Koninklijke Philips Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
January 29, 2024

There are 12 speakers on the call.

Operator

Welcome to the Royal Philips 4th Quarter and Full Year 2023 Results Conference Call on Monday, January 29, 2024. During the call hosted by Mr. Roy Jacobs, 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.

Operator

Please note that this call will be recorded and repays will be available on the Investor Relations website of Royal Philips. I will now hand the conference over to Mr. Leandro Mougouni, Head of Investor Relations. Please go ahead, sir.

Speaker 1

Hi, everyone. Welcome to Philips' 4th quarter and full year 2023 results webcast. I'm here today with our CEO, Roy Jacobs 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.

Speaker 1

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.

Speaker 2

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.

Speaker 2

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 U. S, which provides clarity and a road map for us to demonstrate compliance and restore the business.

Speaker 2

We are confident in delivering the previously stated plan for 2020 3 to 2025, which now takes a constant degree 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. Onto 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 and T, 5% in Connected Care and 3% in Personal Health.

Speaker 2

Group comparable sales growth including the impact of the provisions mainly in connection with the Respironics Concentrix 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 constant degree. This is a strong improvement of 3 10 basis points versus 2022. Adjusted EBITDA margin including the impact of those provisions was 10.6%. Free cash flow saw a strong inflow of €1,600,000,000 in 2023 And we significantly strengthened our balance sheet in the year.

Speaker 2

Restructuring and other charges were high in 2023. This was a result of our focus on resolving the consequences of the Respironics recall, the content 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 last 2 to 3 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 Then when we global then when the global supply chain crisis started and we will continue to support revenues with that water book as planned for 2024. This morning, we announced that Philips agrees with the FDA on the terms of consent decree, which is now being finalized and will be submitted to the relevant U.

Speaker 2

S. Court for approval. The decree is mainly focused on filoplastronics in the U. S. And we'll provide a rollback of defined actions, milestones and deliverables to demonstrate compliance with regulatory requirements and to restore the business.

Speaker 2

In the U. S, Philips Respironics will continue to service sleep and respiratory care devices already with healthcare providers and patients and supply accessories, patient interfaces, consumables and replacements parts. Felis Respironics will not sell new CPAP or BiPAP sleep therapy devices or other respiratory care devices in the U. S. Still meeting the relevant requirements of the consent decree.

Speaker 2

Outside of the U. S, Philips Respironics will continue to provide new sleep and respiratory care devices, accessories, patient interfaces, consumables, replacements parts and services subject to certain requirements. Further details will become available once the consent decree has been finalized and submitted to the relevant U. S. Court for approval.

Speaker 2

We're not able to provide more information on the consent decree at this time. Looking ahead, we remain confident in our plans And in the financial outlook. The previously stated 20% to 20 3% to 2025% group financial outlook Of mid single digit sales growth, low teens adjusted EBITDA and EUR 1,400,000,000 to EUR 1,600,000,000 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 U. S.

Speaker 2

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 €800,000,000 to €1,000,000,000 This excludes the expected remaining cash out related the POC announced resolution of economic loss class action in the U. S. While we continue to see hospitals and healthcare systems exhibit Some cautious buying behavior.

Speaker 2

We expect this to develop positively in the course of 2024 driven by improving hospital financials and more procedures. In China, the government imposed anti corruption 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 twenty twenty four, 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 2020 Let me now provide you with some of the recent customer and innovation milestones during the quarter. We signed an 8 year $150,000,000 agreement with NYU Langone Health in the U.

Speaker 2

S. 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 healthcare workers by putting a diagnostic tool previously reserved for expert technicians in the hands of midwives. This program also received funding of $60,000,000 from the Bill and Melinda Gates Foundation. Our innovations are focused on empowering clinicians with artificial intelligence For deep clinical insights, improved workflow and productivity.

Speaker 2

For example, we recently launched Philips HealthSuite Imaging, A cloud based next generation of Philips Hue packs that offers AI enabled workflow orchestration, high speed remote access for diagnostic reading and integrated reporting. Personal Health, we launched premium S9000 shapers with breakthrough close shave technology in U. S, Western Europe and China. In 2023, we were again recognized with a prestigious A score for Climate Action Leadership by Global Environment Nonprofit 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.

Speaker 3

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 Q4 connected with the consent decree and explaining its accounting consequences as well. In the Q4, we recognized €363,000,000 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.

