Koninklijke Philips NV Q2 FY2024 Earnings Call

Welcome to the Royal Philips Second Quarter and Semiannual 2024 Results Conference Call on Monday, July 29, 2024. During the call hosted by Mr. Roy Jakobs, CEO; and Mr. Abhijit Bhattacharya, CFO, all participants will be in a listen-only mode. Please note that this call will be recorded and replay will be available on the Investor Relations website of Royal Philips. I'll now hand the conference over to Mr. Leandro Mazzoni, Head of Investor Relations. Please go ahead, sir.

Hi, everyone. Welcome to Philips' second quarter and half year 2024 results webcast. I'm here with our CEO, Roy Jakobs, and our CFO, Abhijit Bhattacharya. The press release and investor deck 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 as well. Before we start, I want to draw your attention to our Safe Harbor statement on screen. You will also find the statement in the presentation published on our Investor Relations website. Roy, over to you.

Good morning, everyone and welcome. Great to be with you today. I want to start with the key highlights of this morning's release. We delivered strong order intake growth this quarter. Within a challenging macroeconomic environment, we achieved strong margin improvement supported by our productivity program, solid operational cash flow and comparable sales growth in line with our plan. The improvements were across all business segments as a result of the ongoing actions to enhance execution, supported by our innovations. We continue to make progress and see the effects of our focus on our three priorities: enhancing patient safety and quality; strengthening our supply chain reliability; and establishing a simplified, more agile operating model. Supported by key innovation launches and our ongoing actions, we are confident in our plan and reiterate our outlook for the full year 2024. Comparable sales growth was 2% in the quarter, on the back of high single-digit growth last year. This was driven by 4% growth in Diagnosis & Treatment and 2% growth in both the Connected Care and Personal Health segments. The adjusted EBITDA margin was 11.1% in the quarter, a strong improvement of 100 basis points compared to Q2 2023. Free cash flow outflow was €64 million which included the payment in connection with the Respironics economic loss settlement in the U.S. We delivered a strong underlying operational cash flow improvement which Abhijit will unpack later. I'm encouraged by the 9% order intake increase in the quarter. I'm confident that our innovative portfolio is well positioned to help hospitals worldwide address their staffing shortages, enhance productivity, and improve patient and staff experience, as are our leading innovations for consumers to take care of themselves. We continue to expect positive order intake growth in the second half and in the full year 2024. In China, orders declined as the industry-wide anticorruption measures imposed by the government continue to impact order lead times by hospitals as their internal approval cycles have increased to ensure compliance. I actually just returned from China last week, where I met many of our customers and partners. It is clear that this remains an attractive healthcare market. We do not expect that the anticorruption measures will impact structural demand. Our order funnel is active in the country, and we expect China to gradually contribute to order growth in the coming quarters, albeit from a low base. This will be supported by the recently announced government program for renewal of aged medical equipment. Let me now provide you with some of the customer and innovation milestones during the quarter. We continue to see strong customer pull for our solutions and signed several long-term agreements across the world in this quarter. For example, we signed multi-year partnerships for monitoring, image-guided therapy, and helium-free MRI with several university hospitals in the Netherlands and Belgium. We also signed a major multi-year partnership with Bon Secours Mercy Health, one of the largest health systems in the U.S., standardizing innovative patient monitoring solutions across its 49 hospitals to drive better patient outcomes and reduce the burden on staff. We launched our next-generation AI-enabled cardiovascular ultrasound platform with new FDA-cleared AI tools integrated to advance cardiovascular imaging and increase the automation and productivity of our customers. Demonstrating our innovation leadership in minimally invasive treatments, we announced the first implant of the Duo Venous Stent System following premarket approval from the FDA. In Personal Health, we unveiled a series of innovations in China, including the launch of the first medical-grade Philips Lumea 8000 Series IPL hair removal device with cooling technology. Looking ahead, we remain confident in our plan, acknowledging that uncertainties remain in a challenging macro environment. In 2024, we expect to deliver further performance improvement with 3% to 5% comparable sales growth, building on a strong comparison base from last year, an adjusted EBITDA margin of 11% to 11.5%, and a free cash flow of €0.9 billion to €1.1 billion. I will now hand it over to Abhijit to take us through the Q2 financials in more detail, after which, I will come back on our execution priorities.

