Koninklijke Philips N.V. (NYSE:PHG) Q4 2023 Earnings Call Transcript

Koninklijke Philips N.V. (NYSE:PHG) Q4 2023 Earnings Call Transcript January 29, 2024

Koninklijke Philips N.V. reports earnings inline with expectations. Reported EPS is $0.41 EPS, expectations were $0.41. Koninklijke Philips N.V. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Leandro Mazzoni: Hi, everyone. Welcome to Philips’ Fourth Quarter and Full Year 2023 Results Webcast. I’m here today with our CEO, Roy Jakobs; and our CFO, Abhijit Bhattacharya. The press release, investor decks and the frequently asked questions on the Respironics field action were published on our Investor Relations website this morning. The replay and full transcript of this webcast will be made available on the website after the call. 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 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. Welcome. Great to be with you today. I want to start with the key highlights of this morning’s release. We delivered a year of strong sales growth, improved profitability and very strong cash flow. The improved operational performance is a result of the solid execution of our plan to create value with sustainable impact. We are making progress on all our three priorities; enhancing patient safety and quality; strengthening supply chain reliability; and simplifying our operating model, supporting significant productivity and margins. Patient safety and quality remain our highest priority across the company. We agree with the FDA on the terms of a consent decree focused on Philips Respironics in the US, which provides clarity and a road map for us to demonstrate compliance and restore the business.

We are confident in delivering the previously stated plan for 2023 to 2025, which now takes the consent decree into account and remains unchanged, although recognizing uncertainties remain in a volatile geopolitical environment. Based upon our ongoing actions to enhance execution, we expect further performance improvement in 2024. On to the key financial highlights. Comparable sales growth was 7% in the full year, excluding the impact of provisions charged to sales mainly in connection with the Respironics consent decree, which we will explain later in the call. Sales growth was 11% in D&T, 5% in Connected Care and 3% in Personal Health. Group comparable sales growth, including the impact of the provisions mainly in connection with the Respironics consent decree was 6% for the full year.

The adjusted EBITA margin was 10.5% in the full year, excluding the impact of the provisions mainly in connection with the Respironics consent decree. This is a strong improvement of 310 basis points versus 2022. Adjusted EBITA margin, including the impact of those provisions was 10.6%. Free cash flow saw a strong inflow of €1.6 billion in 2023 and we significantly strengthened our balance sheet in the year. Restructuring and other charges were high in 2023. This was a result of our focus on resolving the consequence of the Respironics recall, the consent decree and the important interventions we are making in the company as part of our plan to create value with sustainable impact. Order intake was lower in 2023 due to the exceptionally high comparison base in the last two years to three years lower China and Russia and lower order to delivery lead times.

We saw sequential improvement in Q4 as anticipated and we remain focused on implementing the necessary actions to reduce lead times and leverage our enhanced operating model and our AI-driven innovations to improve order intake. It’s important to note that our order book which accounts for 40% of group sales is 15% higher than when the global supply chain crisis started and we will continue to support revenues with that order book as planned for 2024. This morning, we announced that Philips agrees with the FDA on the terms of a consent decree, which is now being finalized and will be submitted to the relevant US court for approval. The decree is mainly focused on Philips Respironics in the US and will provide a roll-up of defined actions milestones and deliverables to demonstrate compliance, with regulatory requirements and to restore the business.

In the US Philips Respironics will continue to service Sleep & Respiratory Care devices already with health care providers and patients and supply accessories, patient interfaces, consumables, and replacement parts. Philips Respironics will not sell new CPAP or BiPAP apnea devices or other respiratory care devices in the US until meeting the relevant requirements of the consent decree. Outside of the US Philips Respironics will continue to provide new sleep and respiratory care devices accessories patient interfaces, consumables, replacement parts, and services subject to certain requirements. Further details will become available once the consent decree has been finalized and submitted to the relevant US core for approval and we’re not able to provide more information on the consent decree at this time.

Looking ahead we remain confident in our plan and in the financial outlook. The previously stated 2023 to 2025 group financial outlook of mid-single-digit sales growth low teens adjusted EBITA and €1.4 billion to €1.6 billion free cash flow in 2025 now takes the consent decree fully into account and the plan remains unchanged. This outlook excludes, the impact of ongoing litigation and investigation by the US DOJ related to the Respironics field action. In 2024, we expect to deliver further performance improvement with 3% to 5% comparable sales growth, building on a strong 2023 comparison base and an adjusted EBITA margin of 11% to 11.5%. We expect free cash flow of between €0.8 billion to €1 billion. This excludes the expected remaining cash out related to the previously announced resolution of the economic loss class action in the US.

