Welcome to the Royal Philips First Quarter 2022 Results Conference Call on Monday, April 25, 2022. During the call, hosted by Mr. Frans van Houten, CEO; and Mr. Abhijit Bhattacharya, CFO; all participants will be in a listen-only mode. After the introduction, there would be an opportunity to ask questions. Please note that this call will be recorded and replay will be available on the Investor Relations website of Royal Philips. I will now hand the conference over to Mr. Leandro Mazzoni, Head of Investor Relations. Please go ahead, sir.

Hi, everyone. Welcome to the Philips first quarter 2022 results call. Our CEO, Frans van Houten; and our CFO, Abhijit Bhattacharya, will take you through our strategic and financial highlights for the period. And after that, we will take your questions. Our press release, slide deck as well as frequently asked questions on the Respironics recall were published at 7 a.m. CET this morning on our Investor Relations website. The full transcript of this call will also be made available today on the website. As mentioned in the press release, adjusted EBITA is defined as income from operations, excluding amortization of acquired intangible assets, impairment of goodwill and other intangible assets, restructuring charges, acquisition-related costs and significant one-off items. Comparable growth for sales and orders are adjusted for currency and portfolio changes. With that, I'll turn the call to Frans.

Yes. Thanks, Leandro and thanks, everyone, for joining us this morning. There are three factors shaping our Q1 results and outlook today. Number one, it's the continued strong delivery of our strategy and operational performance, leading to an increased order book despite the very challenging backdrop; two are obviously the shortages and dislocation in the supply chain, geopolitical challenges and increasing inflationary environment; and three, the huge undertaking at Philips Respironics to do everything to deliver a solution to patients and caregivers affected as fast as we can. Patient well-being remains at the heart of everything that we do at Philips. Now, let me unpack these three factors. Our strategy and portfolio continue to resonate very well with customers and consumers and we again experienced solid demand for our products and solutions. Order intake grew 5% in the quarter for the group or 8%, excluding the Sleep & Respiratory Care business, driven by strengths across the Diagnosis & Treatment businesses, Hospital Patient Monitoring and Connected Care Informatics, to just name a few. This further builds on the good order intake growth in recent quarters, resulting in an all-time high equipment order book for Philips, in fact more than 30% higher than a year ago, as shown on Page 27 of our presentation. During the first quarter, we also signed 12 more long-term strategic partnerships across the world, demonstrating the trust hospital leaders have in our ability to help them enhance health outcomes, lower the cost of care, improve patient and staff experience. Also, in China, we signed an agreement with Shanghai East Hospital to provide its hospitals in the Shandong and Hainan provinces with a broad range of advanced imaging and critical care solutions. Thanks to the hard work of our people, we recorded sales of €3.9 billion in the quarter in these challenging circumstances with a 4% comparable sales decline which exceeded our prior guidance of a high single-digit decline. Adjusted EBITA was 6.2% of sales. I am also pleased with the 8% comparable sales growth for our Personal Health businesses which demonstrates strong consumer demand for our propositions in this segment. We continue to face severe supply chain disruptions across our businesses primarily related to the shortage of electronic components, increased shipping times and now, again, COVID affecting suppliers. We expect these headwinds to continue in the coming quarters but we are taking decisive actions with daily management to mitigate the impact. We had already expanded the long-term orders with our suppliers and increased spot buying. Our R&D teams are adjusting product designs to diversify sourcing of components. Moreover, we are calling on suppliers and governments at senior levels to prioritize health care products in the supply of components. While we see some positive effects of these actions, visibility in component availability remains poor due to lack of visibility from suppliers which makes it difficult to forecast accurately. We are concerned about the lockdowns in China which pose additional uncertainty on the outlook for the year both in terms of domestic sales as well as for the global supply chain. The Russia-Ukraine war which we strongly condemn, has so far had a small negative effect on our overall revenues for the year and we continue to monitor the situation closely. The current macroeconomic, geopolitical and supply chain environment also leads to mounting inflationary pressure, so we are implementing price increases and taking additional cost measures to mitigate these headwinds. Now, let me speak about the Respironics recall. As I said, we are deeply committed to supporting the community of patients who rely on our sleep and respiratory care solutions and the physicians and customers who are dedicated to meeting patient needs. The repair and replacement program is underway globally and we have produced more than 2.2 million repair kits and replacement devices to date. We have increased our weekly production output more than threefold over recent months and are accelerating further despite the global supply chain challenges. We recorded a €65 million increase in the field action provision in the quarter which is mainly related to a higher expected volume of devices eligible for remediation and higher communication costs. Since there have been increases over the last two quarters, it is important to explain how the device registration process works. For most markets outside of the United States, the equipment is owned by our customers, the durable medical equipment providers. And hence, we have a fairly accurate view of the quantities to be remediated in their installed base. In the United States, after an initial rental period, ownership of CPAP devices transfers to the patient. As a result, unless the patients register the units, it's very challenging to make an accurate estimation. It is for this reason that we have used a regression model which looks at the existing pattern of weekly patient registrations to project the total number of units that will likely need to be remediated. As you can see from the chart on Page 33 of our presentation, around mid-February, when there was extensive communication around the recall, there was an increase in the number of daily registrations which has subsequently reduced. This increase in registrations led us to revise the U.S. regression model based on which we now anticipate an additional 300,000 units which will need to be remediated. Given the increased number of devices, we now expect to complete over 90% of the production and shipment to customers in 2022. Additionally, a further €100 million provision was recorded for potentially higher cost of execution, such as inflationary pressures and to ensure the speed of the program in a volatile environment as we strive to get a solution to patients as fast as possible. I would like to reiterate that we have a strong program management in place to ensure the field action is executed with speed. As I explained last time, we have a strong team