Speaker 3

Technically, this had a negative impact of around 100 basis points on the comparable sales growth for the full year and 3.50 basis points for the 4th quarter. It also resulted in a positive impact of 10 basis points On adjusted EBITDA margin for the full year and 40 basis points for the 4th quarter as the same Absolute adjusted EBITDA was divided by a lower sales figure. I understand there can be some confusion about our operational performance due to these impacts and have 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.

Speaker 3

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 GEICO 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 and Treatment, comparable sales increased 11% in the full year, driven by double digit growth in Image Guided Therapy and ultrasound.

Speaker 3

In the 4th quarter, comparable sales growth was a solid 5% on the back of tough comps in the previous year. Full year adjusted EBITDA margin for Diagnosis and Treatment was 11.6%, an increase of 2 10 basis points compared to 2022 driven by higher sales, pricing and productivity measures Partly offset by cost inflation. In Q4, the adjusted EBITDA 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 EBITDA 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.

Speaker 3

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 Q4 of last year. Sleep and 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 U. S, primarily within Respiratory Care. Full year adjusted EBITDA margin for Connected Care improved 480 basis points to 6.9% mainly driven by higher sales and productivity measures.

Speaker 3

In Q4, the adjusted EBITA margin improved 170 basis points to 13.3% driven by a strong performance in monitoring and improvement in sleep and respiratory care. Personal Health delivered a 3% comparable sales increase in the full year and a strong 7% in the Q4 driven by strength in the Personal Care business. Geographically, growth in Q4 was driven by China, Western Europe and other growth geographies. Overall, customer cent consumer sentiment remains subdued, but is expected to improve in the course of 2024. Full year adjusted EBITDA margin for Personal Health improved by 180 basis points to 16.6 percent mainly driven by higher sales, pricing and productivity measures.

Speaker 3

In Q4, the adjusted EBITDA margin improved 2 90 basis points to 19.9%. We have been very disciplined in cost management, and our productivity initiatives delivered savings of €956,000,000 in the year, of which the operating model savings were €496,000,000 procurement savings were €219,000,000 And other productivity programs delivered $241,000,000 Productivity savings in the 4th quarter amounted to 2 €71,000,000 The adjusted EBITDA margin for the group increased by 3 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 EBITDA margin for the group increased 50 basis points to 12.5%. We delivered significant cash flow improvement with the free cash inflow of €1,100,000,000 in the 4th quarter €1,600,000,000 for the full year.

Speaker 3

This included a cash outflow of around €150,000,000 related to the resolution of the economic loss class action in the U. S. In Q4. Excluding this, the operational free cash flow was very strong with €1,750,000,000 in 2023. The strong free cash was driven by higher earnings and improved working capital.

Speaker 3

We saw a further sequential reduction of inventory in the 4th quarter And accounts receivables was 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 EBITDA basis compared to the start of the year. On capital allocation, we canceled more than 15,000,000 shares in the Q4 of 2023 From the share buyback program started in 2021, which resulted in a total reduction of 1.5 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.

Speaker 3

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% 11.5%, Recognizing that uncertainties remain, we expect to see this growth of 3 to 5% and adjusted EBITDA 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 twenty twenty three.

Speaker 3

We also see consumer spending increasing gradually through the year. Operationally, we aim to deliver a free cash Inflow between € 800,000,000 to €1,000,000,000 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 U. S. As well as ongoing litigation and the investigation by the U.

Speaker 3

S. 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.

Speaker 3

Financial income and expenses are expected to be a net cost of around €290,000,000 in 2024. The effective tax rate is expected to be within our midterm range of 24% to 26%. We expect sales of €550,000,000 to €580,000,000 in segment Other in 2024 With a loss of about €50,000,000 at the adjusted EBITDA levels, which is €20,000,000 better than in 2023 and €100,000,000 at an EBITDA level, which is €80,000,000 better than in 2023. With that, let me hand it back to Roy.

Speaker 2

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 higher standards across Philips. A year ago, I 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%.

Speaker 2

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. Significantly reduced materials and component risks resulting in a 20% increase in service levels, reduced lead times and improved sales conversion rates.

Speaker 2

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 9 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 a difficult but necessary reduction of over 8,000 rolls to date out of a planned reduction of 10,000 rolls by 2025 was a plan of 7,000 roles in 2023.

Speaker 2

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'm 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 fueled 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.

Speaker 2

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 a constant degree provides clarity and a roadmap for us to demonstrate compliance and restore the business. Looking ahead, we are fully on track with the plan for 2023 to 2025, 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

The first question comes from the line of Hassan Alwakil from Barclays. Please go ahead.