While we continue to see hospitals and health care systems exhibit some cautious buying behavior, we expect this to develop positively in the course of 2024 driven by improving hospital financials and more procedures. In China, the government imposed anticorruption measures, continue to impact short-term decision-making by hospitals, but this is not expected to impact fundamental demand. Our order funnel remains very active in the country and we expect order growth to resume in China in the second half of 2024 following a very difficult comparison base in the first half of this year. Overall, based on the gradually improving market environment, and our ongoing actions to improve order intake, we expect to see positive order intake growth in the full year 2024.

Let me now provide you with some of the recent customer and innovation milestones during the quarter. We signed an eight year $150 million agreement with NYU Langone Health in the US to provide patient monitoring, AI-enabled diagnostic imaging, digital pathology, and enterprise informatics solutions to its latest hospital. Our program to expand access to maternal health through AI-powered ultrasound aims to address the shortage of health care workers by putting a diagnostic tool, previously reserved for expert technicians in the hands of midwives. This program also received funding of $60 million from the Bill & Melinda Gates Foundation. Our innovations are focused on empowering clinicians with artificial intelligence for deeper clinical insights, improved workflow and productivity.

For example, we recently launched Philips HealthSuite Imaging, a cloud-based next-generation of Philips Vue PACS that offers AI-enabled workflow orchestration, high-speed remote access for diagnostic reading, and integrated reporting. In Personal Health, we launched premium S9000 shavers with breakthrough close-shave technology in US, Western Europe, and China. In 2023, we were again recognized with a prestigious A score for our climate action leadership by global environment non-profit Carbon Disclosure Project and as one of the top health technology companies in the Dow Jones Sustainability Indices list. I will now hand it over to Abhijit to take us through the financials in more detail, after which I will come back on our execution priorities.

Abhijit Bhattacharya: Thanks Roy. Good morning everyone, and thank you for joining us on the call. Let me start by providing you some clarification on the charges we took in the fourth quarter connected with the consent decree and explaining its accounting consequences as well. In the fourth quarter, we recognized €363 million in charges connected to the consent decree. This includes provisions charged to sales for field action activities, mainly related to the ongoing remediation of ventilators and provisions charged to costs for the remediation activities, inventory write-downs and onerous contract provisions. Technically this had a negative impact of around 100 basis points on the comparable sales growth for the full year and 350 basis points for the fourth quarter.

It also resulted in the positive impact of 10 basis points on adjusted EBITA margin for the full year and 40 basis points for the fourth quarter as the same absolute adjusted EBITA was divided by a lower sales figure. I understand there can be some confusion about our operational performance due to these impacts and I’ve noticed some headlines mentioning a miss compared to our outlook. I want to make clear that we came at the top end of our upgraded comparable sales growth outlook of 6% to 7% and at the midpoint of the upgraded adjusted EBITA margin outlook of 10% to 11% provided in October, and free cash flow was significantly above our outlook. I hope the above aforementioned explanation helps to clarify. For comparison purposes during this call, I will refer to figures excluding the impact of these provisions as it will help to compare operational performance against the outlook provided earlier last year.

In this morning’s press release as well, as the slide deck, you will find the reconciliation between the metrics including and excluding the impact of these charges. Let me now move on to our performance by segment. In Diagnosis & Treatment comparable sales increased 11% in the full year driven by double-digit growth in Image Guided Therapy and Ultrasound. In the fourth quarter comparable sales growth was a solid 5% on the back of tough comps in the previous year. Full year adjusted EBITA margin for Diagnosis and Treatment was 11.6%, an increase of 210 basis points compared to 2022, driven by higher sales, pricing, and productivity measures, partly offset by cost inflation. In Q4, the adjusted EBITA margin was 10.4%, impacted by an unfavorable mix and phasing of production as we reduced inventory as well as the phasing of costs.

This follows the strong adjusted EBITA margin in the first half that was driven by strong Ultrasound and Image Guided Therapy sales. Connected Care comparable sales increased 5% in the year, driven by double-digit growth in Monitoring. Q4 comparable sales were flat as high single-digit growth in Enterprise Informatics was offset by negative sales growth in Monitoring on the back of around 20% growth in the fourth quarter of last year. Sleep & Respiratory Care sales grew low single-digit in the quarter, driven by growth in sleep systems and patient interface, partly offset by lower ventilator sales. Additionally, a few days ago, we communicated to customers our decision to discontinue the manufacture and sale of certain product lines in the US, primarily within Respiratory Care.

