Koninklijke Philips N.V.’s (PHG) CEO Frans van Houten on Q4 2021 Results – Earnings Call Transcript
Koninklijke Philips N.V. (NYSE:PHG) Q4 2021 Earnings Conference Call January 24, 2022 4:00 AM ET
Leandro Mazzoni – IR
Frans van Houten – CEO
Abhijit Bhattacharya – CFO
Conference Call Participants
Veronika Dubajova – Goldman Sachs
Hassan Al-Wakeel – Barclays
Kate Kalashnikova – Citigroup
David Adlington – JPMorgan
Lisa Clive – Bernstein
Ed Ridley-Day – Redburn
Julien Dormois – BNP Paribas
Delphine Le Louet – Societe Generale
Sezgi Oezener – HSBC
James Vane-Tempest – Jefferies
Wim Gille – ABN ODDO
Welcome to the Royal Philips’ Fourth Quarter and Full Year 2021 Results Conference Call on Monday, January 24, 2022. During this call, hosted by Mr. Frans van Houten our CEO and Mr. Abhijit Bhattacharya, CFO all participants will be in a listen-only mode. After the instruction there will be an opportunity to ask questions. [Operator Instructions] 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 Philips fourth quarter and full year 2021 results call. I am here with our CEO Frans van Houten and our CFO Abhijit Bhattacharya. Frans and Abhijit will take you through our strategic and financial highlights for the period and after that we will take your questions.
Our press release, the related information slide deck, as well as frequently asked questions on 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.
Over to you, Frans.
Frans van Houten
Yes. Hello, everyone, and thank you for joining us today. As the disruption caused by the COVID-19 pandemic intensified in the fourth quarter, our teams remained focused on delivering against what we call the triple duty of care of meeting customer needs; safeguarding the health and safety of our employees; and ensuring business continuity. We remain fully focused on driving the necessary actions to deliver on our strategic performance roadmap, of working through the global supply chain issues, as well as doing everything we can to deliver a solution to patients and caregivers affected by the Respironics recall.
In the fourth quarter we recorded €4.9 billion of sales reflecting a 10% comparable decline with was an adjusted EBITA of 13.1% of sales. As we announced on January 12, sales were impacted by several headwinds, namely supply chain challenges, postponement of equipment installations in hospitals related to COVID-19, and the consequences of the Respironics field action. For the full year we recorded €17.2 billion sales reflecting a 1% comparable decline. The aforementioned headwinds had a combined impact of 5 percentage points on the Group full year comparable sales.
Adjusted EBITA was €2.1 billion in the full year or 12% of sales. Comparable sales growth was 8% in Diagnosis & Treatment and 9% in Personal Health in 2021 despite supply chain headwinds in the second half of the year. Connected Care sales declined 23% in 2021 following the high COVID-19 generated demand in 2020 and the decline in Sleep & Respiratory Care due to the recall.
Our strategy and portfolio continued to resonate very well with customers and consumers generating solid demand for our products and solutions throughout the year. Order intake grew a further 4% in the year driven by 16% in the Diagnosis & Treatment and strength in hospital patient monitoring. This further builds on the high single-digit Group comparable order intake growth in 2020 resulting in an all-time high equipment order book for Philips which in fact is 18% higher than at the end of 2020 as shown on page 30 of our presentation.
During 2021 we also signed 80 long-term strategic partnerships across the world of which 35 were signed in the fourth quarter demonstrating the trust hospital leaders have in our ability to help them enhance health outcomes, lower the cost of care, and improve patient and staff experience. As I mentioned, 2021 sales were impacted by the intensified global supply volatility and issues, so let me now elaborate further on this topic.
We faced stronger than anticipated supply chain disruptions across our businesses which was primarily related to the shortage of electronic components, shipping times, and COVID-19 also affecting our suppliers. We have been working through the global supply chain headwinds for some time now, but earlier in the year our ability to mitigate supply risks was higher. We were increasingly challenged with suppliers that are unable to give visibility on e-component availability and shipping times or even de-commitment orders on short notice.
During the first half of the year, inventory started depleting due to our strong growth and then global supply challenges intensified making the inventory situation very tight. As a consequence the risk in our plan increased which was exacerbated with short-term de-commitments and delays from some of the semiconductor suppliers. This impacted our ability to deliver on part of the revenue upside that in fact we had planned to mitigate the shortfall from Respironics.
In addition to that, we saw customers struggle with the impact of COVID-19 on hospital staff and operations in December which also delayed site readiness partly caused by local material and labor shortages.
Our supply chain teams remained fully focused on further driving the mitigation actions we started in 2021, but we expect the headwinds to continue in 2022, especially in the first half of this year. To address these challenges we have already expanded the long-term orders with our suppliers. We have increased spot buying when it is expedient to do so. We have partially moved to alternate modes of transport to bypass reliance on ocean freight and port congestion.
Our R&D teams are working on developing alternate parts as well as adjusting product designs to diversify sourcing of components. Moreover we are calling on suppliers and governments at senior levels to prioritize healthcare products and the supply of components.
Let me now speak about the Respironics recall. The repair and replacement program is underway globally and we have substantially ramped up our production servers and repair capacity. To date we have produced over 1.5 million repair kits and replacement devices of which more than half have reached customers. We aim to complete the remediation program in Q4 2022.
As announced on January 12, following a comprehensive patient and customer outreach program, Philips Respironics increased the field action provision by €220 million mainly due to the higher volume of registered devices eligible for repair or replace and increased supply and communication cost. As we said at that time, this was done in alignment with corporate and authorities in the interest of patients.
In December we provided an update on the positive VOC test results to date for the first generation of DreamStation devices which indicated that VOCs are within the limits of safe exposure specified in the applicable safety standard e.g. ISO standard 18,562. Comprehensive particular testing and analysis are expected to be completed in the second quarter of 2022. We will continue to provide timely updates on the results from these and other assessments.
I would like to reiterate that we have a strong program management in place to ensure the corrective actions related to the recall are completed as fast as possible. We have a competent team of over a thousand people working under the leadership of Roy Jakobs who is a member of our Executive Committee. We’ve also made organizational changes throughout 2021 which include onboarding the new top management in the Sleep & Respiratory Care business and further strengthening our equality, our regulatory affairs leadership for the Group, the Connected Care and the Sleep & Respiratory Care businessed.
