Philips : Q1 2024 webcast transcript

Philips Q1 2024

Results

Monday, 29th April 2024

Philips Q1 2024 Results

Monday, 29th April 2024

Operator: Welcome to the Royal Philips First Quarter 2024 results conference call on Monday, April 29th, 2024. During the call, hosted by Mr Roy Jakobs, 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. 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.

Introduction

Leandro Mazzoni

Head of Investor Relations, Philips

Hi everyone. Welcome to Philips First Quarter 2024 results webcast. I'm here with our CEO Roy Jakobs and our CFO of Abhijit Bhattacharya. The press release investor deck, and the frequently asked questions on the Respironics Field Action were published on our investor relations website this morning. The replay and full transcript of this webcast will be made available on the website after the call.

Before we start, I want to draw your attention to our safe harbour statement on screen. You'll also find the statement in the presentation published on the website. Roy, over to you.

Presentation

Roy Jakobs

CEO, Philips

Good morning everyone, and warm welcome. Great to be with you today. I want to start with the key highlights of this morning's release. We delivered results in line with our performance improvement plan with 2.4% comparable sales growth and strong margin improvement in the quarter and order intake growth to turning positive outside of China, especially in North America. This was a result of continued strong focus and progress on our three execution priorities.

Secondly, we have taken several very important steps in resolving the consequences of the Respironics recall. The consent decree was signed and approved in court. We received final court approval for the previously announced economic loss settlement. We reached an agreement to resolve the personal injury and medical monitoring litigation in the US and we also concluded an agreement with insurers to cover Respironics recall related product liability claims. Following the remediation of sleep therapy devices and the reassuring test results to date, these are very important milestones to provide further clarity on the way forward for Philips. Supported by key innovation launches and our ongoing actions to enhance since execution, we are confident in our performance improvement plan for 2024.

Onto the key financial highlights. Comparable sales growth was 2.4% in the quarter, driven by 3% growth in the diagnosis and treatment and personal health segments, partly offset by a 1% decline in connected care against very tough comms in monitoring. Group sales grew 2% in mature geographies. Growth geographies sales grow 3% despite a decline in China. The adjusted EBITA margin improved significantly to 9.4% in the quarter. Free cashflow was an

2

Philips Q1 2024 Results

Monday, 29th April 2024

outflow of EUR 336 million in line with normal quarterly phasing. Order intake in the quarter declined as anticipated due to the situation in China. This was driven by the impact of the industry-wideanti-corruption measures, and the comparison against an exceptionally high order intake base from last year. Importantly, order intake grew outside of China with encouraging performance in North America. We remain focused on implementing the necessary actions to strengthen quality delivery, reduce lead times, leverage our enhanced operating model and market our AI-driven innovations to improve order intake. Overall, based on the gradually improving market environment in the US as well as expected improvement of the situation in China, our exciting innovation launches and our ongoing actions, we continue to expect positive order intake growth in the full year 2024.

In China, the government imposed anti-corruption measures continue to impact short term decision making by hospitals, but we do not expect it to impact the fundamental demand as China remains an attractive market. Our order funnel is very active in the country and we expect order growth to resume in China in the second half of 2024, also supported by the newly launched government programme for medical equipment upgrades. It's important to note that our order book, which accounts for around 40% of group sales, remains strong and is further being built down to expected normalised levels.

I've met many of our customers and partners in the last few months and it's absolutely clear that we are a preferred strategic and innovation partner to provide imaging, therapy and monitoring solutions supported by a strong enterprise informatics and AI suite. This has been, again, amplified by how strongly our solutions resonated with customers at the recent Vive, ECR and HIMSS Global Healthcare events which I attended during this quarter.

Let me now provide you with some of the recent customer innovation milestones during the quarter. We launched the new Azurion image guided therapy system and advanced informatics as well as the new AI enabled CT 5300 designed for more accurate and reliable imaging results while enhancing productivity using up to 80% lower radiation dose. We were also recognised as a Clarivate Top 100 Global Innovator for the 11th consecutive year and ranked as a top medical technology patent applicant at the European Patent Office in 2023. We continue to see strong customer pool for our solutions and signed several long-term agreements across the world in the quarter. For example, we signed a ten-year agreement with the Nicklaus Children's Health System in the US to provide AI-enabled technologies such as helium-free MR, ultrasound and monitoring solutions for deeper clinical insights and improved workflow and productivity.

