Koninklijke Philips N.V. (NYSE:PHG) Q1 2020 Results Conference Call April 20, 2020 4:00 AM ET
Leandro Mazzoni – Head of Investor Relations
Frans van Houten – Chief Executive Officer
Abhijit Bhattacharya – Chief Financial Officer
Conference Call Participants
Michael Jungling – Morgan Stanley
Veronika Dubajova – Goldman Sachs
Patrick Wood – Bank of America
Hassan Al-Wakeel – Barclays
Ed Ridley-Day – Redburn
Scott Bardo – Berenberg
Max Yates – Crédit Suisse
Kate Kalashnikova – Citi
Lisa Clive – Bernstein
Dan Wendorff – Commerzbank
Julien Dormois – Exane BNB Paribas
Sebastian Walker – UBS
Falko Friedrichs – Deutsche Bank
Good morning, ladies and gentlemen. Welcome to Philips first quarter results conference call. I am here with our CEO, Frans van Houten; and our CFO, Abhijit Bhattacharya.
On today’s call, Frans will take you through our strategic and financial highlights for the period. Abhijit will then provide more detail on the financial performance. After that, we’ll take your questions.
Our press release and the related information and slide deck were published at 7 a.m. CET this morning. Both documents are available on our Investor Relations website. A full transcript of this conference call will be made available by end of 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 other significant items. For avoidance of doubt, the impact of COVID-19 on our results is not treated as an adjusting item. Finally, comparable growth for sales and orders are adjusted for currency and portfolio changes.
With that, I would like to hand over to Frans.
Frans van Houten
Thanks, Leandro, and good morning to all of you on the call and the webcast. I hope that you and your families are keeping safe and well during these extraordinary times.
With the COVID-19 outbreak, our mission to improve lives is more relevant than ever. I take great strengths in the work we are doing to support health care providers, medical staff and a growing number of critically ill patients, which is a top priority for all of us at Philips, and I’d like to update you on how we are responding to the constantly evolving situation and delivering against our triple duty of care: meeting critical customer needs, ensuring the health and safety of our employees and ensuring business continuity.
We have mobilized our resources since January to address this unprecedented challenge. In line with our business continuity system, we have implemented the relevant safety protocols and we have been able to continue our operations around the world. Our workforce is getting used to new ways of working and our commercial processes are working well as reflected in the robust order intake result in the quarter. Our service teams are following stringent safety protocols and continued to deliver and install critical equipment and provide maintenance services.
Our global supply chain is fully functional with sites in the Americas, Europe and Asia, including several in China where we are back at normal capacity utilization rates. We are making the necessary investments and closely collaborating with our suppliers and partners to steeply increase production where there is increased demand, especially ventilators and monitors. We have also created COVID-19 crisis-oriented solutions propositions to rapidly respond to customer needs.
On employee health and safety, we have implemented personal hygiene measures and safety protocols throughout the organization. Moreover, we have a global working-from-home protocol for employees whose roles can be carried out remotely. This also helps maintain a safe working environment for activities that need to be performed at Philips locations such as production, supply chain and certain R&D activities.
I’d like to point out that the Philips Foundation continues to play a terrific role in providing COVID-19 medical aid and relief, helping to boost humanitarian efforts and protect the vulnerable. The Philips Foundation is actively driving an impressive range of multidisciplinary projects to 8 regions across the world that need it most working with several partners.
Let me now move on to the first quarter financial highlights. COVID-19 has significantly impacted our results in the quarter. Demand for our professional health care products and solutions increased strongly with comparable sales and order intake growth for the Connected Care and Diagnosis & Treatment businesses.
At the same time, there was a significant decline in demand for our Personal Health portfolio and we saw Image-Guided Therapy procedures trending down as the quarter progressed. This resulted in a comparable sales decline of 2% for the group in the quarter.
Adjusted EBITA margin was 5.9% of sales compared to 8.8% in the first quarter of 2019. Free cash improved to an outflow of €57 million in the quarter compared to an outflow of €206 million in the first quarter of 2019. Comparable equipment order intake grew a robust 23% in the first quarter driven by the strong demand for patient monitors, hospital ventilators and diagnostic imaging.