Thanks, Roy. Good morning, everyone. Let me start with our performance highlights. Comparable sales grew 2% in the quarter with 1% growth in mature geographies. Comparable sales in growth geographies grew 3% despite a decline in China. In Diagnosis & Treatment, comparable sales increased by 4%, with growth across Image-Guided Therapy and Precision Diagnosis. It's important to note that this was compared to strong double-digit growth in Q2 2023. The adjusted EBITDA margin improved by 160 basis points year-on-year to 12.2%. The increase was mainly driven by improved sales, pricing, and productivity measures. Connected Care comparable sales increased 2%, with double-digit growth in Enterprise Informatics and flat comparable sales growth in Monitoring on the back of strong double-digit growth in Q2 2023. We saw strong performance in sleep systems and patient interface in markets outside of the U.S. Connected Care's adjusted EBITDA margin improved by 130 basis points to 8.8%, driven by solid performance in Monitoring and a strong step-up in profitability in Sleep & Respiratory Care, which is encouraging. Personal Health delivered a 2% comparable sales increase driven by 5% growth outside of China. Overall, consumer sentiment in the U.S. and international markets is solid, while consumer sentiment in China remains subdued. The adjusted EBITDA margin for the segment improved significantly to 16.9% this quarter, mainly due to operational improvements and productivity. Sales in the segment Other was €70 million lower than in the second quarter of 2022 due to royalty revenue phasing as indicated in our Q1 call. This difference alone resulted in a negative impact of around 160 basis points on the growth of the group in the second quarter. We have been very disciplined in cost management, and our productivity initiatives delivered savings of €195 million in the quarter, of which operating model savings were €57 million, procurement savings were €71 million, and other productivity programs delivered €67 million. The adjusted EBITDA margin for the group increased by 100 basis points to 11.1% despite the lower royalty revenue in the quarter. Productivity and pricing actions contributed 320 basis points, partly offset by wage and component price inflation of 200 basis points. Earlier in the quarter, we also concluded an agreement with insurers to pay €538 million to cover the Respironics recall-related product liability claims. This income was recognized in Q2 2024, and the remaining payment is expected this year. Free cash was an outflow of €64 million in the quarter as it included a payment of €415 million in connection with the Respironics economic loss settlement in the U.S., partly offset by the initial receipt from insurers of €150 million. Therefore, excluding these two effects, free cash flow in the quarter was around €200 million, driven by higher earnings and continued progress in working capital management. Our leverage ratio improved from 2.8x to 2.2x compared to Q2 2023 on a net debt-to-adjusted EBITDA basis. It's also important to note that both S&P and Moody's upgraded our rating outlook to stable. We now have a stable outlook for our strong credit ratings across S&P, Moody's, and Fitch. The effective rate for the first half of 2024 was negatively impacted by the derecognition of deferred tax assets on the Respironics litigation provision and carryforward losses in the U.S. As a result, the effective tax rate for the full year 2024 will be high. Normalizing for these effects, however, the effective tax rate is expected to be between 17% and 19% this year compared to our guidance of 24% to 26% for the period 2023 to 2025. Now let's move to the dynamics in order intake. As mentioned earlier, we continue to see inherent unevenness in order growth between quarters. In the second quarter, order intake grew by a strong 9% driven by improvements outside China, particularly in North America. This resulted in 3% order intake growth for the first half of the year, and we continue to expect to deliver order intake growth in both the second half and the full year 2024, as mentioned by Roy. As a reminder, orders and the order book account for 40% of our revenue. The remaining 60% comes mainly from recurring revenue streams such as services and consumables from the book-and-bill business and from Personal Health. As mentioned in our previous earnings calls, we anticipate sales growth to be back-end loaded in 2024 due to the higher comparison base in the first three quarters of the year, where we grew 9% in 2023. We expect sales growth in the third quarter to stay broadly in line with the first half of the year on the back of 11% growth in Q3 2023 which was driven by mid-teens growth in Diagnosis & Treatment. For the full year 2024, we expect all business segments to be within the 3% to 5% sales growth range provided by the group, with Connected Care expected to be closer to the upper end of the range and Diagnosis & Treatment and Personal Health expected to be closer to the lower end of the range. With that, I would like to hand it back to Roy.

