must play to win according to the rules. We need to adapt our strategy and where we concentrate our resources, including cool new products and what countries we operate in. We must ensure that each segment and each region has the best strategy to drive the greatest value creation. We will prioritize and drive growth across Image-Guided Therapy, Monitoring, Ultrasound and our Personal Health businesses. These are businesses where we can accelerate growth and margins more quickly, given our strong leadership positions. At 70% of sales, you can imagine this will have a material impact at group level.

We will create a new enterprise informatics business, leveraging and integrating our unique ability to integrate vendor-agnostic data from various imaging modalities and monitoring devices. For example, through remote nursing, remote radiology or remote pathology. Scaling of these platforms will increase our margins. In Diagnostic Imaging, we will drive better margins through differentiating innovation, such as helium-free MR, supply chain improvements to reduce our lead times and convert our strong order book, as well as increased services pull-through. And of course, we will continue relentlessly to work on the Respironics recall so that we can restore our position as the leading provider in this market over time. I will address this important matter in more detail in a few minutes.

We also have a tailored approach to address different customer needs across the regions in the world. This is particularly important given the current geopolitical dynamics, which I expect will continue. The principle of leveraging our leadership positions will guide us here, too. So again, we have to make choices where we play based on the attractiveness of the growth opportunities. We can’t and won’t be selling everything, everywhere anymore. North America is likely to be a softer market in the near term. As health care providers are consolidating, we are well positioned to serve customers with long-term partnerships to support their outcomes and reduce operating and staffing costs. Our multi-vendor informatics offer is a clear differentiator, and we need to further strengthen regulatory relationships.

Across the international markets, notably in Western Europe, we expect an opportunity to (ph) the government investments to support with digitalization of health care, and by providing care in hospital and home to deal with the continued increasing patient volumes. We’re also very well positioned with our strong consumer franchise to tap medium-term spending increases. In China, where we have been for a very long time with a strong brand and have a strong position with significant manufacturing innovation footprint, we are adapting to the changing local environment across both the consumer and the health systems market. Innovation is our core strength and will continue to be our core differentiator. But we need to get more impact and more return from the investments we make in innovation.

As such, we will shift our innovation model from being corporate and more technology led to a more patient- and people-centric model driven out of the businesses. A significant step will result in a shift from R&D resources being closer to where our customers are and to improve patient safety and quality, impact and returns. In the businesses, we will focus our efforts and resources on fewer, better, bigger projects. And we will prioritize innovation that has a bigger impact on patient outcomes and help care providers with their productivity and sustainability based on our unique portfolio, sustainability products and design experience. Patient safety will be central to all the design of all our innovations. You will hear more on innovation from Shez in a few minutes.

You will get it by now that I see effective execution as the key value driver and a key driver for change. First, we will put patient safety and quality at the heart of everything we do. Across the company, we will anchor patient safety and quality in the core of our innovation approach to avoid future issues. We will step up accountability for patient safety and quality, for example, by giving all employees dedicated patient safety and quality objectives. We will further invest in our systems, capabilities and in trading and education. And I’m elevating patient safety and quality to the executive committee by creating a new leadership position to drive this priority across the whole company. Secondly, we will reshape our supply chain setup to urgently improve our operations and to deliver on our strong order book.

We’ll move away from being organized around central functions to a structure where we organize procurement and supply chain in our businesses, a structure that works effectively even with the volatile conditions that we have been experiencing over the past few years. We are also pruning our product portfolio, which includes a long tail of smaller product lines, including of older generations of our latest products. And we have a targeted team redesigning products and components to increase our resilience to more volatile demand. You will hear more from Wim on the topic. Finally, we will simplify our operating model by putting prime accountability into the businesses, supported by lean functions and strong regions. Over the past years, the organization has become too complex with a matrix of multiple layers, leading to a lack of clarity and a lack of accountability.