I would like to provide some color on some of our initiatives to respond to customer needs and support health care professionals. Earlier this month, we announced a contract with the United States government to supply 43,000 acute care hospital ventilators for invasive and noninvasive use. This builds on the initial demand in the first quarter, which already enabled additional supply to hospitals in the most affected regions in China, Southern Europe and in the United States. Together with Flex — partners, Flextronics and Jabil, we are working on a fourfold in production increase by the third quarter.
To further address the strong global demand in hospital ventilation, we are rolling out our new Philips Respironics E30 ventilator, a versatile and easy-to-use ventilator for emergency use where there is limited access to a fully featured critical care ventilator. The E30 has been designed for large-scale production and will scale to 15,000 units per week in April. With the strong demand to expand ICU bed capacity, we are also working to significantly increase the production volume of patient monitors.
Related to the COVID-19 diagnosis, we see increased demand for X-ray, CT scanners, point-of-care ultrasound, clinical informatics and interoperability applications. We see increased interest in telehealth solutions like eICU, teleradiology, telepathology, which can help remote working of care professionals as well as move care into the community to relieve the tremendous pressure on the physical constraints of the hospitals.
Building on this theme, to support care providers and protect scarce critical care capacity, we have launched a COVID-19 screening and dedicated scalable telehealth solution that facilitates the use of online patient screening and monitoring supported by external call centers. The solution aims to prevent unnecessary visits to general practitioners and hospitals by remotely monitoring the vast majority of COVID-19 patients that are quarantined at home. Patients infected can be remotely monitored via smart questionnaires about their situation and state of health, identifying if intervention is needed. This solution is already being used by hospitals and general practitioners in The Netherlands and will be rolled out to other countries.
Our eICU solution is also a key enabler for more COVID-19 patients to receive care. With this solution, a co-located team of intensivists and critical care nurses can remotely monitor patients in the ICU regardless of location, supported by high-definition cameras, telemetry, predictive analytics, data visualization and advanced reporting capabilities. Algorithms alert to the signs of patient deterioration or improvement, helping care teams to proactively intervene at an earlier stage or to decide which patients have stabilized and can be transferred, allowing scarce ICU beds to be allocated to more acute patients.
We are currently helping several hospitals to expand their eICU capacity or reach into other settings. Overall, I observed that our strategy to transform care along the continuum leveraging informatics is already validated during this crisis and we expect postcrisis a further step-up of Connected Care in the broadest sense.
We continue to drive market share in our core businesses through deeper, more comprehensive customer partnerships. During the first quarter, we signed several new agreements. For example, we entered into an 8-year partnership with Paracelsus Clinics in Germany offering solutions that maximize availability of imaging systems, leveraging digitalization and process optimization to realize quality and efficiency improvements.
As you are aware, there has been a significant decline in consumer activity, as a result of which, our Personal Health business has been impacted. We currently expect that our Personal Health businesses will be steeply impacted across all geographies in the second quarter despite witnessing the first signs of gradual improvement in China more recently. We have a strong grip on performance management and are taking actions to manage inventory and manufacturing capacity accordingly.
We are also driving reduction of discretionary spending due to phasing. The effect of these actions will kick in, in the second quarter. We are safeguarding innovation and keeping NPIs, new product introductions, on track to be fully prepared to capitalize on the recovery opportunities. While reducing advertising and promotion spend, we continue to accelerate digital channels with a focus on adaptive digital marketing to grow engagement as consumers get more health-conscious than ever. We have endured consumer demand crisis before, though of a different nature and scale, and I am confident that we will come out of this stronger.
Let me now give you an update on the current situation of the divestment of the Domestic Appliances business. As mentioned before, the business has solid financial performance and market positions. We are still in the early stages of the carve-out process and on track to complete it within the indicated 12 to 18 months. The preparations with regards to the deal itself are also in their early stages. We expect to start engaging with interested parties only after the summer and make a call on timing of the divestment based on value as well as the liquidity situation of the potential buyers.
