Philips : Q3 2023 webcast transcript

Q3 2023 Results

Monday, 23rd October 2023

Q3 2023 Results

Monday, 23rd October 2023

Leandro Mazzoni : Hi, everyone. Welcome to Philips' 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 it over to Roy.

Introduction

Roy Jakobs

CEO, Philips

Welcome

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.

Highlights

Now, starting the key highlight for Q3: we delivered another quarter of improved operational performance with strong 11% sales growth, doubling our profitability, and strong cashflow. 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 device is almost complete. We are in discussions with the FDA on the details of further testing. The litigation and 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 of 2023, although recognising uncertainties remain in an 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.

Delivered strong sales growth, profitability and cashflow:

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 EBITA margin was 10.2%, a strong improvement of 540 basis points versus a year ago. Operating cash saw an inflow of €489 million, an increase of approximately €770 million versus last year. Order intake, which accounts for around 40% of group sales

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was lower in the quarter, mainly due to the comparison base related to the exceptionally high orders in 2021 and 2022, substantially lower in 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 behaviour 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 by a strong order book: the order book remains around 20% higher than in Q3, 20 21 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 time from order to delivery and leveraging our operating model change and our innovations. Based on the funnel of orders that are in the pipeline and the visibility we have as of now, we expect to see substantial improvement in order intake in Q4 while there remains the uncertainty and the geopolitical volatility we have outlined.

Preferred strategic and innovation partner for customers:

Let me provide you with some of the key customer and innovation milestones during the quarter. We signed a ten-year over €100 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.

Highlights by business segment in Q3 2023

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 sales 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 Philipo 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.

Financials

Abhijit Bhattacharya

CFO, Philips

Thanks, Roy. Good morning, everyone. Let's begin by looking at the segment highlights for the quarter.

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Segment highlights

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's 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 emained 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 cashflow, with a free cashflow of €333 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 €454 million. This resulted in an improvement of our leverage from 3.6x to 2.9x on an adjusted EBITDA to gross debt basis compared to the start of the year.

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Productivity:

We're being very disciplined in cost management and our productivity initiatives have delivered savings of €258 million in the quarter. Operating model productivity savings were €142 million, procurement savings were €59 million, and other productivity programmes delivered €57 million. Year to date, our productivity initiatives have delivered savings of €685 million.

Orderbook

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.

Normalization of orders/sales

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 here 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.

Actoins to improve order intake

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 '22, significantly lower orders in China and Russia, as well as longer order to delivery lead tanks. 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-termdecision-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.

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Debt maturity profile

Moving to capital allocation in the third quarter, we issued €500 million of 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 €1.5 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.

Further raising the outlook for 2023

As Roy mentioned, we have raised the full year outlook to 6-7% comparable sales growth, and an adjusted EBITA margin between 10-11% for the group while recognising uncertainties remain in an increasingly volatile geopolitical environment. As we had mentioned earlier, Q4 will have a 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 are not seeing nor 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 it back to Roy.

Presentation

Roy Jakobs

CEO, Philips

Resolving the recall for patients remains our highest priority

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 upon 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 form. 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 the provision of 575 million euros in the first quarter of this year. The litigation and the 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.

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Execution priorities

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 to 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 specialised 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're on track to meet our target to de-risk all our high-risk components by year end. As you have seen in the results today, I am 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 are monitoring the situation 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.

Key takeaways

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 cashflow. 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 recognising 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.

Q&A

Operator: Thank you, sir. If any participant would like to ask a question, please press the star followed by two times one on your telephone. Due to the time, please limit yourself to one question. This will give more people the opportunity to ask questions. There'll be a short pause while participants register for questions.

Thank you. The first question comes from the line of Hassan Al-Wakeel from Barclays. Please go ahead.

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Hassan Al-Wakeel(Barclays): 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 midterm growth guidance? Is end market demand changing at all?

Secondly, can you talk about the strong profitability in D&T and your expectations for Q4 given it is typically a higher volume quarter? You already sit at 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.

Then finally, can you talk about the FDA's updates 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? 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 with. So on the orders, you saw that we have presented to 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 fuelling our strong sales performance to date and the 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 up 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 this year, where we had 47% growth two years ago. So the comparable base also played part. Then on top, we are taking actions to continue to work on improved order intake.