Speaker 4

Hi, good morning. Thank you for taking my questions. I have 3, 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 U. S?

Speaker 4

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?

Speaker 2

Thank you, Asar. Let me take that question. So we have been starting to prune our portfolio on an ongoing basis. We did that across the portfolio of Philips, which we have seen in various products, but also businesses. We also did that in Sleep and Respiratory Care.

Speaker 2

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 and 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 and Respiratory Care bottomed in terms of the €1,000,000,000 of revenues. And with the clarity that we have now with the constant degree and the road map to get to compliance and to restore the business, actually we are able to build from there.

Speaker 2

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 constant degree 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 3 year trajectory. There were questions around what content we could still mean. Now we can take that and clarity off the table And we remain very committed. And based upon the 1st year where we actually over delivered 1st to 1st year plan because I mean also remember where we started, we said low single digit growth we did 7% growth.

Speaker 2

We said we would do high single digit EBITDA. We did 10.5 percent EBITDA and we committed to $700,000,000 to $900,000,000 of cash. We did SEK 1,600,000,000 cash. That actually was excluding insights of the consent decree. Now we continue including the consent decree we remain fully committed to the plan as we have.

Speaker 4

And sorry, just the combined revenue these devices and the expectation for connected growth care to care growth in 2024?

Speaker 2

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 DMT. We also did some pruning in Personal Health.

Speaker 2

Actually we have been improving 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. As 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.

Speaker 4

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 U. S. Given you talk about a multiyear process And the duration of profit disgorgement and whether you see any risks to selling OUS?

Speaker 2

So on the first piece, so we have and will not be provide to kind of give a timeline 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 come forward with the details of the consent decree once it's court approved.

Speaker 2

So then you will also have further insight in what it means. But I would say the following. Recall, as of when we come back, we will deliver on our plan. So actually, we have been taking charge of the rest of Philips. You know that kind of we have $18,000,000,000 of revenue, dollars 1,000,000,000 is as a seat, but actually we will drive all of Philips to deliver on our commitment.

Speaker 2

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 U. S, 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.

Speaker 2

We already started to sell new CPAP and BiPAP devices. And we were continuing already earlier to service the market with the consumables, 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 and 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.

Speaker 2

And especially also based on the strong cash performance that we showed in Q4 and for the full year. That of course gives also very strong base to move forward in kind of investing the business, but also be prepared for anything that comes. And the margin improvement of 3 10 bps 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.

Speaker 2

We took almost €1,000,000,000 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, example, the procurement side that will help us to also drive further productivity to support the margin step up.

Speaker 4

Very helpful. And then finally on guidance, you help us understand the breakdown and the rationale for 3% to 5% growth given the provision had an additional 1 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?

Speaker 3

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 2, it's a few tens of basis points.

Speaker 3

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 and Treatment, of course, Connected Care as well, but also Personal Health. And Yes, I think we'll leave it at that.

Operator

Thank you. The next question comes from the line of David Adlington from JPMorgan. Please go ahead.

Speaker 5

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, given that you're still watching the conference call decision. But Maybe if beyond this year, just wondered if the ongoing costs, particularly related to profit will still be recognized below the line.

Speaker 5

I just want to get an idea of how much the headwind we're going to see below the line into this world cost beyond this year. And then secondly, you put towards productivity initiative savings of about €960,000,000 so far this year, but your overall EBITA is only up €600,000,000 So I just wonder if you could point us towards the underlying headwinds, please. Thank you.

Speaker 3

Yes. Hi, David. Couple of points. So regarding The guidance we said, the 100 basis points will be below the line this year for the whole remediation, including the profit disgorgement. Details of how much is for what, we will come with only once we have the signed court order.

Speaker 3

To your second part of the question, yes, of course, we delivered, like we said, the €1,000,000,000 odd of productivity. But of course, there was also inflation in cost in wages, etcetera, etcetera. So the net is what you see back in the P and L. So that's you will see that also in our bridge.

Speaker 5

Thanks, Abhijit. Just to follow-up on the Gazan decrease, should we expect some 11 items in 2025 and beyond.

Speaker 3

Sorry, see what?

Speaker 5

On the consent decree, Should we expect some one off items in 2025 and beyond?

Speaker 3

Yes. But we will come to we provide more clarity later as we get more information. And the other thing, maybe important to understand, is the 100 bps that we talked about and the additional cost, That's all included in the cash outlook for 2024 and 2025. So we are not changing the cash outlook For 2024 or 2025, so this is all included in that.

Speaker 5

That's helpful. Thank you.