We will reduce the size of central corporate functions and simplify internal processes with fewer KPIs and more focused targets. This was also the strongest area of feedback from our employees as the key reason holding them back. I will come back to this topic later in the presentation. Let me now provide an update on the Respironics recall. We understand how important these sleep therapy devices and ventilators are to the patients, and how they improve their lives every day and night. Resolving this for our patients and customers has been and remains the highest priority. A complex and difficult task, but we are making encouraging progress. Heading into 2023, we have reached, as promised, 90% production for the delivery of replacement devices to patients.

Last month, we also provided an update on a completed set of test results for the first generation DreamStation sleep therapy devices, which were reassuring. The tests are run by independent international laboratories, who use a rigorous methodology, including various external parties, using very conservative risk assessments to assure confidence in the results. The completion of the remediation as well as the testing program remain our highest priority. As you already know, various civil complaints have been filed in jurisdictions across the world, alleging economic loss, personal injury and the need for medical monitoring related to the devices subject to the recall. While the litigation is progressing, it’s too early to speculate about any potential impact or exposure.

We are dealing with the investigations and reviews from the competent authorities and the U.S. Department of Justice. We also still in discussions with the DOJ on the proposed consent decree and cannot provide details at this time. We’ve also taken actions to ensure that the Sleep & Respiratory Care business can operate with full authority and end-to-end necessary competencies from the 1st of February to swiftly respond and deliver on the commitments to patients, regulators, and customers. It remains our clear intention to resolve all of these issues comprehensively and to restore Philips’ position in this market. I’m confident that the learnings from this recall will inform how we position patient safety and quality at the heart of our business and at the heart of our business and innovation strategy.

Francis will talk about that today as well. Our strategy, innovation and execution plan is all about progressively creating value with sustainable impact. We will do this with a balanced capital allocation policy. Abhijit will talk about this in more detail. But you can see here what we realistically expect to deliver in 2023, 2025 and beyond. This year is about further addressing the challenges in the business and laying the foundations for growth and value. As we move through the simplification process, implement the strategy and increase our innovation impact of this year and next, we’re looking to see revenue and margin growth accelerate. And we are targeting to reach our full potential beyond 2025 with strong mid-single-digit growth and with adjusted EBITA margin reaching mid- to high-teens.

This guidance excludes the impact of the ongoing discussions on a proposed consent decree beyond the current assumptions, as well as the ongoing litigation and investigation by the U.S. DoJ related to the Respironics field action. This planned strategy lays out how we will manage Philips through this next phase of the company’s journey to create value with sustainable impact. Now, we will go deeper into some of the areas I’ve covered, and we start with the exciting area of innovation. So, let me hand over to Shez.

Shez Partovi: Thank you, Roy. At Philips, we have a long heritage of leadership in innovation. Our plan is to build on that strength to achieve even greater impact for patients and customers. For years, Philips has had a large corporate research function that has led to the launch of historically successful new products. In the past, when the life cycle of health care transformation was slower, a functional approach to innovation was reasonable. In that model, innovation was mostly technology forward. Innovative ideas emerge from corporate research and move from one function to the next in a step-wise fashion until it reached the end customer. However, recent industry trends have accelerated technology adoption life cycle within health care.

As a leading health tech company, we are embracing this trend and shifting how we innovate to deliver impactful outcomes in an industry with rapidly changing end customer expectations, innovation must start with the end customer and work backwards. In other words, we must innovate on behalf of patients and customers. To do that, we will move innovation into the heart of the business by bringing all components of innovation to the same leadership roundtable under one accountable leader, and focused on patient safety and quality by design. In this new model, innovation is business-led and closer to the customer segments we serve. In addition to bringing patient and customer centricity to our innovation model, we will also focus on fewer, better resourced, more impactful initiatives so we can scale them.

We will sustain our significant R&D commitment, but retarget efforts towards high-impact areas that align with our strategic objectives. Practically speaking, that means pruning products and projects that are not aligned with our scaling ambitions and instead doubling down on our strengths in the customer segments we lead. This plan will be supported by an R&D investment of about €1.7 billion in 2023, which is roughly 9% of sales. Now while this is reduced compared to prior years, it is deployed more effectively and efficiently, and it remains significantly above our industry peers. Another key enabler of scaling is tailoring innovation processes to match the operating model of the business, so that businesses are empowered to move with speed and scale.