Now on Respironics. As I said, we have taken very important steps in resolving the consequences of the Respironics recall in the quarter. As said before, we do regret that patients that - the concern that patients may have experienced. Let me call out the milestones reached.

First. Philips and plaintiff's leadership supported by a court appointed mediator have reached an agreement that resolves the personal injury litigation and a medical monitoring class action in the US. This settlement ends uncertainty associated with litigation in the US. It should be noted that Philips and Philips Respironics do not admit any fault or liability or that any injuries were caused by Respironics devices. Philips Respironics has agreed to pay a total capped amount of $1.1 billion. The related payments are expected in 2025 and to be fully funded from Philips cashflow generation. You'll find more details of the agreement in the Respironics field action deck published on our investor relations website this morning, which underscores the high degree of confidence from all parties in achieving closure and finality with the settlement.

3

Philips Q1 2024 Results

Monday, 29th April 2024

Also important, earlier this month, the Philips Respironics consent decree was approved by US court. As communicated before, the decree primarily focuses on Respironics business operations in the US, and we now have made a roadmap to demonstrate compliance with regulatory requirements in order to restore the business in the US and grow outside of the US. Moreover, Philips Respironics obtained the final court approval for the previously announced economic loss settlement in the US, which a provision was recognised in Q1 2023. We continue to work on other Philip Respironics related legal proceedings, including the investigation by the US Department of Justice, and we also concluded an agreement with insurers to pay Philips in relation to Philips Respironics recall related product liability claims. Therefore, following the remediation of sleep therapy devices and the reassuring test results to date, these important milestones on litigation, consent decree and insurance provide Philips with a clear path forward for sustainable value creation.

Looking ahead, we remain confident in our plan and financial outlook. In 2024, we expect to deliver 3-5% comparable sales growth building on a strong comparison base of last year and an adjusted EBITA margin of 11-11.5%. The free cash flow expectation is now increased to 0.9 to 1.1 billion in 2024. Factor in the receipt from insurers that I just mentioned and the remaining payments related to the economic loss settlement.

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.

Financials

Abhijit Bhattacharya

CFO, Philips

Thanks, Roy. Good morning everyone. Let me start with our performance by segment. In diagnosis and treatment, comparable sales increased by 3% driven by growth in precision diagnosis and image guided therapy, and this was against strong double digit growth in Q1 2023. The adjusted EBITA margin was 9.2%, including an impact of a 100 basis points from an accounts receivable provision. The adjusted EBITA margin was lower than last year, mainly due to the normalisation of the product mix as anticipated. To remind you, the increase in profitability in Q1 last year was around 600 basis points due to the easing of supply chain constraints on our most profitable modalities of ultrasound and image guided therapy systems.

Connected care comparable sales declined by 1% as high single digit growth in enterprise informatics was offset by negative sales growth in monitoring on the back of around mid-teens growth in Q1 2023. We saw strong growth in sleep systems and patient interface driven by performance outside of the US, while ventilator sales were lower. Connected care adjusted EBITA margin improved significantly to 6.4% driven by solid performance in monitoring and an improvement in sleep and respiratory care. Personal health delivered a 3% comparable sales increase driven by strength in the personal care business. The adjusted EBITA margin for the segment improved to 15.2% this quarter, mainly due to operational leverage and productivity. Geographically, sales and personal health was driven by mature geographies while growth geographies were flat, mainly due to China. Overall, consumer sentiment remains subdued but is expected to improve in the course of 2024 segment.