Thanks, Abhijit. I would like to continue with the progress we have made on our execution priorities. On patient safety and quality, we again delivered a substantial improvement in CAPA closures in the quarter, driven by stronger processes, capabilities, and governance around it. We continue to drive significant simplification of the way we work and have further reduced the number of quality management systems. We are well on track to achieve our target of a 65% reduction in 2024. We continue to invest in quality improvements across the portfolio and are acting fast on postmarket survey signals. With respect to the supply chain, we now have lead times back to normal across all modalities. We will continue leveraging and regionalizing our end-to-end supply chain to further strengthen first-time-right deliveries and service levels. In China, we have reached around 90% local-for-local supply chain. Finally, our new operating model with prime accountability in the businesses has been live for almost 18 months now, resulting in significant productivity improvements of €1.4 billion to date. We have already reduced close to 9,000 roles. At the same time, we continue the culture journey to drive impact with care and attracted more than 700 talents with a HealthTech background this year alone. As announced earlier this year, Abhijit will retire from Philips after a long and illustrious career with us. I want to thank him for his significant contribution to the company, especially during his time as CFO. Abhijit's leadership, passion, and education have helped shape the transformation of Philips over the last decade and guided the company through global uncertainty in recent years. We will certainly miss Abhijit for his drive, counsel, and sense of humor. His last day will be on September 30. You will have the opportunity to engage with him during the roadshow and investor events over the next couple of months. Our incoming CFO, Charlotte Hanneman, joined us last month and will move into the CFO role on October 1. Abhijit and Charlotte are working diligently to ensure a smooth and seamless transition. As you know, Charlotte brings over 20 years of experience in med tech and pharmaceutical industries, most recently at a global medical technology company, Stryker. Before I wrap up, I want to take the opportunity to extend a warm invitation for our Show and Tell event for investors and analysts in September. It will be a great face-to-face event in the Netherlands. We will take you on a deep dive into our businesses and highlight some of our most important products and innovations. You have the opportunity to directly discuss the latest trends in the HealthTech segments with our management and our business teams. Our Investor Relations website contains more information on the event and how to register. We look forward to seeing you here. Let me close out by repeating the key messages of today's announcement. We delivered strong orders and margin improvement, solid operational cash flow, and comparable sales growth in line with our plan within a challenging macro environment. This was a result of progress on our execution and our industry-leading innovations. Supported by key innovation launches and our ongoing actions, we are confident in our plan and reiterate our outlook for the full year 2024. I would like to thank you for joining the call, and we will now take your questions.

Our first question comes from Hassan Al-Wakeel from Barclays.

I have three, please. Firstly, on orders, can you talk about the strength you're seeing in North America and to what extent? Is it a catch-up on supply issues around MR or, indeed, share gains in other modalities as well? Secondly, can you talk about the Personal Health business in China which looks to be down around 10% in the quarter? What are your expectations here for the second half? And can you talk about the building blocks and the assumed acceleration in the broader PH business over the next two quarters? And then finally, you had an impressive margin delivery in the first half. And with the seasonally strong second half that you typically enjoy, coupled with Connected Care margins building from here, why haven't you raised guidance? Is this a continuation of the conservatism that we've seen from you, Roy? Or is there something we should be aware of, incrementally driving caution into the second half?