Operator

Thank you. The next question comes from the line of Richard Feldman from Goldman Sachs. Please go ahead.

Speaker 6

Thanks. Good morning. Two questions for me, please. First one is on D and C margin in Q4. So can you provide maybe a little bit of color around the mix impact in the quarter?

Speaker 6

I know strong growth in ultrasound had been a tailwind through the year, which I don't think was the case in Q4. But can you maybe help us quantify that impact, please? Then the other driver that you call out in D and C margin for Q4 was the phasing of production and costs. Can you maybe explain what the phasing actually was related to and quantify the impact? Just trying to get a sense of the underlying margin trajectory for that part of the business.

Speaker 6

Then my second question is a little bit more of a medium term one on Sleep and Respiratory Care margins. And look, now that you have a little bit more visibility on the consent decree and I see more detail on what remediation activities are going to look like, What level of profitability do you think is achievable for that part of the business in the medium term? Thank you.

Speaker 3

Yes. Hi, Richard, let me take the first one on the Q4 impact on Diagnostic Imaging. So a couple of things. One is the mix is not just on ultrasound, but it was a combined mix of a Few things. So we had not only the mix of lower ultrasound because last year, we had, let's say, the backlog that we cleared, But also the geographic mix, so we sold more this year outside the U.

Speaker 3

S. And China, so that was another impact. And then also the mix between Equipment and services was also slightly adverse compared to the year ago because we sold we had good sales in MR, etcetera. So that's equipment which comes at a slightly lower margin. So that was the mix impact.

Speaker 3

Now regarding the phasing of production, that was We have also brought down inventory big time. So as you do that, you taper off production so that we start next year with a healthy inventory but not too high, and that results in a slightly lower coverage of our factory costs. So that impacted the margin in the 4th quarter. And then there was some phasing of costs between through the year and most significantly in 2022, The annual incentive payments were very low because or non existent because of the poor performance. That, of course, comes as a cost this year, so that's the difference between the 2 years.

Speaker 3

So those are the 3 big buckets that impacted the margin in the 4th quarter. Your second question on SRC outlook, look, for sure, we will get back to profitability, but But we are not giving separate guidance on every business. I think you should see a significant step up In the overall Connected Care profitability that we have given in our guidance and as part of that is also the improvement that we will drive in sleep and respiratory care.

Speaker 6

Thank you.

Operator

Thank you. The next question comes from the line of Veronika Dubajova from Citi. Please go ahead.

Speaker 7

Hi, good morning, Roy, Abhijit, Leandro, and thank you so much for taking my questions. I will keep it to 2, please. 1, would just love to get your take on China and your current expectations as far as your installations in China are concerned

Speaker 8

And

Speaker 7

what's embedded in the guidance for D and T both from a sales and a profitability perspective? Obviously, China is a very important and highly margin accretive market. So I'm just curious how you're thinking about the anti corruption activity and how that plays out in terms of the China revenue impact this year. Your commentary on orders have been very clear. I'm really just curious about the P and L and what you've kind of factored it in there.

Speaker 7

And then I'll have a follow-up after that if that's okay, but let's get this out of the way first.

Speaker 2

Sure. Maybe thank you, Veronika, for the question on China. I think China has been always an important part of our business also will remain important part of our business. I think it's fair to say that we know that China is going through a difficult phase macroeconomically from a growth perspective Where the growth is lower with around 3% to 5% for the country as they have normally been kind of customized to That has a consumer impact, but it also has an impact in Healthcare. And there in particular on top, we have seen of course the anti corruption measures.

Speaker 2

Now what we know is that on the end to corruption, they are working through a comfy program to actually go state by state. So what we have seen is that they have Party finished their program or at least they made a lot of progress on that in 2023, but we do expect that to continue into 2024. And therefore, actually, we are seeing that China is back end loaded for 2024. We see gradual improvement in China. It will continue to contribute to our total plan and also embedded in the guidance of the 3% to 5%.

Speaker 2

I think what is important from an Order percent perspective, it's only 5% of our global sales, mainly in D and T. And also that on the consumer side, we have seeing them coming back to growth, but we expect that to surely but slowly come further up. So China will Strengthened throughout the year is our expectation. The government actions are not finished and they will still need to complete that program.

Speaker 7

Okay. That's helpful. And would you expect China for D and T to be flat to grow or to be down for the full year?

Speaker 2

No, it should grow. So we expect it to grow.

Speaker 7

It should grow. Okay.

Speaker 2

Yes, yes, it should grow.