4

Philips Q1 2024 Results

Monday, 29th April 2024

Other sales increase by 25 million in the first quarter, mainly from higher royalty income due to phasing. We have been very disciplined in cost management and our productivity initiatives delivered savings of 151 million in the quarter of which operating model savings were 55 million, procurement savings were 40 million and other productivity programmes delivered 56 million. The adjusted EBITA margin for the group increased by 80 basis points to 9.4% in the quarter as our productivity and pricing actions more than offset inflation. Free cash was an outflow of 336 million in the quarter due to the normalisation of working capital phasing partly offset by higher cash earnings. On capital allocation in April, we completed the 1.5 billion share buyback programme for capital reduction purposes announced on 26th July 2021. In the second quarter, we intend to cancel the 4.4 million shares acquired this year.

Moving to orders, it's important to note that the absolute order intake levels remain healthy, although lower than the exceptionally high comparison base of the last two to three years. Order intake grew outside China with an encouraging performance in North America and general improvement in market dynamics, which is expected to continue in the coming quarters. Our funnel of opportunities remains strong.

The order book is significantly higher than the period before the global supply chain crisis. As a reminder, orders and orders book account for around 40% of our revenue; the remaining 60% comes mainly from recurring revenue streams such as services and consumables, from book to bill business and from personal health. As mentioned in our previous earnings call, we anticipate sales growth to be backend loaded in 2024 due to the tougher comparison base in the first half of the year, resulting mainly from the strong China performance in the first half of 2023 and the anti-corruption measures ongoing in the first half of this year. Our expectation for sales growth in the second quarter remains soft as a result of this di difficult comparison base as Q2 2023 grew by 9.4% as well as the impact of the phasing of royalty revenues.

We expect sales in segment others to be around EUR 120 million in the second quarter, 75 million lower than in the second quarter of 2023 due to a large royalty deal recorded last year and the impact of royalty revenue phasing between the first and second quarter of 2024 that I just mentioned. This difference in royalty sales alone results in a negative impact of around 170 basis points on the growth of the group in the second quarter. Note that there is no change to full year outlook of segment other provided in January, both in terms of sales and adjusted

EBITA.

Based on our order book, improving order intake and the ongoing actions to enhance execution, we expect to deliver 3-5% comparable sales growth and an adjusted EBITA margin between 11 and 11.5 for the full year. As Roy mentioned, under the settlement to resolve the personal injury and medical monitoring litigation in the US, Philips Respironics has agreed to pay a total of $1.1 billion. The related payments are expected in 2025 and to be funded from Philips's cash flow generation. Moreover, we received the final court approval for the previously announced economic loss settlement in the US. At the time we announced the settlement in Q1, we recognised the provision of EUR 575 million based on assumptions about the number of claimants that we expected to participate.

Now, a year later, based on the actual claims that we are seeing, these assumptions turn out to be accurate and we fully expect the settlement to stay within the amount provided for. This month, we also concluded an agreement with the insurers to pay us EUR 540 million to cover Respironics recall related product liability claims. This income is expected to be recognised in

5

Philips Q1 2024 Results

Monday, 29th April 2024

Q2 2024 and payment is expected during 2024. As a result, we have increased our free cash flow outlook for this year to 0.9 to 1.1 billion now including the payment from insurers as well as the cash out of around EUR 430 million related to the remaining payment of the economic loss settlement.

With that, I'd like to hand it back to Roy.

Presentation

Roy Jakobs

CEO, Philips

Thanks, Abhijit. I would like to continue with the progress we have made on our execution priorities. On patient safety and quality. We saw substantial improvement in CAPA closures in the quarter, driven by stronger processes, capabilities, and governance around it. We also continue to drive significant simplification of the way we work and we further reduced the number of quality management systems. We are well on track to achieve our target of 65% reduction in 2024, and we continue to invest in quality improvement across the portfolio acting fast on post market surveillance signals. With respect to supply chain, we have now redesigned more than 80% of the planned PCBs and further reduced materials and component risks in the quarter. We will continue leveraging and regionalising our end-to-end supply chain to further reduce lead times and strengthen first time right deliveries.

Finally, our new operating model with prime accountability in the businesses has been live for a year now, resulting in significant productivity improvements. We have reduced over 8,500 roles to date. At the same time, we continue the culture journey to drive impact with care and attracted over 300 talents with health tech backgrounds this quarter alone.