Moreover we have added resources to cross check learnings from the sleep recall, their relevant and strength and capabilities around post-market surveillance, medical affairs, biocompatibility and toxicology within Philips. Our experts, as well as certified labs, and qualified third-party experts, are closely working with the Respironics teams.
Importantly we have submitted a comprehensive response to the November 2021 Form 483 as well as a detailed action plan to the FDA. Philips Respironics continues to engage with the FDA and we will work closely with the agency to clarify and followup with the inspectional findings and its requests.
As I already referred to, as part of our focus on quality and following the Respironics recall, we have reinforced the awareness and focus on patient safety across the company. We have further stepped up scrutiny and raised the bar around this topic and see the organization responding to this. In that respect, in Q4 we recorded a provision of around €70 million in the Connected Care businesses in relation to other quality actions.
As we are currently still in process of informing stakeholders, I cannot provide details right now. While the provision is sizable, we believe the mitigation of these issues as well as the business that it relates to our small business lines in the Connected Care portfolio. These efforts are ongoing and continue improvement of our quality culture and approach is a top priority for management and for everyone at Philips.
As you know, Philips Respironics is a defendant in several class-action lawsuits and personal — individual personal injury claims. However, it is too early to draw any conclusions about the merits and the timelines to handle the claims at this stage. Right now, we are focusing on the patients and the corrective actions required, as well as the completion of testing that I referred to.
As Leandro mentioned we have published frequently asked questions, FAQs on the recall to provide details and clarification on the progress. There are some areas, particularly related to litigation, where we are not able to provide further details at this time. We will share additional 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. At the RSNA Annual Meeting in December we launched a slate of smart connected imaging solutions featuring AI and workflow automation to aid clinicians in providing early definitive diagnosis and treatment. We introduced our MR 5300 system continuing the advancement of our unique helium-free operating portfolio. Powered by AI the MR 5300 simplifies and automates complex clinical and operational tasks for outpatient clinical use and MR departments to help increase access to affordable quality care.
We are expanding our comprehensive CT portfolio we have introduced the new CT 5100 Incisive with CT smart workflow, a suite of AI enabled capabilities designed to accelerate workflows, enhance diagnostic confidence and maximize equipment up time. CT smart workflow is the latest in a continuous program of performance announcement for Philips market-leading Incisive CT system.
We also introduced the world’s first spectral detector angio-CT combining our unique spectral CT 7500 system and industry-leading Azurion platform Reflex arm in a single interventional suite solution. Spectral detector CT imaging brings valuable additional information in minimally invasive procedures for areas such as oncology, stroke and trauma care and the integrated solution provides interventionists with immediate tableside access to these two key imaging modalities.
In the quarter we further expanded our leading image guided therapy portfolio through the acquisition of Vesper Medical adding a venous stenting solution to address the root cause of chronic deep venous disease, and complementing the ambulatory cardiac diagnostics and monitoring solutions we offer, that we already offer with BioTelemetry, we now acquired Cardiologs which is adding a vendor-neutral heart disorder screener and ECG analysis application based on machine learning algorithms. Cardiologs’ technology will accelerate diagnostic reporting and streamline clinician workflow and patient care.
In Personal Health we continue to invest in new product introductions and successfully completed the rollout of the Sonicare 9900 Prestige in North America, China, Europe and the Middle East. This premium electric toothbrush finished #1 in the Stiftung Warentest, Europe’s leading consumer organization. Moreover we further expanded the oral healthcare portfolio with the launch of innovative interdental cleaning devices in North America and China.
Looking ahead, based on strong customer demand, our growing order book and the actions that we have taken, we expect to resume our growth and margin expansion trajectory in the course of 2022. Short term however, we continue to see volatility and headwinds related to COVID-19 and the supply-chain shortages despite our ongoing mitigation actions.
For the full year, excluding Sleep & Respiratory Care, we target to deliver 5% to 6% comparable sales growth. For the overall Group we target to deliver 3% to 5% comparable sales growth and 40 to 90 basis points adjusted EBITA margin improvements. Our order book is very strong and clearly supports strong growth, but we want to be cautious as we manage through the headwinds. We will provide further color or updates as appropriate as the year progresses.
Our journey to leadership in health technology continues and I am optimistic about our potential to grow and create value overcoming this year’s issue. Our customers tell us that we are relevant to them. Our strategic roadmap will unlock higher growth. We are focused on execution and operational excellence to achieve our goals and manage the near term headwinds that we are facing. We have a stronger than ever portfolio to serve our customers and I remain very confident on the medium term growth and margin opportunity of our company. We plan to provide more color on our medium-term performance roadmap in the summer.
And that that, I’ll turn the call over to Abhijit.
Thank you, Frans, and thank you all for joining us today. Let me provide some color on the comparable order intake growth. Diagnosis & Treatment order intake grew 10% in the fourth quarter driven by strong growth in magnetic resonance imaging, image-guided therapy and enterprise informatics. In the full year Diagnosis & Treatment order intake grew 16% due to strong demand across the world and the strength of our innovation. Short term orders momentum in China was affected by the additional procedures related to imported healthcare products which were implemented in the course of the year. We have a strong position in China including R&D centers, factories, local for local innovation and a fully Chinese management team and are further investing in local for local products and capabilities.
Connected Care order intake declined in the fourth quarter and the full year of 2021 as anticipated on the back of the spike in COVID-19 generated demand in 2020. Important to realize that activity levels remained double-digit above 2019 in these businesses and I am very pleased that we continue to see fundamental demand shift in the adoption of our patient care management solutions in both high and low activity care settings and expanding market shares.
Group comparable sales declined 10% in the quarter in addition to the high comparison base from Q4 2020 and the anticipated headwinds in our Sleep business. We also faced stronger than anticipated supply chain disruptions at the end of the quarter as Frans mentioned. The impact is particularly strong on the high volume businesses like patient monitoring, oral healthcare and ultrasound, but also relevant in modalities such as image-guided therapy and magnetic resonance imaging.
Adjusted EBITA in the quarter was €647 million or 13.1% of sales impacted primarily by the lower sales. Adjusted EBITA was also impacted by higher supply cost, including extraordinary high pricing on spot buys and then unexpected push out of an IP bill partly offset by the productivity measures.