Speaker 7

Okay. That's great. And then my second question was And I think, Roy, you alluded to this in your prepared remarks, some of the geopolitical risks, obviously, thinking about shipping and freight costs. Obviously, you have some very localized manufacturing in the Middle East for the CT business. Just kind of curious how much of your We can see that very highly technical term.

Speaker 7

Have you embedded around those risks when you've given the 2024 guidance? And I guess what is for you the single most significant area of concern that you have? Maybe Abhijit can chime in also on the freight side of things there. Thank you, guys.

Speaker 2

Yes. I think we alluded to the uncertainty because just learned that the world around us is and remains volatile. I think the guidance that we have been giving the 3% to 5%, we are very confident in based on the execution improvements that we have been putting into 2023 because that gave us more agility also to adapt to situations that like we see Today, it gave us productivity to absorb some of potential cost increases. And I would also put into perspective kind of, yes, there is Red see, for example, developments. But if you look to the total freight costs that we have, this is immaterial impact that we currently foresee.

Speaker 2

There might be some kind of delivery time challenges, but actually that's what we're also overcoming because we are kind of amping that and we're working already for mitigation. So we are vigilant of what could happen to the world. So far kind of we are on top of the developments both in Middle East. And I think the bigger concern that I think and you alluded to it earlier is that we need a strong global economy And we need all the geographies to contribute. And therefore, China getting stronger, I think, is something that, of course, we all welcome.

Speaker 2

But also Rest of World, we see some strengthening in 2020 for North America should be a bit stronger than 2023. And we see also pockets of growth that we go after in Asia, for example, with Indonesia and Japan. And also Saudi, we see some good So we watch the world carefully. I think by adjusting our operating model, we have become more agile to adapt to situations if they would occur. Currently, we are dealing with any known issues well and they are taken into the guidance as you have seen.

Speaker 7

Thanks guys.

Operator

Thank you. The next question comes from the line of One moment please. Comes from the line of Lisa Clive from Bernstein. Please go ahead.

Speaker 9

Hi, thanks very much. Just a question on your order book and the matchup of inflation and cost increases. I know Fairly early on as inflation picked up, you did manage to put through price increases. And just wondering if you could just remind us roughly what quarter that started and when that started coming through your backlog? And After that initial round of price increases, have you been able to continue moving prices up as inflation has not yet abated?

Speaker 3

Yes. I think what we did was We saw first a small bit coming into Q3 and then Q4 a little bit more. But I think most of the, Let's say price increases you will see coming in, in 2024. That is what we had planned. So in pH, we don't further strengthening of prices.

Speaker 3

So we are where we are. Our margins are at a good level. We are driving productivity, etcetera, to drive cost down. In selected areas in Health Systems, we continue with the price increases that we've had, But we are also seeing component pricing and other things coming down. So we will manage that as a mix into the pricing strategy for 2024.

Speaker 9

Okay. And then just a question on your sleep apnea business. Novo Nordisk will have a readout from an OSA trial for their GLP-one. And Clearly, obesity is a major contributor to sleep apnea, although on the other hand, it's a very under diagnosed condition. So just thinking about How the world seemingly has changed in the last few months around GLP-1s and the potential for even better drugs, the potential for eventually generics to help lower the price point.

Speaker 9

Does that change your long term view on the sleep apnea business, particularly in light of the fact that you're actually just even going to be out of the market year 2 as well, at least in the U. S. Obviously, you're able to sell OUS, but the U. S. Has historically been your biggest market.

Speaker 2

Yes. Thank you, Lisa. I think we don't see it's changing structurally the market opportunity. We believe that there is Significant patient base out there as you say that's undiagnosed. Yes, I think there will be medication that will help address some of The causes of sleep apnea, we also know that on average sleep apnea patient has 5 comorbidities.

Speaker 2

Obesity is one of those. So this will help, but will not take the root causes away. We also know that CPAM BiPAP is by far the most effective therapy that is preferred and also in use and in demand. So we are committed to that segment. We also see the opportunity strong.

Speaker 2

We're fully focused on working through Now the clarified road map for U. S. And outside of U. S, of course, we are already coming back into play. So we believe that there is a strong road ahead that we will work through based on the improved clarity that we now have.

Speaker 9

Great. Thanks for that.

Operator

Thank you. And the next question comes from the line of Sethi Zona from HSBC. Please go ahead. Hello, Sesqui, is your line on mute? And your next question comes from the line of Graham Doyle from UBS.

Operator

Please go ahead.

Speaker 2

Good morning.