Thank you, Hassan, and great questions. Let me start with the first one, orders and the strength in North America. We have seen improvement in our order book across different businesses, building on the strength in the market. North America is clearly the strongest market in the world, where we have seen our customers strengthen their P&L through more patients that are being served. Additionally, we see further consolidation trends in the market that we benefit from as they are choosing key partners that they trust for longer-term technology partnerships. We have seen that across our portfolio, whether that's in monitoring, imaging, or interventional. We've also talked about a very strong Enterprise Informatics growth as software and AI are increasingly used to improve productivity and reach across different sites, whether it be hospital sites or even home care. Therefore, we anticipate that order intake will continue to be strong in North America. Regarding your second question about PH, China was indeed down due to market conditions. Consumers are spending less in China than we were used to. We expect some strengthening in the second half, but not too much from the China market. However, we do see growth in other parts of the world, which will support our full-year guidance, including North America and Europe. Contrarily, we're driving profitability, taking strong actions on productivity initiatives with some support from pricing as well. This overall mix is aiding PH to step up in profitability levels. Lastly, as for the margin delivery in the first half, while we are satisfied with our progress, we chose not to raise guidance midyear. We feel that it is better to remain confident on the full year while continuing to improve quarter-over-quarter.

To add to that, Hassan, if you look at the improvement in the first half, we are within the guided range of 40 to 90 basis points. Therefore, there is no need at this stage, as Roy said, to further improve it since we are in line with the guidance for profit improvement for the first half of the year.

The next question comes from Richard Felton from Goldman Sachs.

Two for me, please. First of all, on some of the recently launched innovation, I think you've mentioned new products across CT, IGT and Ultrasound fairly recently. In the context of those launches, how do you see your current market share trends across those key modalities? That's question one. Then my second one is on Enterprise Informatics. Is there any color or detail you can share to help us think about profitability for that division as the business scales?

Thank you, Richard, for these questions. Good questions again. If you look at the NPIs and how they support market share, I think what you can see from the order intake growth, which was 9% in the second quarter and 3% for the first half, supports strong performance in the market. Some of our new innovations, such as the Ultrasound platform with AI, are expected to provide benefits that have not yet been completely implemented into delivery. Therefore, we believe that we will see our market share increase in the coming months and into 2025. We have indeed been strengthening our positioning in the market demonstrated by multiple deals across North America, Europe, and Asia. On the other hand, we are fully back on track with supply chain lead times, including MR, which we have prioritized. This recovery is also reflected in the momentum we see with MRI and will enhance our future prospects. On the second question about EI, we have seen strong order intake, which contributes to profitability, leading us to be optimistic about achieving a double-digit margin target in the long run.

Our next question comes from the line of David Adlington from JPMorgan.

Maybe just a question around pricing. Of the 2% growth in sales you saw this quarter, how much of that was down to price? And then following on from that, how do you see the pricing environment evolving? Are you seeing positive trends, flat pricing? Or are we seeing some pressure on pricing at this point?

Yes, if you look, we saw some pricing benefit in health systems, which we've been stating for the last couple of years. We saw it translate back into the P&L. In terms of PH, you don't really see further pricing upsides now because consumer sentiment is quite subdued. Therefore, pushing pricing at this time is not helping. However, we are working on productivity and operational improvements in our supply chain and factories, which is contributing positively to margins. Overall, between PH and health systems, the net pricing impact was close to zero, but we are making good progress on material price reduction, aiding overall profitability.

And maybe just a follow-up there. On the orders that you're getting, how is the pricing on the orders?

So far, it is still okay, but we will have to see how it goes in the coming quarters as competitiveness evolves. However, we are still holding our ground and making good progress with the material price reduction, which helps profitability looking forward.

Our next question comes from the line of Veronika Dubajova from Citi.