Full year comparable sales declined 1% for the Group with strong growth in the first half of the year offset by the impact of headwinds in the second half. Excluding the Sleep & Respiratory Care business, full year comparable sales grew over 5%.
Diagnosis & Treatment comparable sales were in line with 2020 in the fourth quarter impacted by supply chain headwinds mentioned before and some postponement of equipment installations in hospitals in December. The volume of elective procedures tracked above pre-COVID levels during the year with some slowdown seen towards the end of December due to the impact of the omicron variants in various parts of the world.
We continue to expect hospitals to normalize their operations and work through the backlog of patients in the coming quarters, although COVID remains a risk of course. We adjusted margin decrease to 13% in the quarter in Diagnosis & Treatment mainly due to the lower sales. For the full year however, the Diagnosis & Treatment businesses recorded 8% comparable sales growth and an adjusted EBITA margin of 12.4%. This compares to an adjusted EBITA margin of 10% in 2020.
Comparable sales for the Connected Care business declined 32% in the fourth quarter driven mainly by a substantial decline in the Sleep & Respiratory Care business on the back of a very strong last year as well as the impact of the recall. The adjusted EBITA margin amounted to 11.7% in the quarter. For the full year, the Connected Care businesses recorded 23% comparable sales decline and an adjusted EBITA margin of 10.6%.
Personal Health comparable sales declined 3% in the fourth quarter driven by supply chain shortages while the underlying consumer demand for our strong portfolio remained solid. The adjusted EBITA margin increased to 21.6% in the quarter, mainly driven by productivity measures. For the full year, the Personal Health businesses delivered a 9% comparable sales growth and an increased adjusted EBITA margin of 17.6%. This compares to an adjusted EBITA margin of 13.4% in 2020.
We continue to focus on driving productivity initiatives that delivered gross savings of €91 million in the fourth quarter and around €400 million in the full year 2021. After deducting the impact of cost increases related to rate cost and spot purchases, net savings amounted to €19 million in the fourth quarter and €279 million in the full year. Adjusting items were €417 million in the fourth quarter. This included the provision related to the recall and the provision for other quality actions which we mentioned earlier. Adjusting items also included an increase of the provision for the onerous ventilator contract from 2020 and a legal provision which are not related to the recall.
Income tax expense was a gain in the quarter mainly due to the positive impact from tax benefits relating to business transfers. Free cash flow was an inflow of €519 million in the quarter resulting in a €900 million inflow in the full year 2021. This is lower than our initial expectation of around €1.4 billion inflow early in the year due to the lower income and the cash out related to the Respironics field action.
Let me provide some additional guidance for certain areas of our business. In the segment other, we expect an adjusted EBITA loss of around €100 million in 2020 and the improvement of €500 million versus 2021, mainly due to higher license income. At the EBITA level we expect a net cost of around €160 million for the full year 2022 compared to almost €240 million for 2021. For Q1 we expect a net cost of around €50 million at the adjusted EBITA level, broadly in line with the first quarter of 2021 and around €75 million at the EBITA level.
Restructuring charges are expected to be around 80 basis points and acquisition related costs to be around 80 basis points in 2020. We expect running costs related to the Respironics recall such as testing, external advisory and others as well as costs related to the commitments made as part of our response to Form 483 from the FDA and broader quality improvements in Connected Care to be around €40 million per quarter. Financial income and expenses are expected to be a net cost of around €160 million in 2022, excluding incidentals, if any.
Free cash flow is expected to be around €700 million in 2022. This is lower than the 2021 free cash flow as higher income will be more than offset by approximately €400 million cash costs related to the field action provision taken in 2021. Our capital allocation in the fourth quarter of 2021, we completed the €1.5 billion program which was initiated in the first quarter of 2019. Under the €1.5 billion program announced in July 2021, we acquired a total of approximately 22 million shares in the fourth quarter of 2021 and in January 2022 through open market purchases.
In previous quarters we had already entered into a number of forward transactions related to this program with the settlement dates in 2022, 2023 and 2024. In December 2021we completed the cancellation of 33.5 million shares that were acquired under both the repurchase programs resulting in a reduction of almost 4% of the outstanding shares. More details on the share buyback programs are available on our Investor Relations website. We will submit a proposal for dividend of €0.85 per share against the net income of 2021, in cash or shares at the option of the shareholder. This is within the targeted pay-out ratio of 40% to 50% of continuing net income.
To conclude, I would like to take you through how we expect the year to progress in more detail. As Frans mentioned, our order book is strong, but we do expect to continue to see headwinds related to COVID and supply chain shortages in 2022, especially in the first half of the year despite our mitigating actions. This caused significant volatility in the sales realization during the year. Excluding the Sleep & Respiratory Care business, we expect low single digit sales decline in Q1 and the first half of the year, on the back of 14% growth in the first half of 2021.
We expect to experience a strong recovery in the second half of the year as we manage through the headwinds and on the back of weaker comps. Excluding the Sleep & Respiratory Care business, we target to deliver 5% to 6% comparable sales growth for the full year. For the total Group this means a high single digit decline in Q1 and a mid-single digit decline in the first half of the year on the back of 9% growth in the first half of 2021. For the full year, we target to deliver 3% to 5% comparable sales growth for the Group and 40 to 90 basis points adjusted EBITA margin improvement.
Let me sum up by saying that 2021 was a mixed year for Philips. While we were impacted by the Respironics recall, as well as supply chain headwinds, a strong start in the first half of the year meant that excluding the Sleep & Respiratory Care business, our sales grew 5% in the year and the corresponding adjusted EBITA margin increased by 230 basis points and we ended the year with our highest order book. Our focus going forward will be to complete the repair and replace program for the recall as fast as possible and mitigate supply chain headwinds so that we can get back to our strategic improvements.
With that, Frans and I will take questions. Thank you.
Thank you, Sir. [Operator Instructions] We will now take our first question from Veronika Dubajova from Goldman Sachs. Please go ahead.