working under the leadership of Roy Jakobs. We have strengthened management's responsibility and oversight with organizational changes made in Sleep & Respiratory Care as well as in the Quality & Regulatory affair teams throughout 2021. These teams are laser focused on resolving this legacy issue whilst ensuring airtight procedures are in place for the future. We have also bolstered staffing and expertise around post-market surveillance, medical affairs, biocompatibility and toxicology within Philips. As you know, Philips Respironics is a defendant in several class-action lawsuits and individual personal injury claims. As the litigation is still in its early stages, it is too early to draw any conclusions on the ultimate outcomes. Ultimately, this science will be very important. And as you know, we are conducting a comprehensive test program to characterize the potential risks associated with the use of the devices. We plan to provide an update on testing in the second quarter. We also referenced the Canadian study which should be reassuring for patients as it does not show any correlation between the occurrence of cancer and the use of Respironics devices based on an epidemiological study amongst almost 7,000 users. Building on the foundation of work already done and the material quality improvements already made over recent years, we are using this pivotal moment to reinforce the focus on patient safety across the company and to cross-check learnings from the sleep recall, where relevant, across the enterprise. We have also further stepped up scrutiny and have relooked at past severe incidents and are reviewing all products and complaints which has not led to the discovery of additional significant quality issues over the ones already announced earlier. Last quarter, I mentioned that we recorded a provision in relation to two voluntary recalls in smaller business lines in the Connected Care portfolio with a well-defined scope. Both field actions are under execution in alignment with customers and regulators globally since earlier in the year. Importantly, we continue to engage and work closely with regulators globally, including the FDA, to clarify and follow up on the inspectional findings and requests in the Form 483. Philips Respironics and certain Philips subsidiaries in the United States recently received a subpoena from the U.S. Department of Justice to provide information related to the events leading to the Respironics recall. Receiving a request for information under these circumstances is not out of the ordinary. At this time, the subpoena is a request for information focused on Philips Respironics to support their investigation and we are not aware of any specific allegations. Respironics and other U.S. subsidiaries are fully cooperating. At this point in time, there's no further information on this subject. As Leandro mentioned, we have published frequently asked questions on the recall to provide details and clarification on the progress. You will also find information on the topic on our presentation and the Investor Relations website. There are some areas particularly related to litigation where we are not able to provide further details at this time. We will share information in a transparent and timely manner as the situation evolves. Now, I would like to provide some color on how we are supporting the needs of today's hospital leaders across the globe as they plan for the future. In the first quarter, we expanded our leading Ultrasound portfolio with advanced hemodynamic measurement capabilities on our handheld ultrasound, Lumify, enabling clinicians to quantify blood flow in a wide range of point-of-care applications, including cardiology, obstetrics and gynecology. During the first quarter, we enjoyed strong growth in our Enterprise Diagnostic Informatics portfolio. Next to winning several customers for our enterprise imaging suite of solutions, we also entered into several partnerships with health care providers, among which in the U.K. and Germany, to deliver our vendor-neutral Radiology Operations Command Center which enables remote collaboration between technologists, radiologists and imaging operation teams across multiple sites, thereby helping to increase productivity and expand access to, for example, MR- and CT-based diagnoses. Our MR business delivered strong, double-digit order intake growth once again in the quarter and continued to deliver market share gains. In fact, our team installed more than 500 helium-free Ingenia Ambition MRI systems to date, highlighting the success of our unique portfolio. In Image-Guided Therapy, we are successfully expanding into interventional oncology with the installation of our lung cancer Diagnosis & Treatment solution called Lung Suite in Belgium, France, Israel and in the U.K. Based on Philips Azurion, this solution enhances the accuracy of biopsy procedures and provides a therapy option to immediately treat early-stage lung cancer patients. We continue to see strong traction for our Image-Guided Therapy suite of solutions which delivers interventional procedures, speed and efficacy. We see strong growth of our portfolio of smart devices, for example OmniWire which is the world's first solid core pressure wire which combines a workhorse design with iFR-proven outcomes and iFR co-registration compatibility, making it easy to use physiology throughout the case. OmniWire is a game changer and we see a 20% to 30% uplift in our sales volumes in accounts that are already adopting this innovation. In Personal Health, we continue to invest in new products and completed the global introduction of the new Philips Shaver S9000 with SkinIQ which is driving accelerated sales growth for the category. Moreover, our Oral Healthcare business recorded strong, double-digit growth in the quarter with very strong performance in North America and China. This is a result of the successful refresh of our entry-range and premium-range electric toothbrushes as well as the recent launch of innovative interdental cleaning devices. To round off, looking ahead, the strong customer demand and order book, coupled with our first quarter sales performance, support our range of 3% to 5% comparable sales growth and 40 to 90 basis points adjusted EBITA margin improvement for the year, as provided in January. At the same time, it is important that we recognize the increasing risk related to the COVID-19 situation, the Russia-Ukraine war, supply chain challenges and inflationary pressures which may potentially impact our ability to convert our strong order book to sales and achieve our margin target if conditions deteriorate further. Our teams, however, are fully focused on everyday execution, delivering on the customer demand and strong order book and are addressing the supply chain risks. Moreover, we are implementing additional cost measures as well as price increases to mitigate the inflationary headwinds. We will, of course, provide further color or updates as appropriate as the year progresses. Our journey to leadership in health technology continues and I remain confident about our potential to grow and create value. Our customers tell us we are very relevant to them and that we have a stronger-than-ever portfolio. We are fully focused on execution and operational excellence to manage the near-term headwinds that we are facing and to unlock higher growth and margin in the medium term. As I mentioned before, we plan to provide more color on our medium-term performance road map in the summer. Over to you, Abhijit.