The best way to tailor innovation to a business operating model is to actually move R&D directly into the business itself. And so, we will deploy 90% of our R&D talent directly in the businesses, whereas previously it was about 70%. These are the innovation shifts you will see at Philips. Innovation will be patient and people centric. It will be business embedded and business-led, focused on products with greatest impact in the segments we lead and with the aim to scale. So, let’s look at some of our innovations that will drive our growth and in doing so, let’s start from care at home and then move to hospital. With the aging population and increasing demand for remote care, Philips’ BioTelemetry helps physicians monitor patients’ heart rhythm while they’re at home.

Today, thousands of U.S. physicians refer patients to Philips’ BioTel, resulting in five times better diagnosis of post-stroke atrial fibrillation. Philips’ BioTel can detect abnormal heart rhythms much earlier, not only speeding up time to diagnosis, but also reducing cost of care by eight times. In addition to helping monitor patients at home, we are also innovating to satisfy increasing consumer interest in self-care. In our Personal Health franchise, our Sonicare Prestige 9900 is the most advanced AI-supported electric toothbrush for personalized oral care. Prestige senses pressure, motion, tooth coverage and other brushing actions and then automatically adapts in real time to those consumer behaviors. Prestige 9900 enjoys 4.7 star rating globally and removes 20% more plaque than manual brushing.

Now, moving to the hospital. Patient monitoring is the cornerstone of acute care delivery. And as aging patients develop more complex medical conditions, AI-powered patient monitoring is increasingly critical to care delivery. Our IntelliVue patient monitoring solutions are based upon superior hardware and predictive AI-based software that together monitor patients throughout their hospital stay. IntelliVue is so easy to use that hospital staff report a 40% improvement in satisfaction plus over five minutes time savings during patient transport between surgical cases. Another key industry trend is a move towards less invasive procedures to improve patient recovery and reduce cost of care. Now, Azurion is our next-generation platform for Image-Guided Therapy that’s supports less invasive procedures.

Azurion helps physicians deliver outstanding patient care by combining clinical excellence with workflow automation. Azurion platform allows data to be collected from every aspect of a procedure, simplifying the task of the physicians and enabling 17% reduction of time spent per procedure and a 28% reduction of post-procedure activities. Simply put, the Azurion platform allows physicians to focus on what matters most, the patient. Now, health care organizations all over the world are becoming increasingly concerned with their carbon footprint, and are demanding environmentally more responsible medical equipment. To that end, one of our industry-defining innovations is our BlueSeal MR scanner that doesn’t require any helium refills. This MR scanner has a breakthrough design where the magnetic components are completely sealed and only need seven liters of helium over its lifetime instead of roughly 1,500 liters.

Our helium-free MR uses 53% less power per patient and is an environmentally-friendly MR scanner supporting our commitment to sustainability. The workhorse of medical imaging in a hospital is CT scanning, where it is critical to arrive at a correct diagnosis quickly and not have to bring the patient back for rescanning. To solve that challenge, Philips introduced the world’s first and only Spectral CT, delivering enhanced tissue characterization far beyond what a conventional CT scanner can do. Studies have shown that Philips’ Spectral CT results in a 34% reduction of time to diagnosis and a 26% reduction in the need for follow-up scans. In other words, Spectral CT helps physicians deliver first-time right diagnosis, improving the quality of care and reducing cost.

Ultrasound is a unique modality where the technician interacts heavily with the machine. And so, user experience is critical to adoption and business growth. Our Compact 5000 ultrasound is a compact unit, but without compromising performance or image quality. It has a host of features that improves the operator’s user experience, such as real-time collaboration with the remote expert; real-time remote training, wireless connectivity and a streamlined and automated user experience. These innovations resulted in a 42% reduction of button pushes, which significantly improve the operator experience while at the same time delivering a 22% increase in diagnostic confidence. Now, all these leading Philips’ innovations that I just reviewed for you generate large quantities of imaging data and patient monitoring data.