Yes, hi guys. Good morning and thank you for taking my questions. I would love to understand sort of the thoughts you have on the supply chain, and I know it’s a very broad-based question, and I appreciate, there’s lots of moving parts there, but maybe you can give us a little bit of flavour for how much visibility you feel you have at this point in time? And just looking at your guidance, versus the sort of almost a €0.5 billion headwind that you had experienced in the fourth quarter, it would be great to understand exactly what you have embedded in terms of supply chains headwinds and how much wiggle room you have as we progress through the first and the second quarter to the extent that things don’t turn out the way that you’re anticipating to compensate for that? I’ll leave it there and I’ll have a follow up after that, but if we can start that. Thanks.
Frans van Houten
Sure. Hi Veronika. Yes, I’d love to go a bit deeper there because I understand this is on everybody’s mind. If we look back at Q4, the supply chain headwind that I flagged in October basically became a bit like twice as much, all right? And then on top we had customer push outs because also customer struggled with site readiness and some of their own supplies to make rooms ready. A significant part of that, let’s say missed sales in Q4 moves into this year, but some of Q1 moves into Q2. So we see moving — a lot of moving parts.
To work this through, we have had our teams make multiple scenarios to understand the variability of, let’s say, the quarter-on-quarter results of sales and results. We have taken the more conservative view on Q1 and Q2, because we want to be cautious, and we do see a lot of uncertainty in the near term. We have of course worked with all our suppliers. We have long-term orders in place. We have increased visibility to Tier 2, 3 and 4 suppliers. We have been working on mitigations, such as qualifying other suppliers. Still, we are from time to time confronted with suppliers who de-commit and or postpone deliveries, similarly with port congestions, and supply chains. And a typical example is how batteries were stuck on a boat on the West Coast of the United States, basically delayed by five weeks or so holding up our ultrasound production, and not being able to get that to our customers.
So we have a lot of people are working these issues. We feel that we are getting a better handle on it. But and I know that many of you said why does Philips seem to be affected so much? Well, we all remain to be seen about others, but I want to bring you back to the beginning of 2021, where we were growing at a much higher pace than the year before, which started to deplete any safety stock that we had. And then with the strong orders and our eagerness to compensate for the sleep recall, missed sales, it all became very tight in the second half here with what you could call really hand to mouth or just in time deliveries.
To restore buffer in that inventory or in that supply chain is not so easy, it takes a bit of time. As I said, we look to take a cautious approach to 2022. We have provided from Page 21, a table with our sales guidance by quarter and for the first half of the year to give you more insight in how we look at it and then we expect to gradually be in a better place as the year progress.
And Frans, can I just ask related to that, I mean, I appreciate everyone is facing different challenges here, but are you seeing any signs that the problems that you are having specifically are starting to impact your customer retention, the pace of orders, just broader relationships, because we are indeed hearing from some of your competitors that are not facing these issues, so I’m just curious if your customers start canceling orders and ordering their MRIs from someone else who might be able to deliver them faster?
Frans van Houten
No, I’ve not seen any indication that customers are taking this out on us. We have not lost a single order. Customers also face their own supply challenges, as I referred, for example, to site readiness. Now you may say you know what does that mean? Well, if a customer needs to place an air conditioner in a room and that’s also stuck on a boat, customers have actually more understanding for our own delays. It also means that some customers have postponed orders or installations from Q4 to Q2 and skipping Q1.
Also COVID has an influence there. But the short answer is, no I’ve not seen cancellations and also in terms of recording new orders, I have not seen issues there. I am actually aware that some competitors also tell customers long lead times for new orders to be delivered. So I don’t think we are unique in this actually, despite what you said.
Okay, that’s helpful. Thank you, guys. I’ll jump back into the queue.
We will now take our next question from Hassan Al-Wakeel from Barclays. Please go ahead.
Thank you for taking my questions. I have a couple please. So firstly, just following up on the supply chain volatility, to what extent if at all is the Respironics recall having an impact on your ability to supply and source electronic components for other parts of the business? And then secondly, on the full year guide, how do you think about the composition of growth across the segments and should we expect any growth at all in Connected Care? And is D&T and PH likely to sit in the medium term range? Thank you.
Frans van Houten
Yes, hi, Hassan. Good morning. There is no relationship between supply chain volatility and the Respironics recall. Of course, also for the recall, we need a lot of materials, to think about plastics, blower motors, but that is unique to that particular production. We have been able to increase production for the recall significantly. We are currently running at a triple rate versus last year. We have a further intent to raise that and it will follow its on course. We are working intensely with suppliers on our other businesses. Abhijit will give you a bit of color on the growth rates by reporting segment.
Yes. Hi, Hassan. For the Diagnosis & Treatment, we expect to continue, like say the strong trajectory that we’ve built over the last couple of years. So we will have a high single digit growth rate. In Personal Health will be mid single digit, and in Connected Care will be a low single digit decline, although, if you exclude Sleep & Respiratory Care, then it will be about a mid single digit growth as well.
That’s helpful. And if I can just follow up on, given the performance in 2021 and what looks to be another transitional year in 2022, could you give us your thoughts on the medium term outlook and your confidence in achieving this?
Frans van Houten
Yes, we flagged that we would like to come back on the medium term outlook over the summer and at the same time, I don’t want to live that to start living its own life. We have full belief in our growth opportunities at Philips and of course, we ended the year 2021 lower starting base, which means that the trajectory has to become steeper. We also guided you for this year and we felt that we need to get some water under the keel this year before we start making all sorts of statements, which you then will question.
So we remain committed, but in terms of underpinning and detailing out the steepness of the trajectory and all the other questions that you rightfully will have, we felt that we should have a dedicated session over the summer rather than piece-mealing it here today. So I really take courage out of the strong interest in our innovations and the order book development or the partnerships that we get, we don’t see any reluctance of customers contracting with us. So as we gain confidence in working through the issues this year, we feel that that would be a more appropriate time to have a deeper conversation about the trajectory next year.
That’s helpful. Thank you.
We will now take our next question from Kate Kalashnikova [Citigroup]. Your line is open. Please go ahead.
Hi, Frans. Hi, Abhijit. This is Kate Kalashnikova from Citi. My first question is on testing results. Could you please explain what additional tests FDA asked Philips to do in respect of particulates steps, that means it will now take longer than you initially expected to get results? And specifically, what kinds of tests are being done to assess risks of form being ingested, or implanted? For example, for VOC mission that is clear applicable ISO standard, but it’s less clear what you need to show with respect to particulates testing, if you could comment on this? And I’ve got one follow up question afterwards.