Thank you, Frans, and good morning, everyone. I’d like to discuss the comparable order intake growth. The Diagnosis & Treatment order intake increased by 7% in the quarter, primarily due to significant double-digit growth in magnetic resonance imaging and Image-Guided Therapy, alongside strong performance in Ultrasound and Enterprise Diagnostic Imaging Informatics. The Connected Care order intake matched the first quarter of 2021, fueled by robust growth in Hospital Patient Monitoring and Connected Care Informatics. However, this was countered by a sharp decline in Sleep & Respiratory Care due to a surge in COVID-19-related demand in Q1 2021. When excluding Sleep & Respiratory Care, Connected Care order intake rose by 9%. I am pleased to report ongoing fundamental demand shifts towards our patient care management solutions and increasing market shares. It's also noteworthy that activity levels in the Connected Care business remained double-digit above 2019, with a mid-single-digit three-year compound annual growth rate. Group comparable sales fell by 4% in the quarter, surpassing our prior Q1 guidance, which anticipated a high single-digit decline. This was due to the high comparable base from Q1 2021 and challenges in our Sleep business, exacerbated by ongoing supply chain disruptions affecting all modalities, particularly high-volume, high-margin businesses like patient monitoring, Ultrasound, and Image-Guided Therapy. Adjusted EBITA for the quarter was 6.2% of sales, influenced by reduced sales and rising supply costs, including exceptionally high costs on spot purchases. This was partly offset by productivity measures and increased intellectual property income. In the quarter, the increasing supply chain costs and general inflationary pressure totaled 250 basis points, comprising 150 basis points from wage inflation and 100 basis points from supply chain costs. We are implementing further cost measures and price increases across our portfolio to address these challenges. Diagnosis & Treatment comparable sales decreased by 2% in the first quarter. Substantial growth in Image-Guided Therapy was offset by declines in Ultrasound and Diagnostic Imaging due to supply chain shortages and previously strong growth in these areas last year. The adjusted EBITA margin in Diagnosis & Treatment fell to 5.9% mainly because of lower sales and supply chain costs. In the Connected Care business, comparable sales dropped by 21% in the first quarter, largely due to the notable decline in the Sleep & Respiratory Care business linked to a recall and supply chain issues in patient monitoring. The adjusted EBITA margin was 0.4%, primarily due to lower sales. Personal Health saw a strong 8% growth in comparable sales in the first quarter, following 17% growth last year, with double-digit increases in Oral Healthcare. Consumer demand for our strong portfolio remains solid. The adjusted EBITA margin for Personal Health rose to 15.3% in the quarter, driven mainly by growth, though this was partly offset by supply chain costs. We are also focusing on productivity initiatives that led to gross margin savings of €97 million in the first quarter. After accounting for increased costs related to freight and spot purchases, net savings for the quarter were €8 million. As Frans indicated, we are implementing additional cost measures of between €150 million to €200 million for the year in response to the growing inflationary pressures. We are tightening discretionary spending while accelerating structural productivity programs and better managing procurement and indirect spending. Adjustments in the quarter were higher than expected, mainly due to €165 million in provisions connected to the recall and around €85 million for restructuring and portfolio alignment actions that stem from quality remediation efforts in Sleep & Respiratory Care. For instance, we have decided to stop manufacturing hospital respiratory care products at our facility in Carlsbad, U.S., and consolidate those operations within the broader Respironics footprint. We recorded a free cash outflow of €402 million in the quarter due to increased working capital from higher inventories and elevated income taxes. Regarding capital allocation, we renewed our €1 billion revolving credit facility, with its interest rate linked to the company’s year-on-year ESG performance improvement. This facility matures in 2027 and replaces the previous one, which matured in 2024. For the segment Other, we reported an adjusted EBITA loss of about €80 million in 2022, which is €20 million better than our earlier guidance, thanks to increased licensing income and cost productivity measures. We anticipate a net cost of around €140 million at EBITA level for the full year 2022. For Q2, we expect net costs of about €30 million at the adjusted EBITA level and roughly €50 million at the EBITA level. We currently foresee an effective tax rate in the high teens for 2022, which is lower than our midterm guidance of 24% to 26%, primarily due to decreased income and one-time tax gains. In conclusion, I want to elaborate on our expectations for the year ahead. We surpassed our sales plan for the first quarter and are set to fulfill the mid-single-digit sales decline communicated in January for the first half of 2022, following 9% growth in the first half of 2021. We continue to anticipate a solid recovery in the latter half of the year, supported by customer demand and a strong order book. Nonetheless, we recognize a challenging external environment and growing uncertainties related to the COVID-19 situation in China, the Russia-Ukraine conflict, persistent supply chain issues, and rising inflationary pressures, as noted by Frans. We are actively monitoring these developments, and our teams are diligently working to fulfill our order book while mitigating the impact of these challenges. Our focus remains on progressing with the repair and replace program, addressing global headwinds, and maintaining a strong focus on our strategic improvement targets to achieve growth and profitability supported by our record order book. Frans and I now welcome your questions. Thank you.