Full year adjusted EBITA margin for Connected Care improved 480 basis points to 6.9%, mainly driven by higher sales and productivity measures. In Q4, the adjusted EBITA margin improved 170 basis points to 13.3%, driven by a strong performance in Monitoring and improvement in Sleep & Respiratory Care. Personal Health delivered a 3% comparable sales increase in the full year and a strong 7% in the fourth quarter, driven by strength in the Personal Care business. Geographically, growth in Q4 was driven by China, Western Europe, and other growth geographies. Overall, consumer sentiment remains subdued but is expected to improve in the course of 2024. Full year adjusted EBITA margin for Personal Health improved by 180 basis points to 16.6%, mainly driven by higher sales, pricing, and productivity measures.

In Q4, the adjusted EBITA margin improved 290 basis points to 19.9%. We have been very disciplined in cost management and our productivity initiatives delivered savings of €956 million in the year of which the operating model savings were €496 million, procurement savings were €219 million, and other productivity programs delivered €241 million. Productivity savings in the fourth quarter amounted to €271 million. The adjusted EBITA margin for the group increased by 310 basis points to 10.5% in the year. Wage and component price inflation was more than offset by operational leverage and by our productivity program and pricing actions. In the quarter, the adjusted EBITA margin for the group increased 50 basis points to 12.5%. We delivered significant cash flow improvement with a free cash inflow of €1.1 billion in the fourth quarter and €1.6 billion for the full year.

This included a cash outflow of around €150 million related to the resolution of the economic loss class action in the US in Q4. Excluding this, the operational free cash flow was very strong with €1.75 billion in 2023. The strong free cash flow was driven by higher earnings and improved working capital. We saw a further sequential reduction of inventory in the fourth quarter and accounts receivables were significantly lower due to a strong performance in collections and favorable sales phasing throughout the year. This resulted in an improvement in our leverage from 3 times to 2 times on a net debt to adjusted EBITA basis compared to the start of the year. On capital allocation, we canceled more than 15 million shares in the fourth quarter of 2023 from the share buyback program started in 2021, which resulted in a total reduction of 1.5% of the outstanding shares in the quarter.

We will submit a proposal to maintain the dividend at €0.85 per share, to be distributed in shares as part of our measures to further shore up our liquidity position. Moving to our order book. As mentioned by Roy, it is significantly higher than the period before the global supply chain constraints and we expect it to continue to support the sales growth in the coming quarters. It is important to note that orders and order book account for around 40% of our revenue. The remaining 60% comes mainly from recurring revenue streams such as, services and consumables, and from the book and bill businesses and from Personal Health. As you can see on the slide, absolute levels of order intake remain healthy, but we see a steep increase in sales level in 2023 due to the enhanced order book to sales conversion following the supply chain and execution improvements.

Based on the strong order book, improving order intake and the ongoing actions to enhance execution, we expect to deliver further performance improvement in 2024, with a 3% to 5% comparable sales growth and an adjusted EBITA margin between 11% and 11.5% recognizing that uncertainties remain. We expect to see this growth of 3% to 5% and adjusted EBITA margin improvement across all our businesses. We anticipate order intake and sales growth to be slightly back-end loaded in 2024, due to the tougher comparison base in the first half of the year, resulting mainly from the strong China performance both on orders and sales, favorable diagnosis and treatment product mix, and high royalty income in the first half of 2023. We also see consumer spending increasing gradually through the year.

Operationally, we aim to deliver a free cash inflow between €800 million to €1 billion this year with higher earnings partly offset by higher working capital due to growth and consent decree costs. This excludes the expected remaining cash out related to the previous announced resolution of the economic loss class action in the US, as well as ongoing litigation and the investigation by the US Department of Justice related to the Respironics field action. Restructuring charges are expected to be 100 basis points in 2024 driven by overall workforce reduction program, as well as the sleep and — reductions in the sleep and respiratory care business. Acquisition related costs are expected to be around 30 basis points. Other costs are expected to be around 200 basis points and include 100 basis points of charges connected to the consent decree remediation activities and disgorgement payments and 100 basis points Respironics field action running costs and other quality-related charges.