And our customers are asking us to help them manage all this data and unlock clinical insights so that they can deliver superior patient care. That’s exactly what our informatics solutions do. We have the largest multi-vendor enterprise informatics business in health tech, helping our customers unlock insights from combined data pools of medical imaging data, patient monitoring data and even third-party systems. Since our enterprise informatics propositions are vendor-agnostic, they can be scaled beyond the Philips’ installed base. For example, our Philips capsule interoperability solution can connect over 1,000 third-party medical devices, bringing all that data together for our customers. Our Philips medical image management platforms offer over 70 AI-powered applications and help increase staff productivity by 50%.

Finally, Philips has been offering remote care management solutions for over 20 years. Our solutions for the intensive care unit are used by health systems all over the world. We have helped customers remotely monitor over 15,000 ICU beds, helping reduce complications in remote hospitals. Now going forward, we have combined our informatics solutions into one single vertical end-to-end Enterprise Informatics business, and we project this business will achieve €1.5 billion revenue by 2025 with a growth rate roughly double that of Philips itself. Well, this wraps up our discussion on focus, scalable innovation, and we will now turn to discuss execution as a value driver starting with Francis Kim on patient safety and quality.

Francis Kim: Good morning. I am Francis Kim, and I lead the quality and regulatory function. As Roy said out earlier, patient safety and quality is our highest priority. Today, I’d like to explain how this translates into changes we have made and we’ll be implementing to our personnel, structure and approach. Firstly, we’re enhancing patient safety and quality by continuing to drive a cultural shift, ensuring a greater level of accountability within the business. We are elevating leadership to the executive committee and holding all business leaders directly accountable for patient safety and quality within the businesses they run. This involves continuous and deep engagement with quality, regulatory and clinical functions. Moreover, patient safety and quality is now a KPI for all employees structurally embedded into the performance appraisal process.

We continue to strengthen our competencies to ensure we have the best team in the industry. This includes recruiting more quality regulatory clinical and medical device experts across the enterprise. We are making progress, however, we fully acknowledge there is still much more work to do, which is why we view our efforts as a multiyear journey and have expanded our patient safety and quality program. Our next major area of focus is to ensure that all product design starts with a patient safety and quality in mind to avoid further issues. Technology has been one of our core strengths at Philips. Going forward, as Shez has mentioned, we need to make sure that our great product innovation starts with a patient-centric lens. Over 70% of the issues we faced in the past few years have been design-related.

Therefore, our primary task has been to ensure the design process is extremely robust. This means, linking product development from inception with a patient view and the highest product performance requirements embedded throughout. The result will be innovative products with highest safety and efficacy. We are catalyzing innovation by simplifying and upgrading critical systems and data integration for faster and better decision-making. We have also hired significantly more medtech experts who know how to operate in this highly regulated space. This allows us to undergo more robust product design, development and validation. Moving to compliance. We are running ongoing regulatory and compliance reviews to increase standards across the portfolio.

And we are making sure we prioritize higher risk areas to better risk manage as well as deploying supplemental resources in the most sensitive areas. This transformation will be supported by an investment of €350 million over three years. Let me highlight some of the progress we have made. In the last two years, the quality and regulatory leadership team has been 90% renewed with a broad range of experience, predominantly from other high-performing medtech companies. We have reduced our number of quality management systems by 30% to significantly simplify and standardize the way we work. Around 30,000 employees have received a role-based training to ensure our skills base is fully relevant. We have standardized 75% of our ways of working for managing complaints.

This translates into more reliable customer and data insights, which prioritizes risk identification and enables us to make better informed decisions. The data insights will also provide a great platform for identifying areas of future innovation. We have also reduced a number of major findings per audit by 50%. But let me emphasize rigor within our processes. For example, if we look at corrective and preventive action system, we are proactively identifying more issues and we’re increasing the number of investigations by design. It will take time to address the root causes and implement fundamental actions. We are, of course, focused on this number improving dramatically as we fully implement our plan. I am proud of the journey Philips has been on and the progress that has been made while knowing there is more to be done.