Frans van Houten
Yes. Hi Kate. You sound already pretty expert to me with regards to testing. And so indeed, let’s first dwell briefly on the VOC testing on doing series one, where we take a lot of encouragement out of the fact that these tests have come out well within the safety norms of the respective ISO standard. And therefore, for patients that continue to use the device, this is really very reassuring.
The testing related to the particulates and the fact that we take longer for that have to do with indeed, as you said, what happens when you ingest, when you ingest the particulates, and they stay in your body. And so then a different testing protocol applies. So it’s no longer just about testing the device, but it is the understanding of what the particulates does inside the body. The two relevant ISO standards that apply are 18562 and 10993. Both need to be done on a duration, right? So it’s not a momentary test, but it is a test over a period of time and that is why it takes longer.
We expect test results in the second quarter of this year. Besides particular testing, we of course, also have a few other tests that we are working on, such as the, all the tests with regards to the use of ozone. But we deem that, let’s say publication of results on ozone should only happen after the particular testing is also completed. It doesn’t make sense to take that out of sequence. We work closely with the FDA, or making sure that all the tests are done with independent test houses and external bodies to evaluate the test results. We believe that being careful here is the right thing to do, rather than to rush to an outcome.
Thank you, Frans. So in this, when do we actually expect to receive testing results, which were requested by the FDA instead of placement, silicone foam? And also to understand correct is that the test to show how ozone accelerates form degradation, and to assess the risk of VOC emission when ozone cleaners are used, will likely come after the particular testing, so after Q2 at some point.
Frans van Houten
Yes. So let’s first talk about silicone foam testing. And all our own tests on silicone foam demonstrate that silicone foam is safe. All the products that use silicone foam have passed the tests and are released for the market in line with the FDA requirements. And you’ll recall that when FDA authorized our repair and replace program with silicone, that that was in the full knowledge of that we are using silicone foam and they have authorized it.
I take the desire for additional silicone foam testing also as an indication that the whole industry needs to, let’s say, do more testing. I don’t expect anything negative to come out from it. The FDA has asked us for a comprehensive proposal on how these tests should be conducted and we are engaged with the FDA on the execution of those tests and we expect that in the second quarter the results are available. On the ozone testing, both what it does to the form and particulates, but also potentially VOCs. A battery of tests are ongoing and those are also expected to be completed in the second quarter.
Okay, thank you for clarifying. Thanks, Frans.
Frans van Houten
We’ll now take our next question from David Adlington from JPMorgan. Please go ahead.
Hey, guys. Thanks for taking my question. I just wanted to touch on the wider quality issues you’ve mentioned. I know you said you are not giving lot of commentary about 70 million provision, but maybe just should we be viewing as a one off cost, or do you expect further ongoing costs around those quality issues going forward? And secondly, should we see any risk around product recalls or sales as a result of those quality issues?
Frans van Houten
Yes. Hi, David. Good morning. The two quality issues referred to in our January 12 release relate to recently discovered product issues that need to be remediated likely through a field call order. These are relatively small businesses, and the issue is well defined, and it is a sizable amount of money, but in your terminology, we should see this as a one off amount. It’s, unfortunately not unusual to have FCOs in the medical technology field. And I have realized that the timing comes on the back of the sleep recall, I apologize for that, but these you could think are issues that were just recently discovered in two products and we are forthrightly dealing with it. We haven’t disclosed the products because we are still let’s say working with the stakeholders on the exact FCO?
Just a quick follow up Frans, when do you expect to be able to disclose what the products are?
Frans van Houten
Yes, as soon as we have agreed with the regulator on what the FCO should be like, all right, that probably will happen in Q1, but that would, is what I would expect?
That’s great. Thank you.
Frans van Houten
We will now take our next question from Lisa Clive from Bernstein. Please go ahead.
Hi, Frans. Just actually a follow up on the FDA topic, the about €90 million that you took in Q4 around quality actions, given the extensive commentary in the Form 483 are you looking into a broader sort of regulatory and compliance overhaul across Connected Care or maybe even across D&T as well? And is this something that you may think about doing over the next few years just to avoid any future issues with the FDA?
Frans van Houten
Yes, hi, Lisa. Let me first correct the number. In that release, there was 70 million on quality actions not 90. The — Philips has been on a trajectory of quality improvement, cultural improvements already for several years and I claim that broadly in Philips, we have made a ton of progress.
In Connected Care, we have taken several measures also following the discovery of the recall in March, April last year with people consequences in the Sleep & Respiratory Care business, as well as with regards to the quality and regulatory function in the Sleep business as well as in Connected Care and also for all of Philips we have already one and a half years ago replaced the overall Q&R leader, so a whole set of people measures.
We have used the occurrence of the recall to also reinforce in the whole company the importance of patient safety and quality actions. The feedback of the FDA that we need to strengthen within the Sleep & Respiratory Care business, the risk assessment and post market surveillance, we are also taking that as a moment to do a broad based look left and right and look back to say, have we missed anything so far that has not yielded a discovery that we have missed something. It is a very important topic. We are on top of it. We very much want to demonstrate to the FDA that we are always in compliance. In that respect, I can point to you that we also have many audits that we pass without issues. So it is not all doom and gloom across Philips when it comes to quality. We routinely pass inspections from the FDA and other regulatory bodies.
Thanks for your comments.
We will take our next question from Ed Ridley-Day from Redburn. Please go ahead.
Good morning. Thank you. I have a couple of follow ups, please. Abhijit, thank you for the commentary on the divisional growth outlook this year, and can you just also help us bridge the 2022 margin guidance that you’ve given? Firstly, on your assumptions around on Personal Health profitability this year, obviously, clearly, we know headwinds in the first half and if you can speak to where you would potentially see that relative to historic levels, or that will be helpful, the same for the D&T? And also, just in terms of the wider assumptions you are making on supply cost inflation and where are you assuming sort of normalization of that inflation? Are you assuming that in the second half that we should have seen inflation stabilize or do you assume inflation the challenges for the full year?
Yes, so, let me start with Personal Health profitability. You saw during the course of the year we continually stepped up profitability. We will see price increases in Personal Health already from January. So we are putting in place measures to compensate for the increase in input cost. So, overall, you will see Personal Health profitability go up in the year. I think similar for Diagnosis & Treatment, you will see an increase in profitability because they say that the operating leverage that we will get from the high single digit growth that I mentioned will give us an impact.