Let me close out by repeating the key messages of today's announcement.

First, we delivered results in line with our performance improvement plan as a result of continued strong focus and progress on our three execution priorities. Secondly, we have taken very important steps in resolving the vast majority of the consequences of the Respironics recall, and in this quarter alone, we had major milestones on litigation, consent decree and insurance, providing further clarity on the way forward for Philips. Thirdly, the progress we are making reinforces our confidence to deliver further performance improvements in 2024, and we are on track with the plan for 2025.

I would like to thank you for joining the call and we will now take your questions.

Q&A

Operator: Thank you, sir. If any participant would like to ask a question, please press the star followed by two times one on your telephone. Due to the time, please limit yourself to one question. This will give more people the opportunity to ask questions. There'll be a short pause while participants register for questions. We will now go to your first question and your first question comes from the line of Richard Felton, Goldman Sachs. Please go ahead.

Richard Felton (Goldman Sachs): Hi, good morning. Congratulations on reaching the settlement. I've got two questions both on fundamentally margins if that's okay. My first one is

6

Philips Q1 2024 Results

Monday, 29th April 2024

a question on precision diagnostics. So I understand last year that you were still facing some supply chain constraints on certain modalities. I think MRI in particular had been facing some challenges. So other supply chain challenges normalising for precision diagnostics and what does that mean for your margins, for outlook for that subdivision this year?

Second question on sleep and respiratory. Look, I understand that sleep and respiratory was still loss-making in 2023. Now that you've got visibility on consent decree and I think better visibility on the outlook of the environment in which that business can operate moving forward, how quickly can you do the right sizing necessary to bring that business back to break even and then positive margin territory? Thank you.

Abhijit Bhattacharya: Hey, Richard, good morning. This is Abhijit. On the PD margins, or maybe because we give diagnosis and treatment margins. Last year we had a big increase. Now, as I mentioned just now in the speech as well of 600 basis points, that was because we supplied in the first two quarters of last year a lot of our high, more profitable modalities. The supply chain constraints are now mostly gone. The last part that is left is on MRs where we still have slightly longer lead times than we would like. That doesn't mean a lot for the margins. It just hampers order intake a little bit for the time being, and in the second half of the year we should go past that. As far as the margins for D&T this year are concerned, you know, we have said that we are going to grow margins this year and that will, you know, - the phasing between the first half and second half is distorted because of last year. So we will grow margins for the year and you will see improvements coming in the second half over last year for diagnosis and treatment.

For sleep and respiratory care, you are right, you know, that that's what we've always said, that once we get clarity on the CD, we will take cost actions to make this business a profitable business even at a 1 billion revenue. I think the good news is that we are already profitable, so we have taken most of those cost actions further actions to come, but already in Q1 we are profitable in sleep and respiratory care, which is why also you see the turnaround and the increase in connected care margins.

Richard Felton: Great, thank you very much.

Abhijit Bhattacharya: Thank you.

Operator: Thank you. We will now go to the next question and your next question comes from the line of Hassan Al-Wakeel from Barclays. Please go ahead.

Hassan Al-Wakeel(Barclays): Hi, thanks for taking my questions and it's great to see today's clarity on litigation. Firstly, can you talk about the remediation needed as part of the consent decree as well as the remediation that you have been doing over the last couple of years? What do you think is a realistic timeline for your return to the US market?

Secondly, given clarity on litigation, could we see a return to bolt on M&A in the next year or two? And if so, in which areas do you see the most opportunities or are you squarely focused on resolving and remediating quality issues at the company?

And then finally, can you break out order growth in China and ex China? How did things end the quarter and how are you viewing this quarter both in China and outside of China? And I wonder if you expect orders to be positive in Q2 for the group, but also in China. Thank you.

7

Philips Q1 2024 Results

Monday, 29th April 2024

Roy Jakobs: Thank you. Hassan, let me take the first question. So remediation part of the CD. So I think as we said, we are very happy that we now have clarity, in essence, we have a very clear roadmap in terms of what we need to do to get back into the US market. As you know, we are already providing patients in the US with patient interfaces and also some of respiratory device. So it's not that we are fully out of that market, but to get fully back, of course, we need to comply with the remediation requirements as said in the CD, including the recall plan. Now, we haven't put a timeline out, we also will not speculate on that. We will of course work very hard to get there. We also are not starting now. We have indeed been actioning already on that earlier.