Speaker 10

Thanks for taking my questions. Just 2 kind of areas. So firstly, just in terms of the adjustments and sort of the So restructuring charge and secondly around the consent decree. In terms of the adjustments, kind of quick housekeeping one. Could you maybe elaborate on what the €81,000,000 of D and T remediations related to in Q4 2023.

Speaker 10

And then just for 2024, it looks like if you To the sums, roughly 100 basis points of the expected adjustments to EBIT is going to be related to the recall, again, which it just seems It seems a large number, given you also say in the statement that more than 99% of the sleep recall is done. So could you give us a sense on When these adjustments will end, I suppose? And then separately to that, just on the consent decree, Is there anything in your 2025 guide for sleep and respiratory sales in the U. S? And I know you don't want to comment on the specific products that were withdrawn on Friday.

Speaker 10

But given the quantum and the previous breakdown of revenue from these products. It seems like a fairly sizable headwind, particularly in the 1st couple of quarters next year when maybe you don't have the tailwinds coming through in revenue. So how should we be thinking about that H2 rating that Abhijit just referred to for 2024? Thank you.

Speaker 2

Yes. Let me take the first one on the €81,000,000 in charge that we took. So as I said, when we start the plan, patient safety and quality is an important focus area for us. And we will put in due efforts to actually improve quality across the portfolio. That actually is where these charges reside from because we are also taking action across all our businesses.

Speaker 2

And in this case, it was in the D and T area that we took the quality action. And that is part of the improvement of quality. We're also seeing that as part of the plan. We would invest behind that. And these are some of these charges that you currently see coming through.

Speaker 3

Regarding the adjustment Of 100 bps, let me clarify. There are 2 parts, sir. 1 is related to the consent decree where we have running costs of the remediation. The second that we mentioned is regarding overall remediation in Respiratory Care, but also for the rest of the company. Now part of that is the legal costs will continue.

Speaker 3

There is some testing costs that will continue. So yes, we are at 99% on the remediation of sleep. There is a very small portion that is left. We still have to do the ventilators for which we have a provision now. But let's say the last part of The legal costs and testing and other related costs will continue into next year.

Speaker 3

Your last question was on, yes, the sizable headwinds. I also saw it in your note. You talked about €400,000,000 of headwinds. I think Roy has clarified The €1,000,000,000 is the bottom that we see that was the revenue for 2023, and that is the bottom. So we don't see any further headwinds to that revenue number going forward.

Speaker 3

And In our outlook, all of this is taken into consideration.

Speaker 10

Okay. Super helpful. Maybe just on That point, the last point on the SEK 1,000,000,000 of Sleep Aspiratory. You have given us plenty of disclosure in the past, so we can kind of We easily estimate what masks is. It gets us to a number of €700,000,000 or something in that region for all of the other non mask, non sleep revenue in this division.

Speaker 10

And if I just go to the U. S. Website, pretty much every product has been removed Bar the bypass, which you're now not selling. So like it just seems like a large number. Even if it's half that number or half of that number, it's still a big number.

Speaker 10

That's why I'm asking, is there something that we're missing in terms of sales that's coming from a different part of Sleep and Respiratory That I've overlooked or analysts have overlooked that would be quite helpful to know and that obviously helps to bridge that 25% gap.

Speaker 2

Yes. Maybe Graeme, so first let me start from what Abhijit said, right? So the SEK 1,000,000,000 that's the number that we build back from. When we talk about this is the roadmap to compliance resource business, that's where we start from. What you see of course is there are mix shift underneath.

Speaker 2

We already stopped selling a lot in U. S, right? So I think actually we are building there from already a base that actually was out there, right? We continue with patient interface, which was the biggest part, which already was in the forecast, including consumables and accessories. Furthermore, as you know, we are building back outside of the U.

Speaker 2

S, Right. So that's something that comes actually on top of what we're doing because that was not in the earlier guidance. So I think, yes, we are have published list of pruning products, but that's not part of kind of lowering guidance. No, actually we have taken that into the guidance and we will building back we will be building back from here. So I think that's where we just really want to be clear that there should be no misunderstanding that, a, we have taken all in the guidance.

Speaker 2

Actually we've delivered a 3% to 5% including the pruning that we did in SRC, but also the pruning that we did in other businesses. B, that we have reached the bottom and we will build back. So we will make sure we comply as well as that we further restore the business. And what we also said, Carnaphe, as well we will kind of have now included this as part of our guidance and the plan 2023 2025. We will not go into specific breakdowns per product line of a business because that's what we don't do in any business.