I have three, please, if I can. The first one is just a follow-up, Abhijit, on your comment that you're expecting D&T growth for the full year to trend at the lower end of the 3% to 5%. Can you maybe elaborate on what is causing your somewhat more cautious outlook for the second half of the year? I guess we're at 4% year-to-date. My second question is just a follow-up on your margin guidance for the year. I look at the first half of the year, you've delivered 90 basis points of improvement. The comps in the back half get easier. To reiterate, is there nothing specific that worries you about the margin development in the second half of the year? Are there no specific headwinds you want to flag as to why the margin improvement in the back half should be, at best, similar to the first half or potentially worse? Lastly, Roy, on China, having just visited there this past week, I'd love to hear your insights on how you feel the behavior on the ground is and when you anticipate your sales and orders in China to return to growth.

Veronika, regarding our D&T growth forecast for Q3, we experienced dramatic growth last year, particularly in the mid-teens, which influences the comparables for the next quarter. We also need to take into account how China plays out and the speed at which the orders come in. For now, that’s how we are looking at our forecast for the remainder of the year. As for margin guidance, we are not going to change guidance frequently. We're confident to remain within our guided range, possibly at the upper end, but further changes at this moment are not necessary.

On China, it was great to be there again. I engaged with customers, partners, and our own team. The impact from the recent measures is still present but there are signs of improvement coming in our activities. We've seen positive indications from our order funnel and discussions with our teams. Typically, orders precede sales, so this aligns with our expected recovery pattern. However, precise timing is challenging to gauge. We anticipate the second half to witness better performance than the first half, as indicated earlier this year, supported by our sequential improvements in Q2. Notably, the Chinese market remains inherently strong, holding significant potential for future patient care.

Do you have thoughts on the stimulus and whether it could notably drive order and sales growth in China in the near future? Could it accelerate growth significantly?

I view the government's stimulus as a bonus program. The Chinese market has underlying growth that we should count on, and the stimulus will act as an additional boost. It should accelerate some replacements to occur sooner than normal. While we expect beneficial effects, our focus remains on the fundamental structural demand which will extensively drive long-term growth. However, given that we don't have precise amounts from the government, it’s premature to put exact figures or firm timelines on this just yet.

Our next question comes from the line of Hugo Solvet from BNP Paribas Exane.

Congrats on the print. I have three, please. First, a clarification on China, Roy, if you can. Do you see a risk that customers' order acceleration or the recovery be held off in H2 as they will be waiting for the stimulus? Second, on Connected Care and Sleep & Respiratory Care, can you quantify for us the margin step-up in that business year-on-year? Are you seeing a sequential margin improvement given that you were already breakeven in Q1? Lastly, on PH: with D&T strong and Connected Care gaining momentum, how committed are you to nurturing the Personal Health business?

I don't expect that the Chinese customers will delay orders because they are waiting for stimulus. The primary demand for replacement and new investment is essential. There is also pent-up demand from previous lead time pressures. So while stimulus timing remains uncertain, it will not hold back our projected improvements for the second half of the year. Regarding Connected Care, we are pleased to see SRC regaining momentum initially driven by sales growth outside of the U.S. and progressing positively in the remaining business segments as well. We anticipate continued strengthening in profitability, although I won't disclose exact margin figures for business confidentiality.

We are overall excited about Personal Health. We have solid market positions in oral care, personal care, and mother & child care, and we expect increased demand as care moves increasingly toward the home. Our strategic positioning provides strong differentiation in the healthcare market.

Our question comes from the line of Julien Ouaddour from Bank of America.

The first one in D&T. You mentioned growth in IGT and Precision Diagnosis. What about Ultrasound this quarter? We've seen data from China suggesting important market share loss for you there during the first six months of the year. What’s going on? The second question on Respironics: we've also seen some European class action for Respironics emerging this summer. Could you update us on that situation and its potential outcomes?

Regarding Ultrasound, we had substantial growth last year over 30%. Therefore, given the high base, we don't expect significant growth this first half. I’m not aware of any market share loss information, though our new product launches are exciting, and we expect to strengthen in that area. As for the Respironics case, we have limited information on the European class action. We haven't been served with a complaint yet and expect it to mirror the theme of the U.S. case since it's still early in the proceedings.