As Abhijit said, if you look to the totality of SRC, we are growing outside of the US, and also we have been bringing it back into profitability. So the sleep and respiratory care business will show an improvement and contribution trajectory into Philips, which we are very positive about. But we will not put any specific timeline on any injunction because that also is in of course collaboration with the FDA that we need to achieve that.

Secondly, on your question on the clarity that we get now also on cash and cash profile and bolt on M&A. As part of the plan that we started last year, I've been very clear how important cash generation is. Now, we were very happy with the 1.6 billion cash flow last year. Now we see that also this year we will have a strong cashflow profile of 1 billion. We upped based upon the clarity we now have on the economic loss payment we need to do, but also the insurance inflow we have in the year; and the litigation settlement we have today, we can actually pay in full or out of our operational cash flow. That also means that we will indeed be able to do bolt on acquisitions. Of course those need to be the right ones, and we do kind of need to look at our own priorities first, which meaning extracting value out of the current portfolio of assets that we have because we have a lot of potential there. But that doesn't mean that if we see the right target, we could do that, and we will remain active. And of course, if we then think of which areas, those will be areas where we are strong, either whether it's in the IGT domain, which we kind of see potential, but it could also be in monitoring or what we said - did as bolt on acquisition and ultrasound where we had AI, portfolio of AI solutions that we added there that actually will be coming to market as part of the innovation launch in ultrasound actually mid this year. So that will also bolster our profile and our portfolio towards the market. Maybe order intake, Abhijit you can take.

Abhijit Bhattacharya: Yeah, so I think yeah, we had a decline in in China in Q1, and that is what we expected, it was, yeah, in the high double digits because, you know, last year we had

1. growth of in the mid-thirties last year, right? So you had mid-thirties growth last year, that was with the incentives coming out of Covid, and then you had really the counterbalancing this year with the anti-corruption measures, which of course slowed things down. The good news, as Roy mentioned, you know, outside of China, we have returned to growth and most positively is that North America grew nicely for us in the quarter.

We are not going to at this stage give specific numbers there because let's say that's not something that is even shared by our competitors, but I think we are pleased with the momentum in North America, and that also gives us the confidence for the remaining part of the year. We expect also China, as we said, to contribute in the second half of the year. Roy was in China recently. And, you know, with the new incentives that the government is planning to give, that should give let's say good impetus. So overall, I think there's no change in our

8

Philips Q1 2024 Results

Monday, 29th April 2024

view on China. It fundamentally remains an attractive market. For the short term, consumer sentiment is subdued. We expect that to improve through the year; hospitals will continue to work through the industry-wideanti-corruption measures, and then we will - we expect to see more hospitals putting in orders. And yeah, so therefore that the second half we expect China to contribute. And so far, we've kind of started the year on plan.

Hassan Al-Wakeel: Perfect. Thank you very much.

Abhijit Bhattacharya: Thanks, Hasan.

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

David Adlington (JP Morgan): Hey guys, thanks for taking the questions. So first one, Abhijit, in your prepared remarks, you mentioned that there was a 100 basis point hit to the D&T margin, I think, from a provision. Just wondered if we get some more colour around that please.

And then secondly just in terms of the cost savings, you delivered 151 million I think in the first quarter year on year, but your adjusted EBITA was only up 30. I just wondered where you are reinvesting some of those savings or whether if they are being eaten up by headwinds elsewhere.

And then the final one is just now you've got more clarity on the cash, just wondered if you plan to reinstate the cash dividends. Thanks.