We will now take our first question from Hassan Al-Wakeel from Barclays. Please go ahead. Please make sure the mute function on your telephone is unmuted.

Hello? Can you hear me?

We can.

Yes, Hassan, we hear you. Go ahead.

Apologies. Thank you for taking my questions; I have two, please. Firstly, a broader question around guidance to start. It would be helpful if you can discuss how some of your underlying assumptions have changed, if at all, since initially guiding the market, given arguably stronger demand than the top line but margin weakness owing to supply chain pressures and inflation. Do you expect supply chain issues to persist for longer? And how do you think about the margin target range and whether the lower end of this range is more realistic in your view? Secondly, could you please talk about the hospital CapEx environment as investor concerns here increase with hospitals facing rising OpEx costs and whether you're seeing any impact here at all?

Thank you for your question, Hassan. Let's begin by discussing our guidance. You're correct that our strong order intake reinforces our growth potential, which is positive. The growth range of 3% to 5% reflects a contingency from the high to low end. If things go well, our solid order book will enable significant growth. In the first quarter, thanks to our team's efforts, we managed to address many supply chain challenges, but not all. If we had resolved all issues, sales could have been even higher. We're addressing these challenges day by day and week by week. Our engineering team in India is actively redesigning parts and finding alternative suppliers, which aids in overcoming supply chain obstacles. Looking back at the guidance from January, we're on track regarding revenue. Although I expect supply chain issues to linger longer than anticipated in January, we shouldn't underestimate our capacity to find solutions, despite the significant volatility. Moreover, we expect to see higher volumes in the second half of the year compared to the first, in line with our typical seasonal trends. Your question also touched on margins. As a business operating with high margins and high fixed costs, volume plays a vital role in profitability, and the second half of the year typically sees greater profitability. The guided range is achievable, particularly as we've implemented price increases. In Personal Health, we're already seeing some impact, with additional measures planned for the second quarter. In our healthcare recurring revenue base, we've enacted indexation in previous years, allowing us to pass on some increased costs. However, the order book, especially in the tender sector, includes some prices from last year. For book-and-bill businesses like Ultrasound, we can already raise prices. Furthermore, we've taken measures to manage costs, understanding the inflationary pressures as I mentioned earlier. We expect driving an additional €150 million to €200 million in revenue will help offset this inflation. While we're mindful of volatility and risks, we remain optimistic and stick to our January guidance. Regarding hospital CapEx, we continue to see robust demand, but there's a heightened focus from hospital leadership on staff productivity. As staff costs rise significantly in the U.S., every investment decision must enhance efficiency and reduce reliance on operating expenses. This aligns with our strategy for care pathway optimization and the Quadruple Aim, which resonates well with hospitals. For example, our MRIs can halve scan times, improving staff productivity. Thus, there is available CapEx for the right innovations, and we're confident in our offerings. Additionally, hospitals are increasingly establishing ambulatory surgical centers to facilitate shorter stays or day interventions. We see opportunities for orders, and I want to emphasize that we remain confident in the market's resilience.

That's very helpful, Frans. If I could just follow up on the top line. Could you talk about how installations are trending and whether you're seeing any improvement here globally, presumably maybe a worsening situation in China?

Yes, we definitely see a worsening situation in China, where, at least in the cities where there's a lockdown, we see the slowdown. Now we hope that Shanghai will come out of the lockdown in the course of May and then we can still do a lot in the remaining part of the quarter. But globally, installations are going well. The only thing that affects installations are incomplete supply chain deliveries, where, I must say, customers are very understanding and are really trying to lean in, in accepting installations and thereby also helping us to realize our revenue.