A progress update then on regulatory matters, we continued to address the follow-up request of the U.S. Food and Drug Administration as part of the efforts to fulfill our obligations under the consent decree. We remain in dialogue with the FDA. However, given the nature of the process, we still cannot provide a definitive time line for the expected lifting of the injunction. We are also making good progress with EU MDR certification. Also important, while we have a strong balance sheet and robust liquidity position, in view of the possible continued impact of COVID-19, we have taken measures to further protect the liquidity position of the Company, which will be detailed out by Abhijit in a moment.
As part of those initiatives, we announced this morning that we maintain the proposed dividend of €0.85 per common share against the net income of 2019. The distribution of this dividend will be in shares instead — in shares only instead of the currently proposed distribution in cash or in shares at the option of the shareholder. To that effect, we will withdraw the dividend proposal that was already submitted to the annual general meeting of shareholders to be held on April 30. We plan to convene an extraordinary general meeting of shareholders in the second half of June 2020, the agenda of which will include the revised proposal to declare a distribution of €0.85 per common share in shares only.
The increase in issued share capital is to be expected to be more than offset by our share buyback program. On changes in our management team, I’m happy to inform you that Rob Cascella who most recently led our Precision Diagnosis business and was jointly responsible for the Diagnosis & Treatment segment together with Bert van Meurs will take on the role of Philips strategic business development. I want to express my gratitude for Rob’s considerable contribution to the Company since he joined us in 2015, and Rob will remain a member of the Executive Committee.
Kees Wesdorp, currently General Manager of Diagnostic Imaging, will succeed Rob in his current role as of May 1. He joins the Executive Committee with a strong record of accomplishment, having led the significant transformation in Diagnostic Imaging by increasing customer and employee engagement and reviewing the product and solutions portfolio.
Let me conclude. Looking ahead, we remain focused on innovating with purpose, driving operational excellence and delivering on our transformation. We are also managing the headwinds from COVID-19 in some of our businesses, while at the same time, capturing the upsides as we support health care providers to expand critical care capacity to fight the pandemic.
The outbreak will continue to have a negative impact on the second quarter financials. Assuming that we can convert our existing order book for the Diagnosis & Treatment and Connected Care businesses as planned, elective procedures will normalize and consumer demand will gradually improve, we aim to return to growth and improve profitability for the group in the second half of the year.
Consequently, for the full year 2020, we aim to achieve a modest comparable sales growth and adjusted EBITA margin improvement. Given the current uncertainty and volatility, we will not provide more specific guidance for 2020 at this time. While we have a great deal of hard work ahead of us, I’m satisfied with the way Philips is able to handle the crisis. I’m proud of the commitment, hard work and resourcefulness of our employees to keep the Company fully functioning and want to thank everyone who has worked so hard to mobilize our resources in this way.
And with that, ladies and gentlemen, I’ll turn the call to Abhijit.
Thank you, Frans, and thank you all for joining today. I hope you are staying safe. Let me provide some color on the first quarter comparable sales for the group. As mentioned by Frans, we saw a strong increase in demand for our Professional Health Care portfolio and a significant decline in demand for the consumer products in the quarter. The sales for the Connected Care businesses grew 7%. Sleep & Respiratory Care sales grew double digit primarily due to strong shipments of respiratory devices. Monitoring & Analytics sales grew low single digit in Q1.
Our Diagnosis & Treatment businesses delivered 2% comparable sales growth in the quarter led by a solid mid-single-digit growth in Diagnostic Imaging. Comparable sales in Image-Guided Therapy and Ultrasound declined low single digit. The decline in Image-Guided Therapy was caused by a strong decline in our devices business as hospitals postponed elective procedures as well as a pushout of installations from the first quarter. For the Ultrasound business, we were unable to install against orders in China as hospitals were battling the crisis and chose other priorities.