We are also putting in price increases, but of course, the impact of that in the health systems businesses is limited, because we have a big order book, which has come at earlier prices and so therefore, the new orders only will come at better prices. I think supply chain cost, but whether it is component pricing, but also in terms of higher cost of people, staff cost, et cetera, that is something that will happen through the years. So normalization, I think before 2023 is not likely to happen and therefore we have put in the price — pricing measures that we think we need to drive the margin expansion we’ve talked about.
Now we’ve given a bit of a broader range and that depends about of course on how much growth we are able to ultimately get. As Frans mentioned, the group — the challenge around growth is not related to the orders because we have them, it’s about the supply chain. And once we are able to make it, yes then we will get there and this is — this is all part of the guided range in sales, including the quality issue that David just mentioned.
Thank you, Abhijit, that’s helpful. And can you gives any color on the price increases you’ve been able to push through in Personal Health?
Yes, I think it’s different per category, but it’s — there are two rounds of pricing increases, one in January and one from April. So it’s about a mid single digit kind of price increase mid single digit percentage.
That’s helpful. Thank you.
We will take our next question from Julien Dormois from BNP Paribas. Please go ahead.
Hi, good morning Frans. Good morning Abhijit. Thanks for taking my question. The first one relates to Respironics and would be just curious to get your thoughts on the pace of recovery of the business from Q4 onwards. And particularly, if you would already feel comfortable giving your thoughts on how long it could take to return to the run rate of €150 million per quarter whether that is a multi quarter process or whether it is a multiyear process in your mind?
And maybe Just a quick follow up on that one. I’m sorry if I missed that, but could you just provide an update on the legal action, maybe in terms of number of cases and number of plaintiffs if you have it? And then second question is some sort of a housekeeping one, but I was just curious to understand why in D&T you were able to deliver double digit growth in IGTs despite the supply chain issues, is it because the underlying trend for IGT was much stronger in Q4, and you got impacted by supply chain, but it was still growth, or is there anything else at play here?
Frans van Houten
Hi, Julien, Frans here. We are very intent on getting the Sleep business back in play and we are expecting to be able to allocate some production capacity to that in the fourth quarter. Of course, then we have to rebuild pipeline inventory with the DMEs et cetera, but we are — we have a team working on the recovery of the business as we speak. When I refer to a session, perhaps over the summer, I can imagine that we would also dare talk about how we look at Sleep business from 2023 onwards. Today, I find that too early, nevertheless I don’t want to leave you hanging there.
I think the recovery of our strong market share is likely to take a few years. However, there’s a strong pent-up demand in the market for sleep devices and so we should get a kind of out of the gate boost to the revenue once we are back in the market. But at the same time, it’s not realistic that our 50% market share in sleep apnea systems will just fall into our laps in the first months. So it will take a bit of time and I hope to give a lot more color on that when the kind of speaks and over the summer as I refer to that session.
Now on your question of legal action, we have about 100 class actions, about 120 personal injury suits. And then otherwise, this is in the United States and then outside of the U.S. not many, one or two or let’s say in Australia, Canada, similar nature as in the U.S. and then we have the SEC claim as well from shareholder suit. So that is the situation is really very early to classify this. And as you know we are very, very determined to provide, let’s say, the data, such as with the VOC testing, to start scoping what is now the real risk. And therefore, there’s no point in getting ahead of ourselves before we have kind of put all that evidence in place. It’s my estimation that the earliest that we are able to scope litigation is going to be somewhere in 2023.
Now then, on your last question, our Image-Guided therapy business is really on a tear. We see strong demand, a lot of interest. We see hospitals wanting to buy more ambulatory surgical centers and expand capacity for elective procedures. We see that minimally invasive therapy is being expanded beyond cardiovascular into neuro, stroke, spine, into minimally invasive oncology and so broader and broader application, more therapeutic areas and Philips is just very well positioned in all of this. Also our portfolio of devices very much reinforces our strengths in this business. We do have significant supply chain issues also in IGT, but the order book is growing very, very nicely.
Okay, that’s very helpful. Thank you, Frans.
We will now take our next question from Delphine Le Louet from Societe Generale. Please go ahead.
Delphine Le Louet
Yes, hello, hi. Good morning, everybody. I was wondering can you, Abhijit can you give us more precision regarding your inflation targets within your guidance and can you size that on a divisional basis? That would be the first question. And Frans please, you’ve certainly been very active in reorganizing part of the organization regarding post marketing quality, but how far do you think you are in this journey? Do you think you have the appropriate setup right now or is there still internally some more additional restructuring to be made?
And finally, can you give us more precision regarding the Respironics business, distribution, way of doing it, meaning the normal term sheets in term of a contract? And when you’re talking about multiyear recovery of the market share, do we have to think of a two-three years timeframe or more five to seven years according to your current contract you have with your distributor? Thank you very much.
Frans van Houten
Well, are you ready for your — question?
Yes, on the inflation, I think we will probably have more than 1.5% on top of what we normally have. So, we typically guide to about 1.1% inflation and probably be more in the 2.5% range for next year. And then, yes we will do like I said, there are cost increases to compensate for that. So, per business there is not really a huge shift from one to the other.
Frans van Houten
Then Delphine the question on quality journey, I feel that we have taken the right measures on the organization structure, all right? So, this is not a matter of reorganizing. We have also stepped up quality of people. We have been able to attract quite some new talent, who can look with fresh eyes and we have been upgrading processes and systems so that we have also the ability to do AI enabled review of Post-Market Surveillance data. And also there have an opportunity to have multiple sets of eyes look at the data rather than only the business unit.
As part of the program to raise patient safety and quality, we have taken a commitment to relook all our past severe incidents and or S3 and S4 rated incidents, to say, what can you learn from it? Have we missed anything? We are already kind of halfway through that look back. And as I inferred on an earlier question, we have not found anything significant that we missed. Nevertheless, I want to see that through completion, also as a learning exercise for the whole company to say, I want diligence in that process. Probably in the next two or three months, we will complete that look back and then undoubtedly we will have your question again to say, what have we learned from that. So we are using the incident also very much to reinforce the importance of diligence in all these processes that you cannot skip a beat and you can never look away. But so far, we have not discovered another big issue.