Perfect. Thank you.

You’re welcome.

We will now take our next question from Veronika Dubajova from Goldman Sachs. Please go ahead.

Hi Frans, Abhijit, hope you can hear me okay. Two questions from me. I think, Frans, you mentioned this in your prepared remarks and obviously also in the press release this morning saying that you expect to achieve the guidance if there's no further deterioration in the current conditions and I just was hoping you could clarify this a little bit for us. And does this mean if we see that current cost pressures and inflation pressures persist through the remainder of the year, you can still make the guidance but if they get worse you can't? Or is your expectations that they must improve? And if they don't improve, then you don't make the guidance? Just a little bit of clarity around this. I mean I think we all appreciate the world has changed a lot since you gave this guide in early January but I think we're struggling to reconcile that a little bit. And then my second question is just on the DOJ request. And I appreciate there's not a lot you can say here but just what are your expectations, I guess maybe more broadly, for further action from the regulatory agencies in U.S.? I'm thinking warning letter, consent decree and potential fines. What are your assumptions, your expectations? And when do you expect to have more clarity on all of those things?

Where to start? The guidance indicates that volatility impacts parts availability, which is our top priority. Despite this volatility, we demonstrated in Q1 our ability to navigate some challenges, and I remain optimistic about converting enough of our order book to achieve the 3% to 5% sales growth. If everything proceeds well, we could reach the higher end of that range due to the significant order book we have. Thus, the 3% to 5% already includes a revenue contingency that I feel confident about. We acknowledge the risks present, particularly concerning China, and I would be curious to meet anyone who can precisely predict what will happen there and its effects on the global supply chain. We don’t have clarity on that issue, but it’s evident that the Shanghai harbor needs to reopen; otherwise, it will impact the entire world. We haven’t factored that into our plans yet. Additionally, I can reiterate that our revenue strategy includes several safeguards. Regarding margins, I already noted that achieving growth is essential for profit expansion. We believe that raising prices and controlling costs can help mitigate the inflationary pressures we're currently experiencing.

Yes.

That is in the numbers. That is what we are counting on. We don't see at this time further deterioration on that. So we will work with the 2.5% assumption and with the price rises and cost tightening offset that, while then the volume and mix will help us on the profit expansion. That's your first question, Veronika. Then...

Yes. I have a follow-up but I'll let you answer the DOJ part first.

Yes. On the DOJ, I can be shorter because at this time, it's a subpoena for information, right? And that means they are preparing an investigation and we just have to accept that. As we said in the introductory speech, that is not uncommon for a situation of this magnitude. What to expect from the regulatory agencies? We are in close collaboration and contact with them. Like us, they feel the pressure from the patients and they are very focused on working with us to achieve the remediation as fast as possible. That is what the conversations are about, let's say. That's priority number one in all our conversations. Secondly, there is keen interest in the testing that's going on and what we expect to share in the second quarter. At this time, there is nothing to be concluded, what I would point to. You asked me about could that be a warning letter. I don't exclude anything. But the measures that we have taken voluntarily are of such a significance that it has gotten the attention of the FDA and they appreciate those measures ranging from closing the site in Carlsbad to retiring some of the older product ranges, to a slate of activities to relook at patient signals from the field. And of course, we are sharing all those findings with them. So we are doing a lot and I think that will help very much on how the agency will judge us. So it's work in progress.

All right, understood. Just to revisit my initial question for Abhijit, is it accurate to say that revenues continue to be the primary variable? If you reach 3%, could you demonstrate some year-on-year margin improvement, assuming there is no additional increase in cost inflation?

Yes. And Abhijit, you're immediately nodding, so why don't you answer it?

No, I think it's how you explain, Frans. I think the biggest risk that we have is on the top line. If we get the top line for our business, as actually Frans mentioned, once we cross the breakeven point, then the drop to the bottom line is pretty strong. And we are struggling in the mainly our high-margin businesses. So in Image-Guided Therapy, patient monitoring, Ultrasound. Once these go above a certain threshold, the profitability goes very high and that's the biggest risk.

Yes. But we did tell you that we expect higher volumes in the second half versus the first half despite the supply chain challenges.

Understood. Thanks, guys. I’ll just go back in the queue.

Thanks.

We will now take our next question from David Adlington from JPMorgan. Please go ahead.

Good morning, Frans. One question, please. Just on Personal Health, I just wondered if you saw any stocking in the quarter ahead of the price increases and if you're able to quantify that. And within that 7.7% growth number, just wondered how much was volume versus price has contributed to that?

Let me be straight up on stocking. We have not seen any stocking happening. In fact, there is good sell-out and good consumer traction. Then I look at my team with regards to volume versus price.

I think it's largely volume. So the price agreements were made in February. So by the time, new supplies in March with the new pricing. So I think largely volume, David, that's how you should look at it. Very small part in price.

Great. Thank you.

We will now take our next question from Julien Dormois from BNP Paribas. Please go ahead.