Financial income and expenses are expected to be a net cost of around €290 million in 2024. The effective tax rate is expected to be within our midterm range of 24% to 26%. We expect sales of €550 million to €580 million in segment other in 2024 with a loss of about €50 million at the adjusted EBITA levels, which is €20 million better than in 2023 and €100 million at an EBITA level, which is €80 million better than in 2023. With that let me hand it back to Roy.

Roy Jakobs: Thanks Abhijit. I would like to continue with some of the progress we have made on our execution priorities and focus areas for the year ahead. First, we’re taking the learnings of the Respironics field action to raise patient safety and quality to the highest standards across Philips. A year ago high elevated patient safety and quality to the Executive Committee by creating a new leadership position to drive this priority across the company. We drove significant simplification of the way how we work by further reducing the number of quality management systems, which is already 50% down since the inception of the program against our target of reducing them by 65%. We added significant capabilities and talent across the businesses and continue to invest in our systems capabilities and in training and education.

We also improved our capital closures by strengthening processes, capabilities and governance around it. Looking ahead, we will remain focused on driving the cultural shift to deliver the highest quality innovations and put safety and quality at the center of everything we do with a greater level of accountability within the businesses. With respect to the supply chain in 2023, we reshaped our setup and moved to customer-centric end-to-end teams aligned to our businesses. We significantly reduced materials and component risks resulting in a 20% increase in service levels, reduced lead times and improved sales conversion rates. For example, we redesigned more than 75% of the planned PCBs and derisked all high-risk components identified at the end of 2022.

We will continue leveraging and regionalizing our end-to-end supply chain and further reduce lead times in 2024 enhancing reliability and service levels. Finally, our new operating model with prime accountability in the businesses has been live for nine months now and we have fully completed the realignment of the workforce roles and reporting lines. This enabled more effective ways of working across the company, resulting in significant productivity improvements. It also included the difficult but necessary reduction of over 8,000 roles to date out of a planned reduction of 10,000 rules by 2025 versus a plan of 7,000 roles in 2023. At the same time, we started a cultural journey to drive impact with care and attracted over 900 talents with HealthTech background this past year.

As you have seen in the results we presented today, I am pleased to see that the actions we have taken continue to positively impact our performance. We are very focused on our priorities and on executing with excellence to keep improving when needed to deliver our AI field innovations to our consumers and customers. We remain confident that our focused growth strategy for scalable innovation will further strengthen our business and results going forward, and we see huge potential to make a difference, helping more health care providers, help more patients in an efficient and sustainable way and making it easier for more people to take care of their health and well-being. Let me close out by repeating the key messages of today’s announcement.

We delivered a strong year of improved operational performance, as a result of the solid execution of our plan to create value with sustainable impact. We are making progress on all three priorities: enhancing patient safety and quality, strengthening supply chain reliability and simplifying our operating model. Patient safety and quality, remains our highest priority across the company and the consent decree provides clarity and a road map for us to demonstrate compliance and restore the business. Looking ahead, we are fully on track with the plan for ’23 to ’25, although recognizing uncertainties remain. The progress we are making reinforces our confidence to deliver further performance improvement in 2024. I would like to thank you for joining the call, and we will now take your questions.

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. Thank you for taking my questions. I have three please, if we can take them in turn. Firstly, can you talk about the portfolio pruning in Connected Care and why you’ve chosen to exit some of these businesses in the US? Was this directed by the FDA? And what is the combined revenue from these devices? And how should we think about 2024 revenue growth in Connected Care on a clean basis?

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Q&A Session

Roy Jakobs: Thank you, Hassan. Let me take that question. So, we have been starting to prune our portfolio on an ongoing basis. And we did that across the portfolio of Philips, which we have seen in various products, but also businesses. We also did that in Sleep & Respiratory Care. What is important to understand is that actually, these prunings actually are aimed to accelerate our performance. And so far, as you have seen also in 2023, that is actually what they do. So also for the Sleep & Respiratory Care business and also what you’ve seen in terms of the pruning that we take there, it’s aiming at the same objective. We see that Sleep & Respiratory Care bottomed in terms of the €1 billion of revenues. And with the clarity that we have now with the consent decree and the road map to get to compliance and to restore the business, actually we are able to build from there.

And actually that is also why we were happy to announce that actually we could now confirm that we remain on our plan including any consent decree implication for 2023 to 2025. And I think, as you remember when we started last year with the plan and we said that we have a three-year trajectory there were questions around what consent decree could still mean. Now we can take that unclarity of the table and we remain very committed. And based upon the first year, where we actually overdelivered first, the first year plan because I mean also remember, where we started we said low single-digit growth where we did 7% growth. We said, we would do high single-digit EBITA. We did 10.5% EBITA and we committed to €700 million to €900 million of cash.