We are confident that through our expanded program with a focus on patient-centric innovation, we will uphold the highest standards within the industry. Thank you. And with that, I will hand it over to Wim.

Wim Appelo: Thank you, Francis. Hello, everyone. I’m Wim Appelo. I’ve recently joined Philips and taken on the role of Chief Operations Officer. Before this, I held several roles in the medtech industry and before that, in the technology industry. Let me give you an update on the current supply chain situation. Five years ago, in the context of a changing business portfolio, Philips centralized a functional supply chain organization at the enterprise level. Over the years, the structure (ph) value by creating common practices and capturing cost efficiencies for Philips. It created multimodality manufacturing sites, shared innovation and excellence, standardized product development and processes. However, in recent years, our industry has seen a number of extraordinary headwinds, including significant disruptions due to COVID, markets that are becoming more and more volatile, global supply chain disruptions and, in particular, e-component shortages and supplier decommits.

These headwinds severely challenged our internal functional structure and led to an accumulation of issues, impacting our agility and resilience, suboptimized information flows, compounded by a broad and complex product portfolio. As a result, the delivery of our health systems has suffered delays, increased backlogs and inventory levels, and thus, our customers have been negatively impacted. To ensure reliability of delivery for our customers going forward, we have taken a close look at our supply chain and have concluded that we need to change on three fronts: our end-to-end supply chain setup; our products and processes; and third, our supplier management. With respect to supply chain setup, the current environment requires agility and resilience in each individual business.

Therefore, as of April this year, we’re moving to a customer-centric end-to-end supply chain teams. These are going to be closely aligned to the different businesses we operate and with dedicated leaders for each individual business. It will help us to step up capabilities tailored for specific business requirements such as enhanced data transparency, digitization of the information flow and improved procurement and ordering practices. This will further enable our businesses to grow and deliver quality products on time and in full. With respect to our products and processes, we plan to reduce the complexity and, where appropriate, develop more fit-for-future modular platforms, as Shez talked about earlier this morning. Given the rapid changes in technology and e-component shortages, we have started the redesign of electronic subsystems and printed wire boards, of which the first 200 are well underway.

And finally, to make sure we deliver our products when patients and consumers need them, we will improve our planning and forecasting processes, considering the specificity of each business. In terms of supplier management, our base has become too broad in recent years with well over 5,000 suppliers and has been hampered by significant decommits and visibility challenges, resulting in increased material supply risks. To respond to this, in the short term, we are strengthening our relationships with suppliers and driving better visibility deeper into our supply base. We are also continuing to improve resilience and re-evaluating dual sourcing initiatives. The next stage is to reduce the number of suppliers and develop long-term strategic partnerships, which we strongly believe will improve quality, consistency and delivery.

If there is one thing we have learned this year, it is that we need to be capable of navigating volatile market conditions better in the future. As such, we have started on our journey towards a more predictable, reliable and efficient supply chain that we are confident will better serve our customers and the patients around the world, even under the kind of challenging external conditions we’ve experienced recently. It is clear that this will be a multiyear effort, but we know what changes we need to make and have set our targets to ensure this program remains on track. We will significantly improve service levels for our customers and partners, and plan to take around €400 million to €450 million in cost. On supplier resilience, we target zero high components by the end of this year.

And to get back to a superior supply chain, we plan to invest €200 million to €250 million in the next three years. We are committed to share our progress on this, rebuilding the trust of customers and patients and of our employees. Let me conclude by highlighting a few examples of our progress so far. 2022 marked the start of this program, and we have already seen proof points of success in the last quarter. We reduced our backlog by delivering more systems than planned, contributing to patient monitoring sales being up 22%. We also had record production of IGT Systems with sales up 7%. And in Ultrasound, we supported revenue growth of 8% by overachieving our expected output in equipment. We also made progress in accelerating redesigns of components by completing the first 56 printed circuit boards, and we have continued to diversify sourcing of high-risk components, and are now at over 700 compared to 400 at the end of quarter three.