Therefore, I'll also mention that actually we are ahead of the first year of our three-year plan. Actually, this have given us further confidence in also executing the second and third year of the plan that I presented in January. 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. That's maybe a bit of a different profile that we have for some other companies because we have 20% of our total business coming off PH, which you saw coming back to strong growthSecondly, 40% is tied to services, but also software subscription revenue. And then the remaining 40% is on the CapEx business, where this affects the current profile. So that's 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, 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 is our biggest quarter.

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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 the consent decree. 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 dialogue on the consent decree. There is no further update to share. The moment we have it, we will come forward.

On testing, we are currently in active discussion with the FDA to finalise what exact testing needs to be done so that actually we can supplement the current testing that we have. Also there at the moment, we have that finalised, 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. 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: Yeah, Hassan, let me take that. We have said we expect sequential improvement. Now, we also talked about the uncertainty, especially what you see in China. 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 (JP Morgan): Morning, guys. Thanks for questions. Maybe just firstly on orders again. Obviously China, I just wondered if we can get to your thoughts in terms of when we might be through the anti-corruption slowdown, when we might be through the other side. Just getting various different bits of commentary in terms of when we might be through that.

Then secondly, just on personal health, just wondered how much that 7% growth is due to price, and effectively your thoughts on pricing going forwards from here, please.

Roy Jakobs: Okay. Thank you, David. Let me take the first question on China. We had a very strong start of the year in China, as you have seen. We grew orders and revenue double digit. That was good market momentum that we saw because of pentup demand and also strong progress we made on our local-for-local portfolio. We also expect that to continue that indeed there is this current short-term slowdown as hospitals work through the anti-corruption measures. It is a phasing issue. 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 three quarters. That to be expected. It's hard to say how exactly it will pan out, but we are very confident on the Chinese market and that it will resume and that also we will be able to then resume our trajectory that we had in China, as it's fundamentally very attractive and we see great prospect. As I said, we celebrated 100 years. We will continue to work on that because we

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see also another 100 years in China up for us. So lets work to capture the full opportunity.Also, the consumer side of China is important. We also saw that coming back to growth in Q3. So that's also, I think, an important part of the China opportunity, and we will continue to work both sides of it.

Abhijit Bhattacharya: Hey, on the question, it was a bit distorted the line at that time. Let me just be sure that your question is, how much of the 7% comes from pricing. Is that your question, David?

David Adlington: That's right, Abhijit. Yeah.

Abhijit Bhattacharya: Yeah, so I would say a couple of percent came from pricing. The rest came from volumes. That's how you would look at it

David Adlington: And your thoughts on pricing from here?

Abhijit Bhattacharya: I think we are not going to make big price increases now. I think we have also stabilised in terms of our raw material pricing, etc. So if we are able to hold the current level of pricing, we are in a good zone for our margins. So I don't see further price raises.

David Adlington: Perfect. Thank you.

Operator: Thank you. We will now go to the next question, and the next question comes from the line of Richard Felton from Goldman Sachs. Please go ahead.

Richard Felton (Goldman Sachs): Thank you. Good morning. Just to follow up on your lead times, so you're able to comment on which modalities are lead times still an issue, and how much visibility or control do you have to drive further improvement from here? Any sense of how long the process might take to return your lead times to standard in line with peers would be, it would be very helpful. That's my first one.

My second one is a follow up on D&T margin. You called out pricing as one of the drivers for margin progression in the quarter. Is there any colour you can share on the size of the pricing impact? Then also, how should we think about pricing as a driver for D&T margin in coming quarters? Thank you.

Roy Jakobs: Thank you, Richard. Let me take the first one on lead times. I think when I started, I said supply chain improvement is very important for us. I'm very happy to see also that supply chain improvements have been materialising, and that actually is driving the 11% sales growth realisation in the quarter. So we have been making a lot of strides.

I also shared that actually we were working on high-risk components because what we were facing is that because of the misses of some components, we could not complete and then not deliver. Now, actually we reworked 70% of the high-risk components already year to date, and we expect to complete the program by year end towards 100% of the high-risk components. That also means that you will see therefore further improvement of the lead times.

Actually, if you look to the lead times of many of our businesses, they are already fully in line with market. The single biggest one that we call out earlier that we need to work through to fully get in line with market is MR. That's the one where we have been working it further. The good news there is that on the [inaudible] issues that we had, we also now resolved that. So

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