Hi, good morning Frans and Abhijit. Thank you for taking my questions. My first question is about the growth assumptions for the full year, broken down by division. I recall you previously mentioned high single-digit growth in D&T, low single-digit decline in CC, and mid-single-digit growth in PH. Does that still apply when considering the Q1 numbers? My second question is focused on D&T, as you unfortunately started with a decline in that business, and the comparisons will be more challenging in Q2 and Q3, especially in IGT. I'm curious to understand what we might expect in this division to reach the full year number.

Yes. I think on the first question, those growth assumptions stay largely the same.

Yes. I think mid-single digit growth for Connected Care and high single digit for D&T still applies. Additionally, for D&T, we had indicated a high single digit growth.

Yes.

And for PH, we had said mid-single digits. So we will be there or slightly higher. But Connected Care will be, yes, mid-single-digit decline.

Yes. Regarding D&T, Julien, our progress is significantly impacted by supply chain issues. The order book for IGT continues to expand. Despite the challenging comparisons, if we can secure the critical components we need, we expect the second half of the year to be robust with solid growth.

Okay, thank you.

So you will also see growth coming back in Q2, but the second half will be also very strong.

We will now take our next question from Graham Doyle from UBS. Please go ahead.

Good morning. Thank you for taking my call and my questions. Regarding the recall, we haven't discussed it much today. I noticed on Slide 33 that you mentioned a spike in registrations in February. It's interesting because you released a statement about an FDA update on March 10, which indicated the need for improved communication with patients. Is there a possibility that this could lead to another spike soon? Can you explain how the communication with the FDA relates to the spike you observed? Additionally, I would like to follow up on your comment about 90% of production for these devices being completed by the end of this year, which suggests there will be ongoing production related to the recall in 2023. Should we assume there will be a time in 2023 when you are not selling systems commercially? That's my first question, please.

Yes, it's true that the increased communication around February resulted in more patients registering. However, shortly after that, there was again a decrease in the weekly rate, so the initial increase was not very substantial. To clarify, if you envision a regression model that continues to decrease as shown in the slide, raising that curve a bit leads to a higher numerical assumption. At this moment, those additional 300,000 patients have not yet appeared, but this is a result of using a regression model. With the slightly increased registrations in the first quarter, the overall trend is lifted. The shape of that curve is indeed strongly confirmed. We are observing a continuous decline week by week, giving us confidence that there won’t be any drastic changes in insight as time goes on. In fact, the model becomes more precise over time. The additional €65 million is partly for the extra volume and partly because we chose to maintain a higher level of patient communication into next year. Our current outlook on production and deliveries indicates that we will exceed 90% by the end of 2022, and I emphasize delivery since there is a time lag before it reaches the patient. This means we will finish production internally before the last unit is delivered to patients. There's some flexibility in this timeline. We expect, depending on the area, to finish either by the end of this year or in early Q1 next year, which also suggests that around that time, we can resume commercial activities. There may be some variations by country, as we can start preparing for sales resumption once we complete our plans in a specific region. While we cannot pinpoint an exact week or date, we are quite confident in our progress with the recall. Please bear with us as this involves a large volume. We are proud of how we have increased our output and anticipate further growth this year. Additionally, we have set aside an extra €100 million as a precautionary measure to address unforeseen issues, such as suppliers requesting expedited fees, ensuring we maintain our momentum. We did not want to repeatedly present surprises, and with the decision to reserve this €100 million, we believe we are well-prepared.

And maybe just a quick follow-up. In terms of the sort of go or no-go decision about when you can start selling commercially, obviously, depending on geography, how much certainty do you need to have? And how do you have certainty that you have reached all the patients that require the machine to be replaced or repaired?

I think it starts first with a moral obligation to treat patients first. And therefore, we want to get very far in, let's say, in delivering against the registered patients. And maybe that's where the core of your question is: could somebody register even next year? Yes. And then we will deal with it, right? But if there's a late registrant, it will not make a huge impact. So we see that, that moral gate relates to having done the registered patients. And yes, then given logistical consequences, it needs to be somewhere in the high 90s, by which time we feel that we have fulfilled on that obligation and that resuming commercial activities is justified. And as I said, that's somewhere end of the year, early next year with the current looks of it.

Okay, that’s very clear. Thanks a lot for taking my questions.

You’re welcome.

We will now take our next question from Delphine Le Louet from Societe General. Please go ahead.

Yes. Hi, good morning everybody. Thank you for taking my question. I’ve got two. I was wondering regarding the price hikes that you're going to pass on across the year. What sort of a flexibility do you have on a divisional basis? Can you be more specific if we stick with this 2% to 3% percentage figure that you gave? Do you see far more flexibility into the PH division than into the CC, for instance, or D&T? Second question deals with the cost-saving, additional cost-saving program you're putting in place. Can you clarify which division is going to be the most impacted by this €150 million to €200 million envelope?

Yes. Let me take it. In terms of flexibility, I presume you mean elasticity?

Yes.