With this programmatic structure in place, a customer-centric organization with talented leaders in key roles, we are confident that we will deliver on our 2023 revenue commitments and accelerate growth. We know how important our devices are for patients and customers, and we are committed to ensuring predictability, reliability and efficiency going forward. Moreover, progress on our slide chain improvement program will be a catalyst to deliver on the quality program Francis just walked you through earlier, which is our highest priority. Back to you now, Roy.

Roy Jakobs: Thanks, Wim. I want to give additional color on the simplification of our operating model that I explained earlier. Our goal is to remove complexity and become much more focused on strategy and innovation execution. We will organize around our business segments, supported by strong regions and leaner functions at the center. These businesses will have end-to-end accountability, including sales and services, direct supply chain support and more integrated patient and people-centric innovation resources. This will also include the difficult, but necessary further reduction of our workforce by an additional 6,000 roles globally by 2025. 3,000 will be implemented in 2023. This is in addition to the reduction of 4,000 roles announced in October 2022.

This change and these reductions will help make Philips more agile, more competitive and ultimately result in supporting better outcomes for our customers, and a simpler, more productive and more engaged workplace for employees, motivated and attracted by our purpose. To enable this, a renewed culture will be built at Philips, focus on our core purpose, transparency, being patient and people-centric and where we have all clear capabilities and feel fully empowered. We are also strengthening our teams with new technology talent, including seasoned leaders with deep domain expertise and will include changes to our executive committee. I mentioned that we have elevated the patient safety and quality function to the executive committee level. Steve C.

De Baca has been appointed as new Chief Patient Safety & Quality Officer, a member of the Philips Executive Committee effective February 6. Steve brings more than 30 years of quality and regulatory affairs experience in the health technology industry. Additionally, Jeff DiLullo, a leader from within Philips, has been appointed as the new Chief Market Leader of Philips North America. Jeff brings fast experience in customer and service delivery, enterprise account management and government relations to drive growth in this very important region for Philips. Jeff will succeed Vitor Rocha, who has decided to leave Philips. We also expect to announce the new leaders for Precision Diagnosis businesses as well as the Connected Care businesses in early 2023.

And here, you have the experienced and highly motivated team that creates and owns this plan together. With that, I would like to call back Abhijit to the stage to take us through the financial details of our value creation plan.

Abhijit Bhattacharya: Thank you, Roy. Let me now take you through our value creation path. And as Roy mentioned earlier, you saw on this slide, it’s a progressive part in three phases. 2023 is when we lay the foundation. You’ll then see an improvement and an acceleration in performance during the period ’24 and ’25, and then moving to the full delivery on our full potential in 2025. For this year 2023, as I guided earlier, you will see low single-digit growth, high single-digit EBITA and a free cash flow of between €0.7 billion and €0.9 billion, that moves in the 2025 phase to a cash flow above €2 billion moving to the higher range of the mid-single-digit bandwidth and moving profitability to the mid- to high-teens. What I’ll do now is take you a little bit more in detail on each of the segments.

So, if you look at Diagnosis & Treatment, you see that the growth rate will be in the mid-single digit, but progressively increasing over time. You see the same for Connected Care. And Personal Health, as I mentioned, will have a low single-digit growth this year, returning to mid-single-digit growth over the period from ’24, ’25 and onwards. You will see across all clusters an improvement in the EBITA margin, and you will also see that Diagnosis & Treatment moves from the low-teens to the mid-teens, and then Connected Care moving also from low teens to the high teens. Personal Health is already in the high teens and will improve this year over last and continue in that journey in the high-teens. This will — this improvement in profit trajectory will be driven in a big part with productivity initiatives that we have taken.

And we have stepped that up from the €1.5 billion to €2 billion. A big part of those savings, about €1 billion of that comes from the change in the operating model, the simplification that Roy just spoke about and the reduction of the 10,000 roles that we have spoken about earlier today. Procurement savings still forms an important part of the reductions that we have been planning. You see that it will be between €550 million to €600 million. We have a strong team that now is adequately staffed and working as we de-risk our supply chain but also drive lower cost as a result of that. And then, there are a string of other productivity measures including the rightsizing of Sleep & Respiratory Care. Our business has been impacted. It now is at a lower base.