Then on your third question, on the recovery of the Sleep business, look I just wanted to be realistic when I said it will take time for the market share to recover. I do know from discussions with both the physicians as well as with the DMEs, is that they all want us to be back. They want our brand in their lineup. The doctors appreciate the device and the informatics capabilities to analyze the disease progression and the patient experience and the DMEs don’t want to be dependent on one big player only.
So all those signs are positive and the product is competitive. So we are going to make a compelling case to recoup our market share. At the same time I won’t — not to get ahead of our skis and claim victory while we still have to get started. By the way as a data point, the mask business is continuing as we speak, and we actually have some good traction with that, even to the extent that the originally guided sales gap has been become a little bit smaller because of ongoing ability to sell masks and accessories.
Delphine Le Louet
Okay. Thank you very much.
We will now take our next question from Sezgi Oezener from HSBC. Please go ahead.
Hi, thanks very much for my question and thanks for the presentation. I think the Slide 21 was very helpful in terms of seeing the sales growth progression for 2022. Would you be able to provide a similar progression for your EBITA, adjusted EBITA guidance, expansion of 40 to 90 basis points in terms of how that will be divided over the quarters, as well as how that will be, how you expect that to break down over the different segments? And my second question would be about like the recall issue, you changed the mix from 70% to 30%, to 50/50 between repair and mix, repair and replace, maybe you could give some idea about like what changed there?
Frans van Houten
Yes, maybe I’ll start with the repair and replace, and then pass it to Abhijit on the margin developments. Initially, we were unsure about how many products we would get back from patients and in what state they are, and whether they are repairable in the first place. In the meantime, we have a sizeable quantity back and evaluated by our factory and we know that we can repair a significant volume that comes back. Still, there is a time — also a time lag between what you get back and how you can deal with it. So in the early days, the replace ratio was much higher as a consequence of the two factors, you know.
Now, as we gain experience, we feel now more comfortable, confident that we can achieve the 50/50 ratio. And if you would plot that out between last summer and let’s say towards the next, this summer, that you will see, of course, the repair ratio go up constantly, because we get more and more volumes back. And the logistics of filling the pipeline have then been covered, therefore the need for replace only, which happened in the beginning will become smaller.
So that’s basically, what has happened. And also maybe I should add, that initially, we only had authorization from the FDA for replace and that was the August, September message and repair protocols were in fact only approved in what was it? October, if I recall off the top of my head. Abhijit maybe I think we are not able to give a lot of guidance on the EBITA development by segment.
I think Sezgi, given the volatility that there is and then the uncertainties, I think now giving per segment, per quarter is only going to make it more complex. So I think, we have guided to lower growth in the first half that has a big impact, of course, on the profitability. So using that I think you should be able to model it.
Okay, thanks, very helpful. And just as a follow up, is there a cost difference between replace and repair nowadays? Like has it changed or like is — that is there a difference in terms of the costs you are projecting that might lead to the eventual there?
Frans van Houten
Yes, I mean, obviously, there is some cost difference between repair and replace, even intuitively, I think everybody would realize that. Nevertheless, the logistical processes on repair are much more substantial than on replace, because you have a return pass. You need to clean the device, you need to inspect it. By the way we also need to photograph all the units that come back and so the cost difference is therefore not that huge. But still, of course repair is more favorable to us than replace. All of this is included in the provision. Yes, let’s leave it at that.
Okay, very helpful. Thanks a lot.
Frans van Houten
We will now take our next question from James Vane-Tempest from Jefferies. Please go ahead.
Hi, good morning. Thanks for taking my questions. I’ll start with the first one and then I’ll pause for a follow up. And just on the 17 million for quality related items and you mentioned this relates to two recently discovered product issues. Just wondering if you can confirm these are from the same facility you received the 43 and what risk you see a further product recalls and if your revenue guidance includes any potential for sales absorption there? Thank you, and then I’ll come for a follow up.
Frans van Houten
These two products are out of different facilities than the one that is, let’s say, we’ve got to 483 on from the FDA. It’s likely that the two product issues will come with an FCO field call order and that there will be some sales impact on those product lines. We have said in the introductory comments that these are smaller product lines and therefore we don’t expect a major impact and on an earlier question, I said the provision was a one off.
Thank you, that’s helpful. And then just on your overall Group guidance, and the mid single digit decline in first half, and high single digit growth in the second half. And we’ve heard some other companies give out some over cautious tone in the second half, so I’m just kind of curious what you’re seeing at this stage to give you more confidence? And just related to that, if you can help us bridge the first half to second half of the full year, because if I look at first half and get that a mid single digit decline at the low end and high single digit in the second half, I get to around 3%, which is at the lower end of your 3% to 5% guidance. So I’m just wondering what else we need to see to get to 5%? Thank you.
Yes, let me take the second question first. So look, if you, we have not given a guidance range. So if you take of course the low end in the first half, and the high end in the second half, you’ll get, and then you would get roughly to the lower end of our guidance. If we do better in the first half and better in the second half, you will get to a higher range of the guidance. I think the important thing about the growth in the second half is, you need to look at the comps. Right? So if you look at 2021, we grew by 8.8% in the first half and we declined by 8.8% in the second half and now because of the higher weightage of the second half overall we declined 1.2%. So if you take the similar weightage for this year on the basis of the high or top end of the high single digit range, you will come roughly to the area that we guided for.
Frans van Houten
But we thought for that reason the table on page 21 will be helpful.
We will now take our next question from Max Yates from Credit Suisse. Please go ahead.
Thank you. I just had a quick question on the portfolio and obviously you completed the domestic appliances disposal, but I was wondering whether you had any sort of further thoughts on portfolio and thinking about sort of where we are today, whether there were some further opportunities that that you may consider in 2022? That was my first.
Frans van Houten
Yes, hi Max. We are happy with the portfolio as we have it and there are no further plans to make divestitures at this time.
Okay. And just quickly on the buyback, obviously you’ve completed that sort of quite a bit more quickly than expected. I mean, clearly, it probably relates to sort of the opportune moments in the share price. But when you think about sort of updating the market in the summer or how sort of capital returns may go from here, is this something you’re continuing or you’re thinking of doing more of when you update us in the summer or just wondering about how you think about plans going forward given the speed of completion of the last plan?