Speaker 2

And it should also not be of your concern as actually we reiterated that we have a strong outlook, right, and that we are committed to deliver that 3% to 5% growth, That profit further step up to 11% to 11.5% and the cash, which is really important focus area. You saw that we are Very much focused on that. We had a very strong close on cash, and we will continue that cash discipline moving forward. And that totality of Phillips That actually we see strengthening and we will after a strong 1st year where we over delivered on our plan significantly versus what we came out with in January, We want to continue that performance trajectory in 2024.

Speaker 3

Maybe The cost of repetition. Roy mentioned earlier pruning parts of our portfolio is something that we have been doing for a while also to focus on our high growth drivers and to get our innovations out there and put scale behind our winning products. So maybe there is a heightened sense of sensitivity around the pruning in sleep and respiratory, but just look at it as part of stuff that we do across the portfolio, across the company.

Speaker 10

Okay. No, that's really helpful. I'll follow-up, Leander, just to make sure I haven't The

Operator

next question comes from the line of Cecilia Zona from HSBC. Please go ahead.

Speaker 11

I'm so sorry about a Few seconds ago, I hope you can hear me now. I will have 2 questions, please, and thanks for taking them. One of them on the Respiratory Care portfolio. You said you will I mean, you disclosed About this continuation of the sales of these products, you had said in the past that in order to deal with the recall, you had Quadrupled capacity of CPAP, EPAP production. I know you've been undergoing a lot of changes, How much of that capacity has been built away?

Speaker 11

Or will you how much of that will you be able to utilize in OUS sales on or in other products. And if we think about long term profitability of Connected Care, my impression was that sleep and respiratory care had higher profitability than Patient Monitoring, how does that impact your long term margins for these segments? And my second question will be you're showing much lower inventory levels in all of your segments at the end of year end. Do you expect further downsides or RDEs inventory levels sustainable? Will they Or do you should we pencil in some rise going forward?

Speaker 3

Yes. I think on the capacity, what we had done, the additional capacity that we put in was flex capacity with co makers. So they were kind of Not in our own plants, but we did it with co makers. Those have been wound down as we have progressed with the remediation. So that's not something that will remain as an overhang.

Speaker 3

In terms of SRC profitability, You say it was never higher than monitoring. Monitoring, of course, is a very highly profitable business. SRC in the past was a mid- to high teens profitability business, it will probably not get back there, but we will improve profitability over the period so that we get into the guided range for Connected Care as we have given for 2025. Regarding the inventory, yes, we have done a big reduction last year. There are still a couple of areas that we would want to reduce this year.

Speaker 3

So yes, we will have a couple of 100,000,000 reduction this year as well on inventory, so that we get our supply chain then working at an optimal level.

Speaker 11

Thanks very much.

Operator

Thank you. The next question is a follow-up question and comes from the line of Veronika Dubajova from Citi. Please go ahead.

Speaker 7

Hi, guys. Thank you so much for squeezing me in for a follow-up. I'm going to go back to the topic that I think Bunch of people have asked just maybe for clarification, we can close the circle. But I think when you gave the guidance Back last year, the midterm guidance, you had assumed a 10% CAGR for SNRC sales. I just want to confirm whether that still stands Or should our working assumption be different?

Speaker 7

And maybe just to confirm that SNRC sales went from 1.3 to $1,022,000,000 to $23,000,000 Just so we have the right starting point, that would be great. Thank you.

Speaker 3

Yes. I think the €1,000,000,000 sales for 2023 is what we have said now multiple times in this call. So Confirmed and reconfirmed again, Veronika. Regarding the growth rate for Sleep and Respiratory, we are not giving a separate guidance at this point of time, we have the overall guidance for Connected Care. And within that, we will manage the sleep and respiratory monitoring, Enterprise Informatics and all of the businesses to get to the target that we have set for ourselves.

Speaker 3

And You see there's quite a big step up in profitability from where we are now, and we have high confidence of getting there in the next 2 years.

Speaker 7

That's very clear. Thank you, Abhijit. And the $1,000,000,000 are you able to give us a flavor for U. S. Versus OUS In terms of the breakdown of that?

Speaker 3

The $1,000,000,000 is a $1,000,000,000 and then we build from there.

Speaker 9

But let me ask you differently.

Operator

It's fair to assume it's more OUS than U. S. At this stage, correct?

Speaker 3

Yes. Veronika, I appreciate you asking differently, but let me answer in the same way, the €1,000,000,000 retains the €1,000,000,000 right? So we don't want to give more because it gets into level of So much detail that it creates more confusion than clarity. So I think if we take this as a starting base, I think your models will be simpler and easier to get through.