Comparable sales declined 13% in the Personal Health business for the quarter. Lockdown and social distancing measures impacted demand for our consumer product portfolio initially in China and Asia Pacific starting late January and subsequently in the rest of the world from March onwards. This led to high single-digit comparable sales decline in the Oral Healthcare business and a double-digit decline in Male Grooming and Domestic Appliances. Consumer sales through digital channels declined significantly less than in-store sales in impacted areas.
Comparable sales in the segment Other declined by €31 million compared to Q1 2019 due to lower license income in line with our expectation and prior guidance. Mature geography sales increased by 2% in the quarter as growth in North America and Western Europe was partly offset by a decline in other mature geographies driven by Japan. Sales in growth geographies decreased by 12% on a comparable basis due to a double-digit decline in Personal Health sales in China and certain Asia Pacific countries as a result of COVID-19.
To round off on sales, we estimate an overall negative impact of COVID-19 on group comparable sales was around 5 percentage points in the first quarter. Moving on to orders. Comparable order intake in Connected Care grew by 80% driven by strong demand for patient monitors and hospital ventilators. The agreement to deliver 43,000 ventilator units to the U.S. that we mentioned earlier in the call was signed in April and is therefore not included in the number reported in the first quarter.
Diagnosis & Treatment comparable order intake was in line with Q1 of last year. Diagnostic Imaging delivered high teens order intake growth, driven by strong demand for X-ray and CT scanners as well as the continued strong performance of our MR portfolio. Ultrasound order intake grew mid-single digit in the quarter as customers selected products they could easily place within reach of COVID-19 patients. Specifically, our handheld and portable solutions, namely, the Lumify and the CX50 are critical bedside tools for rapid assessment of patients with heart and lung distress in both the emergency department as well as the intensive care unit.
Our handheld ultrasound solution, Lumify is a valuable tool for clinicians during COVID-19 as the portability, easy disinfection and remote integrated tele-ultrasound capabilities allow for clinical collaboration within challenging conditions. Similarly, the CX50 provides the big system class performance for lung and cardiac imaging while traveling easily and safely to disaster sites and compromised patients. This was offset by a low double-digit order intake decline in Image-Guided Therapy due to delays of elective non-urgent procedures and a mid-single-digit decline in Enterprise Diagnostic Informatics.
It is important to note that we have not seen any cancellation of orders due to the COVID-19 outbreak. We also expect to have continued increasing market share in the professional health care market. On reporting matters, I would like to mention that effective Q1 2020, we have simplified our order intake policy by aligning the order book criteria for all equipment modalities to an 18-month time horizon from order to revenue.
At the same time, we have — we have also aligned our order book criteria for software contracts to the same 18-month horizon compared to the full contract value that was recognized under the previous policy. This change aims at eliminating reported order intake growth variances caused by different lengths of software contracts and better reflects near-term expected revenues from orders recognized in the reporting period.
Even though we previously used different horizons per modality, this realignment has not resulted in any material impact to comparable order intake in the first quarter of this year. Let me now turn to the profitability development in the first quarter. Adjusted EBITA for the group was €244 million, or 5.9% of sales compared to 8.8% in the first quarter of 2019. We estimate that the overall negative impact of the COVID-19 outbreak on our profit was around 3 percentage points. This was primarily due to lost margin on lower sales, factory coverage due to lower production and other direct costs.
Looking at the business segments, we are encouraged to see an adjusted EBITA margin increase of 150 basis points in Connected Care in the first quarter to 9.8% of sales as a result of growth and productivity. The Diagnosis & Treatment business delivered an adjusted EBITA margin of 6.3% of sales, up 10% compared to the first quarter of 2019. The positive impact from growth and productivity was offset by unfavorable product mix driven by lower growth of the Image-Guided Therapy and cardiac ultrasound portfolios.
In Personal Health, adjusted EBITA decreased to €81 million or 7.1% of sales due to the impact of lower sales. As mentioned by Frans, we are taking actions to manage manufacturing capacity and drive reduction of all discretionary spending. Due to phasing, the effect of these actions will start kicking in, in the second quarter and will partly offset margin headwinds from lower sales in the segment in the period.