Regarding SRC, we are pleased with the resolution of the North American settlement. However, various cases are ongoing outside the U.S. The European class action just came to attention, and we are thoroughly managing our legal responsibilities as we receive information.

No, Julien, we would prefer not to give a breakdown of order intake by modality as it's sensitive competitive information. However, we are pleased to see strong results outside China, particularly in North America.

Our next question comes from the line of Robert Davies from Morgan Stanley.

I had a couple. One was just on the competitive environment in D&T. Do you see any changes there? In your earlier comments, you mentioned progress in North America. Any areas of particular strength or weakness?

We've experienced significant progress in North America with increased order growth across various modalities. Our competitive positioning has strengthened due to ongoing recovery and stability in lead times. The interplay of software, AI, informatics, and D&T has also differentiated us in the market, helping us capture more from the overall opportunity available.

On free cash flow, we saw a skew due to the economic loss settlement impacting first-half numbers. We are confident moving forward, projecting a cash flow in the €900 million to €1.1 billion range driven by improved earnings and effective working capital management as we compensate for the initial outflow.

Can you give a bit more color on what you're seeing in North America for Personal Health?

In North America, we are gaining market share in Personal Health. Consumer confidence remains solid. We anticipate reasonable growth in the second half of the year based on our product launches.

Our next question comes from the line of Sezgi Ozener from HSBC.

Three questions. First, do you have an update on the DOJ case? For the rest of the European cases, what might the timelines and potential outcomes look like? Secondly, what's the portfolio of Connected Care post-pruning? A big step back in ventilators and respiratory care, or still a consideration? Lastly, regarding reimbursement in the DME market, do you see stronger inclusion in reimbursements affecting margins?

There is no update on the DOJ case or the European litigation other than we are cooperating with the investigations. As for Connected Care, we are seeing growth and profitability returning, though we will have a leaner portfolio. Ventilation and respiratory care remain relevant in our plans. Concerning reimbursement changes, we have seen demand in this area, but there are no significant alterations affecting margins at this time.

As for the Connected Care segment, we are focused on core products with strong volume driving capabilities in respiratory care. The overall restructuring allows us to maintain relevance in this segment and position us for future growth.

Our next question comes from the line of Falko Friedrichs from Deutsche Bank.

Regarding your strong 9% order intake growth in Q2—should we expect lower growth in Q3 and Q4 given recent improvements in North America and China? Briefly remind me about the order comparisons for the second half.

Order intake is inherently uneven, and while we anticipate growth in Q3 and Q4, we should not extrapolate the 9% increase seen in Q2. Our comp in the second half does not show significant weakness, but growth will depend on how China recovers. Nevertheless, we are optimistic about continued strength in North America and other international markets.

The last question comes from the line of Ed Ridley-Day from Redburn.

Could you provide some insight into growth in Ultrasound, excluding China? Additionally, regarding Image-Guided Therapy, how does your revenue growth look for IGT?

I need to check on the specific growth numbers for Ultrasound excluding China. However, we don't expect significant growth for the first half due to the strong base last year. For IGT, we are observing a slow recovery but expect it to be lower than double-digit growth. This aligns with the overall guidance we've provided for D&T. Maybe first of all, let me thank everybody for joining the call since this is going to be my last analyst call after 50 quarters of doing this both as IR and as the CFO. Just wanted to say a big thank you to all of you for putting up with me and for all the moments we shared.

Thank you, Abhijit. We will miss you indeed. As I close the call, I want to repeat the key message: we delivered strong orders and margin improvement, solid operational cash flow, and comparable sales growth in line with our plan in a challenging macro environment. Supported by key innovation launches, we are confident in our plan and reiterate our outlook for the full year 2024. Thank you all for joining and enjoy the rest of your day.

This concludes the Royal Philips second quarter and semiannual 2024 results conference call on Monday, July 29, 2024. Thank you for participating. You may now disconnect.