We did €1.6 billion cash. That actually was excluding inside of the consent decree. Now we continue including the consent decree and we remain fully committed to the plan as we have.

Hassan Al-Wakeel: And sorry, just the combined revenue from these devices and the expectation for connected growth – Connected Care in 2024?

Roy Jakobs: So it’s really immaterial that’s also why we would not disclose. We remain very committed to the 3% to 5% growth for 2024 and that includes any impact of any pruning that we did in 2023. And that was not only in SOC. We also did it in D&T. We also get some pruning in Personal Health. So actually we have been pruning across the portfolios. But actually what we do is to focus our efforts on the innovations that we can scale faster and better, right? So that we have less fragmented portfolio and the portfolio that we have does make a better impact and also that helps us to drive better margins because we said also, if you kind of consolidate your portfolio more you will be able to get more leverage and that will support your margin trajectory as well.

Hassan Al-Wakeel: Perfect. And then secondly so another on the consent decree. Could you help us understand the time line of your return to market in the US, given you talk about a multiyear process and the duration of profit disgorgement and whether you see any risks to selling OUS?

Roy Jakobs: So on the first piece so we have – and will not be provided to kind of give a time line on that. I think we are committed to work through the consent decree as soon as possible. We’re also taking all measures needed. We have a team lined up to do that. We will comfort with the details of the consent decree once it’s core approved, so then you will also have further insight in what it means. But I would say the following. Regardless of when we come back, we will deliver on our plan. So actually we have been taking charge of the rest of Philips the – you know that kind of we have €18 billion of revenue €1 billion is SOC, but actually we will drive all of Philips to deliver on our commitment. And actually that therefore also gives us the opportunity to work through this and comply as we need to do.

And there’s no dependence on that trajectory for delivery of Philips. Outside of US, as you have seen already in 2023, we started to resume and come back into the market. Actually that will continue because we got the regulatory approvals. We already started to sell new CPAP and Bi-PAP devices. And we were continuing already earlier to service market with the consumers the patient interface. And we saw actually in the patient interface also some good performance. So actually we will continue that track. But what for me is the most important piece is, if you look to the totality of Philips in 2023, we have been growing every single segment D&T, Connected Care Personal Health. We have been pulling growth out of every geography, China, Europe and Americas and we will continue to drive that total performance in 2024 and especially, also based upon the strong cash performance that we showed in Q4 and for the full year.

That of course gives also a very strong base to move further in kind of investing in the business, but also be prepared for anything that comes. And the margin improvement of 310bps in 2023, we of course need to continue. We said also we have a target now of 11% to 11.5%. And that’s also underpinned by further growth momentum, but also the productivity measures that you saw. We — took almost €1 billion of productivity that we realized in 2023. Now we take another 1,000 roles out in 2024. And we continue to work also on wider productivity, because we see also some market easing on for example, the procurement side that will help us to also drive further productivity to support the margin step-up.

Hassan Al-Wakeel: Very helpful. And then finally on guidance, can you help us understand the breakdown and the rationale for 3% to 5% growth given the provision had an additional one percentage point drag in 2023? Is there anything driving caution here? Or are you trying to retain your more conservative approach to guidance? And then on the margins, how should we think about the 50 to 100 basis point margin levers by business segment?

Abhijit Bhattacharya: Hi, Hassan. Good morning. This is Abhijit. No. Yes, while there is a bit of benefit because of the provision that went against sales this year, but we also over delivered. So we came at the top-end of our guidance for 2023. So if you net the two it’s a few tens of basis points and given the wide range of 3% to 5%, I think there was no need to further change that range. That’s one. I think on the profit improvement you will see that across businesses, like you’ve seen that this year. So we will continue to drive margins up in Diagnosis & Treatment of course, Connected Care as well but also Personal Health. And yeah, I think we’ll leave it at that.

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

David Adlington: Hey guys. Hope you can hear me okay. So first question really is just on the consent decree, I know it’s a bit difficult had you still taking the call decision. But maybe beyond this year, just wondered if the ongoing costs particularly related to profit disgorgement will still be recognized below the line. I’m just trying to get an idea of how much the headwind we’re going to see below the line in terms of the wages costs beyond this year. And then secondly, you put towards productivity initiative savings of about €960 million so far this year, but your overall EBITA is only up €600 million, so just wondering if you could put towards the underlying headwinds please. Thank you.