Adjusted EBITA for the group was also impacted by a decrease of license income in the segment Other in the first quarter, in line with our prior guidance. Income tax expense decreased by €88 million in Q1, mainly due to lower income and a noncash benefit from lower tax liabilities.
Net income amounted to €39 million in the quarter, including charges of €31 million related to a value adjustment of capitalized development costs resulting from actions we have taken to address parts of the portfolio and performance in Diagnosis & Treatment. The adjusted diluted EPS from continuing operations was €0.18 in the first quarter compared to €0.29 in Q1 2019.
Net cash flow from operating activities increased by €129 million compared to the first quarter of 2019 mainly due to lower cash outflows from working capital and lower payment of taxes. Free cash flow was an outflow of €57 million compared to an outflow of €206 million in Q1 2019.
We have not seen a material impact of COVID-19 in our working capital or cash flow generation in the first quarter. We expect — while we expect to face accounts receivable delays in the near term due to the impact of COVID-19 on our customers, this is not expected to impact our total free cash flow generation over the next 12 to 18 months time horizon.
We remain well on track for our overall 2017 to 2020 productivity savings target of €1.8 billion, and our productivity program delivered €95 million net savings in the first quarter. More specifically, procurement savings, in part driven by our Design for Excellence program delivered €36 million of bill of material savings year-on-year. Net nonmanufacturing cost reduction amounted to €30 million and the manufacturing productivity program contributed €29 million in the quarter.
As mentioned by Frans, Philips has a strong balance sheet and robust liquidity position, and in the first quarter, we took action to further protect our liquidity in view of the possible continued impact of COVID-19 on markets in 2020. We successfully placed €500 million fixed Sustainability Innovation notes due in 2025 and €500 million fixed-rate notes due in 2030 both at very attractive rates.
With that, we ended the first quarter with a net debt position of a €4.7 billion or 1.4x adjusted EBITDA, well within our target range. Our debt has no financial covenants, and long-term maturity profile with an average tenor of long-term debt of more than 9 years. As of the end of the first quarter, we have completed 50.3% of our €1.5 billion share buyback program for capital reduction purposes that was announced on January 2019. This was done through repurchases by an intermediary to allow for purchases in the open market during both open and closed periods.
In March, we announced that the remainder of the program will be executed through individual forward transactions to be entered into in the course of 2020 with the majority of the settlement dates expected in the second half of 2021. The size of the share buyback program up to an amount of €1.5 billion remains unchanged. By using forward transactions, we aim to optimize the number of shares to be repurchased under the program while maintaining our current liquidity position.
With regards to dividend, as mentioned by Frans, we maintain our proposal to make a dividend distribution of €0.85 per common share against the net income for 2019. However, the proposed dividend will consist of shares only. To arrange for the changed distribution method, the dividend topic will be withdrawn from the AGM agenda, and an extraordinary general shareholder meeting will be called to approve the adjusted dividend distribution of €0.85 in shares.
Let me provide some guidance for certain areas of our business. Based on the announcements made so far, including the recent ruling on tariff relief on medical devices that can be used to treat chronic respiratory disorders, the full year gross impact of tariffs is now expected to be around €70 million, including mitigating actions. We expect the net tariff impact to be around €40 million in 2020. This is €30 million lower than the net impact seen in 2019.
In the segment Other, we expect a net cost of around €60 million at the adjusted EBITA level and around €70 million at the EBITA level for Q2. I in line with our previous guidance, restructuring charges are expected to be 90 to 100 basis points, and acquisition-related costs are expected to be around 40 basis points for 2020.
We expect onetime EU MDR investments of around €50 million in the year and consent decree-related costs to be around €10 million a quarter similar to the quarterly run rate of 2019 until any change in status with the FDA.
Taking our full COVID-19 Diagnostic and Connected Care portfolio into account, we are investing more than €100 million to meet urgent demand from our customers for ventilators, patient monitors and certain diagnostic modalities. Part of this CapEx is CapEx and part of this is additional cost. Despite this, we expect our net CapEx as a percentage of sales to remain broadly in line with last year due to expenditure decreases and reprioritization in other parts of the portfolio.