I believe we have the capability to raise prices across the board due to widespread inflation. It’s not that we face challenges in specific areas for price increases. It's important to note that the effect of these price increases varies in terms of timing. For instance, as Frans mentioned earlier, the impact in Personal Health is reflected in the profit and loss statement sooner. In contrast, for businesses with longer order books, we need to work through existing orders that were placed before the price increases before new orders that incorporate the higher prices can take effect. So while timing is a factor, we don't face any barriers to implementing price increases. Furthermore, even within our health systems and services businesses, we can raise prices with relatively short notice, which is what we are currently working on.

Yes.

Regarding the additional cost savings, they occur throughout the entire enterprise. This includes group costs as well as individual businesses, so there won't be a significant increase in just one specific area. You will observe this across all businesses, similar to how inflation is affecting them universally.

We will now take our next question from James Vane-Tempest from Jefferies. Please go ahead.

I have two, if I can, please. Firstly, just on the existing contracts. Can you remind us how many of them have an indexation clause so you can pass on some of those higher costs versus those where you need to perhaps absorb some of the higher inflation? And I guess although you have a strong order book, are you seeing any signs installations are getting delayed due to hospitals' own higher costs, especially labor? Second question is if I can just follow up on the €150 million to €200 million savings and the timing for those. Just curious, is this muscle of the business that these savings were not identified earlier? And can you give us some examples of potential tactical discretionary savings which, I think, how you refer to them? Also, without those, my math implies margins would otherwise be going down this year. So I'm just curious of the timing and phasing of those through the year as well.

Yes. Let me address the first question, and then Abhijit can discuss the second one. Most of our service contracts include indexation clauses, which allow for regular price adjustments. As Abhijit mentioned earlier, we are actively implementing these price increases. In the Equipment business, much of the process involves tendering, which means it takes a full order cycle before new prices are reflected. This creates a significant time lag for equipment, as Abhijit pointed out. For our book-and-bill business, such as Ultrasound and some shorter-cycle healthcare system businesses, we can implement higher prices almost immediately. So, as we currently take new orders, they will be at these increased prices. To summarize, we have three categories: services, which are fairly immediate; book-and-bill business, also fairly immediate; and the larger tender-driven businesses like Diagnostic Imaging and IGT, which take longer to adjust. I believe I have addressed that. Abhijit?

Yes. I think in terms of cost savings, the plan is to get the savings this year, right? So it's still in the remaining three quarters. If you look at the discretionary or tactical savings we talked of, be it in travel, be it in exhibitions or shows that we conduct, it's also looking at our temporary labor force to see where we can flex it. We also have factories which are idle for a certain amount of time because of the lack of parts availability. So we have programs running there. So it's a multitude of actions that we take. But to your concern on timing, the amount that we talked about, the €150 million to €200 million, is a mitigation that we are expecting within this year.

Yes. I realize I haven't addressed your question about whether customers are delaying orders. Customers are facing challenges with accessing parts and materials from the supply chain. Additionally, if they have a renovation project in their hospital, we've noticed some delays in room readiness. However, this is more of a logistical challenge than an intention to delay. In fact, I see no desire to postpone. Hospitals are looking for increased capacity and productivity. They understand when there are delays, so we're not overwhelmed with requests for penalties or similar issues. Overall, there is a positive coexistence in this situation.

Thank you.

We will take our next question from Kate Kalashnikova from Citi. Please go ahead.

Hello Frans, Abhijit, Kate Kalashnikova from Citi here. I've got two questions. So firstly, looking at the comparable order intake growth chart in the presentation, North America order intake looks like it decelerated on what was an easy comp in Q1. What gives you confidence that there's no deterioration in demand? And by that, I mean, hospital CapEx trend in the U.S. And then secondly, in a typical year, 70% of order book is converted to sales in the next 12 months. What is your current expectation given ongoing supply chain challenges? How much of the current order book do you expect to convert to sales in the next 12 months?

Yes. Regarding the order book development in North America, the overall order growth is in the low single digits. However, for Precision Diagnosis, we are experiencing double-digit order intake growth. Connected Care shows some challenges, particularly in the hospital respiratory business where we see a decline, but in patient monitoring, growth remains strong. Overall, for Diagnosis & Treatment, IGT's performance is slightly lower compared to last year, as we had significant growth of 82% in order intake during the same quarter last year, making comparisons difficult. We are not observing a significant decline, and we believe there is no slowdown or shift in priorities in North America.

Conversion?

In terms of conversion, it's primarily a matter of availability. The longer order book will extend the conversion time slightly. I don't have a specific number at the moment, so I may need to follow up on that. However, it will be a bit lower than what we've typically experienced due to the large order book and supply constraints. As a result, it will take a little longer for us to convert all of that into sales.

Okay, understood. And then for North America CapEx part?

Yes. And we continue to see good momentum in Q2 in North America as well.

Great. Thanks.

We will now take our next question from Sezgi Oezener from HSBC. Please go ahead.