Speaker 7

Understood. Had to try anyhow. Thanks guys.

Operator

We will now go to our last question for today. And the question comes from the line of Julien Dormois from Jefferies. Please go ahead.

Speaker 8

Hi, good morning, Raul. Good morning, Abhijit. I'm left with 3 questions, if that's okay, but they should be fairly short. The first one, and sorry if you've provided it, but I was just wondering whether you could provide us with the Please on the order book between DNT and CC. 2nd question relates to the imaging or to the DNT business, sorry, and given the normalization in the backlog in that division, do you see anything that could prevent you from returning to the Same sort of margin that you exhibited in full year 2019, which was a margin of, let's say, between 12% 13%.

Speaker 8

And more specifically into this, if you could give us sense of where your imaging business currently sits? Are we now in the double digit range for that segment? And the last question is For the consent decree, I was wondering whether you could give us any sense of when you expect the terms of the consent decree to be formally signed off. Are we talking about a few days, weeks or could this be months? Thank you very much.

Speaker 2

Yes. Thank you. Speak the line. Yes. So on the maybe on split, in terms of the

Speaker 3

Yes. On the split Between DMT and Connected Care, it's pretty much similar, right? We start Connected Care also in monitoring with actually a very strong order book that gives us confidence for the growth in 2025. D and T, look, were I think we ended at 11.6%. So we are very close to the 12% to 13%.

Speaker 3

So with the profit improvement of this year, we will get to The peak ranges of 2019, as you pointed out. And then on the consent decree, When you expect it to be signed, Roy? Maybe you can take that. But we don't have VLNA there because that is a court process.

Speaker 2

Depending on the FDA and the court. So that is due process. So we cannot give you a date on that. So that's something that is running. Of course, people will try to expedite to make sure that this gets clarified and closed.

Speaker 2

But I think there's no date that we could give you here.

Speaker 8

Okay. Thank you very much. Just for the sake of clarity on the order intake that was down 3% in the 4th quarter, That number would be pretty similar between D and C and CC. Did I get it right?

Speaker 3

Yes. Perfect.

Speaker 2

Yes. Okay. Thank you very much, And important to know, right, Julien and you probably know that in terms of the order book, it supports 40% of the sales that we have, right. And we have 60%, which is in services consumables recurring revenue and personal health. And actually we also saw Good growth there.

Speaker 2

You saw it in the Personal Health product, but also in the Services and Software growth. So of course, we all want to improve the number. That's our target. We have the actions in place. But I think it's also important to kind of put it into perspective of total SEK 18,000,000,000 and what this supports.

Speaker 2

Furthermore, as I said, 15% higher order book. So actually, if you look to the ratio of conversion going into 2024, we are still actually higher and above the supply chain and COVID crisis numbers in terms of our underpinning of the sales by the ratio of the order book. So that also gives us the confidence going into the year for the 3% to 5%.

Speaker 8

Kristal here. Thanks.

Speaker 2

Thank you.

Operator

Thank you. Gentlemen, that was the last question. Please continue.

Speaker 2

Okay. Thank you, Paul, for your questions. I think reiterating, I think the key messages of today, we came out with Our full year results were if you compare to where we start the year and the guidance of the plan, we had a strong beat on sales where we did 7% versus guidance of low single digit where we had a profit improvement of 310 bps, which actually was high single digit target and we delivered €10,500,000,000 And we had a cash flow target of €700,000,000 to €900,000,000 where we did €1,600,000,000 That was on the back of strong execution of our plan where we focus on patient safety and quality, supply chain and the operating model. Now we continue to execute that plan. That also gives us the confidence into 2024 where we said that actually we give you a range of 3% to 5% of sales growth as our target then 11% to 11.5% profit improvement, so we continue our trajectory as well in profit and then a strong cash generation of € 800,000,000,000 to €1,000,000,000 We also provide you with clarity on the consent decree, which I think is a very important milestone that we have all been longing for And also what important message there is, on one hand, we have now roadmap to comply to restore the business, but most importantly, that actually we stay fully committed to the plan that we have and the financial guidance that we put out there that now includes the full consequences of the consent decree.

Speaker 2

And actually, therefore, we are kind of now building from that in terms of further delivery of the plant. So we're looking forward To further dialogue around how we progress, we will remain focused on executing our plan and delivering continuous improvement. Thank you so much

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Earnings Conference Call
Koninklijke Philips Q4 2023
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