While the impact of COVID-19 gradually increased in the course of the first quarter, the outbreak is expected to cause a steep revenue decline for our Personal Health businesses and a sizable high single-digit decline of the Diagnosis & Treatment business in the second quarter partly offset by a significant increase in revenue in Connected Care. Assuming we can convert our existing order book for the Diagnosis & Treatment and Connected Care businesses as planned, elective procedures normalize and consumer demand gradually improves, we aim to return to growth and improved profitability for the group in the second half of the year.
Consequently, for the full year 2020, we aim to achieve a modest comparable sales growth and an adjusted EBITA margin improvement. Given the current uncertainty and volatility, we will not provide more specific guidance for 2020 at this time.
To conclude, I also want to thank our employees for their incredible resourcefulness to keep the Company fully functioning and especially our finance colleagues and auditors who timely closed the first quarter books while working fully remotely.
With that, we will now open the line for your questions. Thank you.
[Operator Instructions] The first question comes from Michael Jungling from Morgan Stanley. Please state your question.
I hope you can hear me.
Frans van Houten
Yes, Michael. We can hear you.
Great. Great. So I have 2 questions then. The first question is on ventilators and the second question is on telehealth.
So question number one is can you talk about how the ventilator order book sort of growth rate or order book backlog will be recognized as revenues throughout the coming quarters? And what visibility do you have that you have the parts necessary to deliver on that order backlog?
And then question number two is on telehealth. It seems that the U.S. is pushing quite hard towards telehealth. I think the CARES Act is making a push towards that as well. How big is the telehealth business for you? And how are you being impacted by the CARES Act for telehealth going forward?
Frans van Houten
This is Frans. We already saw in the first quarter significant order intake increase. We expect also in the second quarter a significant order intake. At this time, it’s difficult to forecast how much orders we would get in Q3 and Q4. The order book that we build up in Q1 and Q2 is of such a size that it will take us the whole year to deliver that. We have given some guidance as to the revenue increase that we expect in the second quarter in Connected Care, we have not made it more specific than that.
You’re right to point to parts delivery. The supply chain all has to follow what our ramp-up plan is, and that is quite hard. We have gone to Tier 2, Tier 3 suppliers in order to work with them collaboratively, to help them sometimes to reopen if they were under lockdown. We help them expedite logistically to get the components to our factories as fast as we can. I’ve been personally on the phone with many of these vendors to also get the right priorities. The Philips team, but also our contract manufacturers are doing an incredible job in ramping. So far, that’s going reasonably well, but it is certainly — as we are going to quadruple production, it’s going to be the gating item, frankly speaking, as to how fast we can turn the order book into revenue. We have taken a kind of a middle-of-the-road scenario in our forecasting to not take the best case, but also not take the worst case as you would I think reasonably able to expect.
Then on your second question, we see some vindication in our strategy. We have been investing, as you know, in telehealth, in Connected Care, in cloud technologies, sometimes to — causing you guys to ask questions, is this all deserved as an investment. We do expect now an acceleration of the deployment of cloud technologies to connect patients and caregivers. How sizable that is in terms of phasing is still to be determined.
Also, the CARES Act, while talking big numbers, we still need to see how fast it will turn from intent into revenue. But definitely, there are parts in the CARES Act that are applicable to us and that we will be engaging with the government and DoD and VA on. I think it’s a topic that we probably should come back up — on in a future quarter. It’s also good to see, by the way, that reimbursement is also going up. So there are more and more consultations and monitoring activities that are going to be rewarded. From my personal interaction with several large IDNs in the United States, I know that there is keen interest to build out command centers and telehealth programs. Let me leave it at that, Michael.
And Frans, can I just follow up, please, on the spare parts situation. So for the Q2 revenue guidance for ventilators, is it fair to assume that you’ve secured all the parts necessary for at least the second quarter for those ventilators?