We will need to rightsize our costs so that we bring the business back to profitability as soon as possible. We will continue on our price reductions in the service domain as well as in R&D, as Shez just highlighted a short while ago. So, if I sum this up, how do you see the profitability improving from 2022? We get about 4% to 5% from growth, a similar range from pricing as well as the improvement in the cost of goods sold. Cost reductions that will happen will drive savings of between 3% and 4%. We have taken inflation, about 6%, starts heavier in 2023, but gradually tapering. And we have built for certain risks and unforeseen circumstances to get us to the low teens. That’s how you see the profitability improving. A big part of our progressive journey in value creation is the improvement in cash flow and a big part within that cash flow is the improvement that we need for inventories.

Now, you’ll see here that over the last three years, we have been building up inventory. That’s a — two primary factors. One is the Sleep recall, where we had to have significantly more inventory to be able to build the material that we need for the recall that will be wound down as we come to the end of the recall. But also, we have a lot of incomplete inventory, right? 90% of an MR or 95% complete because we cannot complete the coils and ship. And as the supply situation is remediated, you will find more of this going into revenue and, therefore, we will bring down apart from the other measures that Wim just highlighted in his part of the presentation. Let me then tell you how the cash situation will improve over time. We start this year with a poor cash flow, as I mentioned, a negative of €1 billion that had two big things: the earnings of this year, the cash cost on the recall as well as what we had to do in terms of additional inventories.

Now if you look at next year, we have better cash earnings, so that helps to get from negative €1.400 billion improvement. And the big element is the working capital. So, the receivables as well as the inventories we have will help next year get to a much better level. So, then we get to the €0.7 billion to €0.9 billion. And then, going further to 2025, you see that we will further improve our earnings as in the trajectory we just shared with you. Our one-off costs will come down as we get towards the 2025 period. And of course, once we return to growth, there will be some more investments in working capital. With that, we expect the 2025 cash flow to be in the range of about €1.5 billion. Let me now take you through what we want to do in terms of our capital allocation policy.

It’s a balanced capital allocation policy, as we always say. And the primary focus of this plan is organic growth. So that’s our first priority. We also stress dividend stability. So, we have a payout ratio of 40% to 50% of our net recurring income with stability as we showed this year. M&A will be on a reduced basis. It will be a few bolt-on acquisitions if we find necessary in our stronger businesses, which are going to be the beachheads for growth. And finally, we have an ongoing share buyback program for €1.5 billion. And then, as and when the cash situation evolves, we will make a call on whether we do further share buybacks or not. Let me now tell you a bit about what we are doing to ensure that we are adequately funded. We have made quite some improvements this year.

Our actions on liability management have led us to improving the debt repayment profile over the next two years. We’ve brought that down from €3.2 billion to €2 billion. So that gives us some room. In addition, we have increased the maturity period of our bonds by about 20%. So that goes up now close to eight years. And I think a very important point to understand is that none of our financial instruments have financial covenants on them. So that gives us a certain amount freedom to operate. So, what does this — all of this tell us? So, let me try to capture what I just told you in a nutshell, right? So, our comparable sales growth will be in the mid-single-digit territory moving from the lower end to the higher end of that range between 2025 and onwards.

The adjusted EBITA will move from a range of low teens to mid- to high-teens. The cash flow from a range of €1.5 billion to the €2 billion range. The adjusted EPS growth over the period will be in double digits. The organic ROIC will grow from low-teens to mid- to high-teens. And through the period, we will maintain a strong investment-grade rating that is critical for us. We will also maintain dividend stability as well as the payout ratio. In the short term, we see the tax rates being between 24% and 26%. In the longer term, that will be determined by how tax rates change around the world. But this picture should convey to you that we have a strong financial plan to create the path to value that we talked about. Now, let me invite Roy back on stage to sum up this section before we go to Q&A after that.