Abhijit Bhattacharya: Yeah, so I think couple of things. So let's say the 100 basis points I talked about was that was a provision for a receivable where a certain - with a certain customer. So there's no - it's not an operational performance in a factory or anything to do with the cost structure of the business, but just a part - provision on a receivable with a particular customers. I think if you look at the overall productivity, of course, in that, you know, that productivity is compensating for our cost inflation. So you will see that, you know, we have a bridge in the deck on slide 13 where you see, you know, 2% is going towards cost inflation that is a negative, therefore you don't see all of it back, but you see a significant portion. And then the part that I mentioned, the 100 bps on DNT, of course, has an overall impact on Philips as well.

On cash dividend, I think it's a bit too early to comment now. So let's first get through this year and then, you know, at the end of the year we will decide on how we will deal with our dividend for next year. But as Roy mentioned, the good news is that we can deal with our cash obligations with regard to the litigation from our operating cash flow, and that also gets us, let's say, to our - very close to our targeted leverage next year, which will be actually a very good performance after paying off all the fines.

David Adlington: Got it. Thanks guys.

Abhijit Bhattacharya: Thank you.

Operator: Thank you. Your next question comes on the line of Veronika Dubajova from Citi. Please go ahead.

Veronika Dubajova (Citi): Hi guys, good morning and thank you for taking my questions. I have two please if I can. The first one is just, Abhijit, you sort of alluded to this, but the margin progression that you expect in DNT in particular through the year, if you could outline a little bit, sort of, you know, how we should be thinking about that. I think you've talked about the

9

Philips Q1 2024 Results

Monday, 29th April 2024

sort of maybe 50 basis points or more margin improvement for the full year. You know, do you still expect margins to be down in the second quarter and then I guess, you know, is the improvement in the back half of the year particularly pronounced in Q3 versus Q4? Just because last year was such an unusual year, you know, if you could help us understand that and maybe just a comment on growth as well for DNT.

And then I have a separate question on the settlement announced this morning, and just to maybe give us all reassurance, I guess we'd love to understand, you know, to what extent there are kind of exceptions. So is this all-encompassing? Does it include situations like death as well as injury? Just if you can talk to sort of what are some of the instances where you could see separate litigation that is outside of the scope of the settlement, and then to finalise the settlement, what are the steps that are remaining both in terms of the courts and discussions with the plaintiff, and when can we sort of consider this completely done and dusted. That would be - some colour around that would be very helpful. Thank you guys.

Abhijit Bhattacharya: Hi Veronika. Good morning. Let me take the first question and then I pass it on to Roy for the second one. So you know, the first two quarters of last year we had very strong improvement in the margins of DNT. If I remember right, quarter one was 600 basis points. First half of the year was 500 basis points. And we said at that time itself that that's a bit of an unusual pattern. So for this year, the way you should read it is that we will improve in the - first in the second half, and the first half will be lower. So including Q2 will be lower than last year, but then Q3, Q4, you will see the improvements and then you see the improvement for the full year.

Important to note that the guided range for 2025 is low-teens. We are already in that range, so we will make further progress into the range this year and then progress in the range next year as well. So we are on a good track with D&T.

On the litigation. Maybe Roy.

Roy Jakobs: Yeah, may, let me take that one. Veronika, thank you. I think important question on indeed this finality. I think we are very firm that we believe that for the US this is as final as it can get. The settlement addresses all the 60,000 known claimants as part of the census registry, including the 700 filed cases that were active. We do not believe that there is a meaningful number of plaintiffs out there that will still come forward. That's also the view of the plaintiffs themselves. And if they do, they will be subject to a so-called lone pine order, which requires them to bring forward a full case at once, or else they will be dismissed, and also they will need to kind of come forward with all their individual evidence as everything that was gathered as part of this process now will cease to exist.

There are six months that actually people can still come forward. After the six months, actually the whole class action or the whole MDL cease to exist. And that's also why it was important that this was court approved and or don't - not yet court approved, but there was a mediator from the court that actually was part of this whole process. She has been very I think affirmative of this deal. You also saw that in our announcement. She will also make sure that this will be going through the court proceedings. Now, we don't know exactly when that will be, we don't expect that will take too long. And so we are actually very confident that this will really put an end to this. And that's very important because then with ending economic loss, economic personal injury and medical monitoring, we really have put the vast majority of these cases

10