Frans van Houten
Yes, we added the buyback last summer also recognizing the low share price and let’s say looking at the priorities for the company also vis-a-vis M&A. And so continuously we make the evaluation about capital allocation was in the policy that is also in the slide deck, that we will continue to do. We accelerated the buyback again given where the market was taking a responsible view. At this time, there’s nothing else to announce other than that we continually review on how we can enact the policy.
Yes and delivery of the forward transactions will continue to happen in 2022, 2023 and 2024. So it’s not that we paid for everything and it’s all in.
Understood, just the final quick question I had was on backlog margins and I just wanted to understand kind of exactly how the sort of mechanism actually worked between taking an order and to diagnosis and treatment, maybe delivering it six months later. Do you sort of then go out and acquire the materials required? Is there any sort of hedging? And just whether we could see margins in that division under pressure in the short term as you maybe deliver on orders that were taken sort of mid last year or later last year and we’re sort of are reflecting the current cost environment?
Frans van Houten
Yes, maybe it’s helpful to think of the portfolio as in three buckets, right? First, you have Personal Health business, which relatively fast cycle business and Abhijit already mentioned that we have increased prices as of January and therefore, we can cope with the higher input cost and still expand margins. Then the second bucket is basically our recurring revenue on service, which is sizeable bucket and where we also have, in many cases, indexation clauses on cost, right? So we have some protection on higher input costs in the service arena.
And then the third bucket is of course, where you refer to which is the Health Systems equipment business. Abhijit mentioned that, of course, those orders that came in last year were against prices of last year. Now, you can look at the WIP inventory, and you’ll see that quite some inventory is already in the — in stock. Right? So, because typically, the process of starting to build and then ship and then staging for an installation can take several months with a make to order program, where a lot of things have to come together. And some of the postponed deliveries or installations of course, have their inventory already allocated, so that gives some protection to higher input cost on the order book, but part of the order book of course, is exposed. And then Abhijit do you wanted still to mention something about the flow business?
So the flow businesses like ultrasound, the biotech business, as well as monitoring where you have a large amount of book and bill in the year, those we of course have better options to move pricing along.
Frans van Houten
That follows more in the same category as Personal Health.
Frans van Houten
Okay, understood. Thank you.
Frans van Houten
We will now take our next question from Wim Gille from ABN ODDO. Please go ahead.
Yes, very good morning, gentlemen. My question will be that, if I look at the guidance for 2022 with 3% to 5% comparable sales growth and a margin at least between 40 and 90 basis points that is quite well within kind of the medium term guidance. And then the second comment that you guys made already on 12 January is that the sales that we missed about 350 million about 85% of that was related to systems and 15% to Personal Health. And back then you said it remains to be seen, but added to the Personal Health miss is this is a fungible business, so they will likely not come back. Whereas you guys more or less said, the other 85% is more related to, that’s a shifting in time have orders moving from one quarter to the other rather than actual, let’s say cancellation of orders.
So how should I combine these two statements? Is it that you are guiding conservatively for 2022? And if all the orders that you missed in the fourth quarter indeed shifts to the coming year, that there’s actually upsides to let’s say your guidance for 2022 or are we more likely to basically see the missed sales that we have in the fourth quarter as just lost in the guidance? Thank you.
Frans van Houten
Yes, it’s quite a perceptive question Wim and because if everything goes right, you know, we could look at quite an attractive sales growth this year. But we said also in the opening comments that we need to be a bit cautious and therefore the range of 3% to 5% is how we want to talk about it. The order book gives a lot of credibility to a strong year. But yes, if we can’t get the supplies, then the sales realization wouldn’t happen. All right? So, hence the 3% to 5%. Anything to add Abhijit?
No, so I think it’s good to reiterate that we are not saying that any of the 350 million in the health systems businesses are lost sales. They will flow into this year, but in our guidance, there is some that will flow from this year to the next year because we don’t expect all the supply chain issues to be fully remediated or to be fully dealt with this year. So that’s the — that’s why I think that’s how to explain it.
So basically to summarize, the guidance that you gave is also taking a bit of a caution as in to count with respect to then of sales that might slip over to the next year? And if there indeed happens, then, let’s say for 2023, we’ll likely see a year where it is possible to outgrow the next term guidance that you’ve given?
Frans van Houten
But technically, yes some orders can shift into 2023. In the earlier discussion, I already said, growth wise we feel quite comfortable with the originally guided range, to now start speculating how far above we are going to be I think then that’s more of a discussion that we wanted to have in the summer to speak about how to get back to the ambition statements as fast as possible. And I don’t think it’s very useful to do that today.
Thank you very much.
Frans van Houten
Due to the time, we will now take our last follow up question from Veronika Dubajova [Goldman Sachs]. Please go ahead.
Thank you guys for squeezing me in at the end and just a point of clarification, Frans because I think maybe there’s a little bit of misunderstanding of what you’re saying about the midterm guidance or it certainly I am unclear. So I want to understand the update you will give us in the summer, is the intention of that to give us a new midterm guidance and are you therefore implicitly stepping back from what you told us last year or does the midterm guidance still hold in your mind and it’s about the past with which you get there, just if you can clarify that?
Frans van Houten
It’s the latter, Veronika, but I also realized that in terms of credibility with you and others, we need to get some water under the keel and make some progress to give credibility to that pass to the targets. And so we are not walking away from any ambition and commitment, but we need to detail out how we get there and a lot depends on how we perform this year. Right? And therefore, let’s focus on performance this year, which we are intensely focused on and make some progress on that and then talk about it with much more credibility than I, let’s say can do today. At least that’s how I feel about it. I need — we need to deliver in the coming months and quarters. All right? And get over this, let’s say the supply chain challenges and the recall and then we can have the conversation about next year.
Frans van Houten
But by no means is this signaling that we want to walk away from anything. That’s not how it is intended at all.
That’s very clear. Thanks, guys.
Frans van Houten
All right. Well, then thank you for book ending this conversation Veronika. I really appreciate that. We didn’t want to leave that hanging. And I think everybody for your engagement with Philips and all your questions. So with that, I think we can close the conference.
This concludes the Royal Philips fourth quarter and full-year 2021 results conference call on Monday January the 24th, 2022. Thank you for participating. You may now disconnect.