Hi, Abhijit. Hi, Frans. Thank you for taking my questions. I have two, please. Firstly, regarding the restructuring plans you've mentioned. You specifically noted that you'll see the production of hospital restoration products in one plant. However, I'm curious about how you expect these restructuring plans to develop. Are they limited to future hospital products, or do they encompass more? Additionally, do you anticipate any revenue impacts from this? My second question is more broadly related to your overall quality checks. You mentioned conducting extensive quality checks in the Connected Care segment, which revealed new areas that required caution. What is your perspective on the risk of issues arising from other segments, such as D&T, potentially contributing to this? Also, did your quality check program include the D&T area along with all other sectors you are involved in?

Yes. The restructuring and cost measures go across Philips. Specifically, we indeed called out the closure of the Carlsbad site. But we have also other measures where we are seeing opportunities to accelerate savings. Think about high-wage versus low-wage transitions, reduction of complexity, reducing the long tail of projects and SKUs, et cetera. There's no direct revenue impact from these measures because they're already included in our plans, right? So for your modeling, there's no new news. Other than that, we try to accelerate cost savings and measures. Now on your second question, the expansive relook at post-market surveillance data that I spoke about in January applies to the whole company and not just only to Connected Care. And broadly speaking, we have made good progress with that relook to post-market surveillance data and severe incidents and we have not found new issues coming out. In January, we already flagged the quality issues in Connected Care that by now you have seen the field safety notices for, among which the defibrillator and the V60, right? And so that's basically the follow-up on what we already referred to and took a provision for in the Q4 results.

No, you didn't miss anything. Just as a follow-up then, is it safe to conclude that this relook at quality actually covers the whole of D&T as well and you haven't actually come out any incidents worthy of mentioning?

That's correct.

Okay. Good to hear. Thank you.

We will now take our next question from Falko Friedrichs from Deutsche Bank. Please go ahead.

Thank you. Good morning, everyone. I have two questions. First, how confident are you in your ability to obtain the comprehensive test results for the recalled devices in the second quarter, as you indicated? Are there any binding contracts that the labs must adhere to, and are they on track to deliver these results in that timeframe? Secondly, regarding the DOJ request, it seems that they are mainly asking for some paperwork at this stage. Could you share how much time you have been given to submit this information so we can understand the timeline for a potential investigation?

Yes, there are many tests currently in progress since last year. Sometimes, these tests lead to the need for additional testing as we explore further. There are no strict deadlines for these tests since we have to allow the experts the time they need. These are external testing facilities and specialists who cannot be rushed. We anticipate being able to deliver the test results in the second quarter. However, with the large number of data points from these tests, the interpretation of the results depends on an expert panel. Everything is planned out, and we expect it to all be ready by the second quarter. Yet, as I mentioned, we are heavily reliant on those external expert panels and testing facilities. We are confident in our current plan, but it is not a guarantee because results can only be published once those experts have reached their conclusions.

Okay. Thank you.

We will now take our next question from Max Yates from Crédit Suisse. Please go ahead.

Thank you. Just my first question is on cash flow. So I just wanted to understand, given the current environment, do you think you will have to hold structurally more inventories going forward given kind of what looks like ongoing disruption to supply chains? And I guess how does that view on working capital and inventory differ to when you previously talked about free cash flow guidance? And as an extension of that, could you just help us with, of the provisions that you've taken for the product recall which I think is about €890 million, how much cash has actually come out of that? And how much is still to come over the next few quarters?

Yes. Currently, our inventory levels are at an all-time high due to an imbalance; we have 98% of the parts available, but we can't complete the remaining 2%, which prevents us from shipping. I anticipate our inventory will decrease, but I do not foresee significantly higher inventory levels that would impact our cash flow guidance in the coming years once we return to normal operations. Regarding cash utilization, last year we used around €175 million, and this year we expect to spend approximately another €650 million. Therefore, the increase from last year will be close to €500 million.

Okay. For my second question, I remember that when the product recall issues first emerged, you mentioned that this was around a €1.1 billion business, with approximately two-thirds from the systems and one-third from the masks. I’d like to know how the mask sales have been impacted over the past 12 months since the issue came up, since you’re not selling the systems externally. You mentioned before that 30% to 40% of sales were tied to new machines, which might not be sold now. I'm particularly interested in how the replacement masks business has been affected during this time.

Actually, we've performed fairly well in that area. As you mentioned, around 30% to 40% of our sales were related to new systems, and while that has decreased, the overall decline is much smaller. We are experiencing nearly a double-digit decline in the overall mask business. Our sales team, which is focused solely on the mask business since we are not selling complete machines, has done a remarkable job keeping the decline to about 10% or so.

Understood. Thank you very much.

Thank you. Mr. Van Houten and Mr. Bhattacharya, that was the last question. Please continue.

All right. Then I appreciate everybody's attendance and thank you very much for your questions. Rest assured we remain laser focused on the execution of our plan. Despite the challenging environment, we are full of confidence about the opportunities ahead. Thank you very much.

This concludes the Royal Philips first quarter 2022 results conference call on Monday, April 25, 2022. Thank you for participating. You may now disconnect.