Roy Jakobs: Thanks, Abhijit. So, let’s move to conclude, and let me summarize where we are and where we are going. Then, we will have time for your questions. When I spoke earlier, I said that it’s important to lead company with realism right now. The approach we have taken and presented to you to the strategy and plan is to be realistic. And with the team around me, I am both confident as well as excited for the roadmap we have laid out for you to deliver the change and to create growth and value. We have the determination and we are and I am committed to improve the performance and fully capture Philips’ potential. So, let me remind you how we will create value with sustainable impact. Philips operates in attractive, growing markets and holds leading positions in key segments.

Our portfolio is very well positioned to take advantage of the growth and margin opportunities in the segments where we operate. The combination of strong customer relationship and established trusted brand and purpose gives us a compelling platform to build on. But the opportunities can only be realized if we confront the structural challenges facing us. And we are ready to do that. Our strategy and plan to focus on segment leadership positions, adopt a patient and people-centric approach to innovation, radically simplify how we work and execute patient safety and quality, top of mind are the ingredients that will drive change and create value with sustainable impact. And the oil that will lubricate this process is operational excellence and disciplined execution.

We look forward to being a force of innovation and change in a world where making a difference has never been more important. I would like to thank you for being with us. We will be back to take your questions in a couple of minutes.

Operator:

Leandro Mazzoni: Welcome back, everyone. Let me hand over to the operator for Q&A.

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Q&A Session

Operator: Thank you. We will go to our first question. And your first question comes from Ms. Veronika Dubajova from Citi. Please state your question.

Veronika Dubajova: Hi. Good morning, and thank you guys for taking my questions. I have two, please. One, Roy, would just love you to hear a bit more from you on the operational and organizational changes that you’re making within the company. In some ways, as a long-term follower of Philips, it strikes me like we’re moving a little backwards in terms of what the organization looks like and the supply chain and R&D sitting more within the individual businesses. Just would love to get your thoughts on why that’s the case. Maybe some of the risks that you see to the business as you kind of implement this plan and to what extent they’re reflected in the guidance in ’23 and ’24, and just conceptually kind of how you’re thinking about this change?

And then, my second question is, please, if you can just give us an update on where you are with the consent decree and DoJ discussions? And to what extent you’d expect or when we might expect an update from you on that? And how much longer you think that process might take? Thank you so much.

Roy Jakobs: Thank you, Veronika. Let me start with the first question. So, when we look at the simplification of the organization, we’re responding in first place, also to what we have heard from our employees. We have become too complex both in terms of how we have been setting up as well as the processes that we run. So, there’s a real need and opportunity to make it simpler for all of us to work. And what we do actually will make very clear single accountability and bring that to the businesses. And they will be supported by leaner functions and strong regions where we have the customer-facing interactions. So, we’re moving from a phase where we have been functionalizing quite strongly towards actually going more integrated about winning in specific segments and making sure that the segment is set up to win.

Take an example, in the exciting area of Image-Guided Therapy, which we have a leadership position, we actually have strong plans to grow further. Now that means that you really need to focus on how do you serve those customers the best. Therefore, actually, we bring the innovation forward into the business to more closely where the customers innovate. Secondly, IGT has also its own supply chain demands, because it’s very different if you orchestrate your supply chain to deliver a complex system in cath lab like in Azurion versus if you, for example, deliver a toothbrush to a consumer. So, we’re actually making sure that the supply chain is integrally organized around the specific demands for that segment. We’re also putting patient and people-centric innovation in that business and making sure that the quality norm is exactly for what you need to do.

And again, there are differences across the different that we serve. So actually, where we’re moving towards is really winning in all these strong portfolio elements that we have, but doing it with the rules of the game of that specific segment. And then, your second question on the consent decree, we are in continued dialogue with the regulating that. So therefore, it’s too early currently to disclose what any outcome could be. Of course, we know how important it is for all of you and also for us. So, when we have news, you will be the first one to be updated on that. In a similar fashion, actually, it’s about the litigation. We’re also there, still in the early phases. There is nothing that we can say currently about any quantification of potential impact.