Frans van Houten
Yes. Just a small correction, they are not spare parts. Of course, if they were spare, then we would have an easy time. Sorry, I was not trying to be cute on that. We are — we have not yet secured all the parts necessary to realize the full revenue of Connected Care in the second quarter. So — but we are becoming increasingly confident that our suppliers will follow. But we are not — it’s not done yet. This is a 24/7 daily battle where we get a lot of support from our suppliers, but it’s not yet in the bag.
That’s why we don’t give more specific guidance, Michael, because there’s a lot of moving parts and situation, as Frans mentioned, keeps improving. But for us to be precise at this point is not possible.
The next question comes from Veronika Dubajova from Goldman Sachs. Please state your question.
My first question is on Personal Health. It’d be great if you could comment a little bit on the growth that you’re seeing in China at the moment. So if you can share any data points for us, with us in terms of April performance.
And then I think myself as well as a lot of other folks who were a bit surprised by the magnitude of the lost EBIT in PH. So Abhijit, can you maybe give us a little bit more insight into what are some of the cost measures that you’re taking into — for the second quarter and how those will improve the margin performance.
And then if I can, just a big picture question on the guidance, please. You make a number of assumptions in the press release as to what the guidance assumes. It’d be great to get your thoughts on when do you think elective procedures normalize. I think it’s a big debate out there in the industry, and it’d be great to understand what you are assuming for that within your guidance.
Frans van Houten
Okay. PH china insights, I think, are quite interesting as they could be a proxy for the rest of the world, although there are some differences. Abhijit’s team did a very good analysis comparing the depths of the crisis in week 4 where we saw a 62% decline in consumer sellout, even more steeply so in retail brick-and-mortar stores, but also online with a significant decline. In March, that all started to recover with an online back to, net-net, growth. But off-line retail brick-and-mortar stores still about 50% down.
Of course, some of that business also shifted to online. That’s probably why online was already positive again. The totality of PH in China in week 13 was still close to 20% below last year, right? So it does also show that it takes some time to come back. In April, we see further recovery, but probably will take the whole quarter before we are back to net growth. Of course, the rest of the world is a quarter behind and we take quite a conservative view on how fast PH is back to growth. I think for the whole year, we expect quite a modest situation there.
China, of course, is quite profitable for Philips, also for Personal Health with shavers and oral care being the high runners and the big contributors to profitability more so than, for example, emerging markets in international markets. And therefore, the lost sales had a significant loss of profitability in the first quarter. You asked for cost measures, and I’ll be passing to Abhijit for that.
Let me first say something around the elective procedures. So we have seen in March, a significant drop-down of the elective procedures as hospitals prioritized emergency care. We think that will continue throughout the second quarter and therefore Q2 for IGT will see a significant drop.
Nevertheless, we are of course in contact with interventionists and we know they are discussing and preparing for the resumption of elective procedures, which we think will start happening in Q3. Perhaps even faster in office-based labs, but then certainly also in hospitals at large. It may then take a little while for it to normalize. But for IGT, we expect a strong second half of the year assuming that hospitals are open for the postponed orders to be installed. Abhijit?
Yes. So on PH, let’s say, most of the costs for Q1 were committed. So therefore, in a high-margin business like Personal Health, the drop-through of the gross margin when you come with so much lower sales is — pretty much hits your bottom line. We — on top of that, we also curbed our production because if on top of this we built a lot of inventory, then from a cash position, we would be in strike. So we basically cut back production so that we could keep our inventories in check and that, of course, doesn’t help the P&L at that time.
So you will see in Q2, of course, the drop will be more severe because, let’s say, in Q1, although you saw a drop in — about 12% or so, March ended with a much higher drop, somewhere in the mid-20s. So if you — and of course, the exit in March was even higher. So we expect Q2 to be weaker. And then — so the cost measures will drop, but profitability will be impacted with such a severe drop in top line. And cost measures include factory, let’s say, slowdowns, asking people to take leave, cutting off all discretionary expenses, quite a steep reduction in advertising and promotion.
So there’s a slew of measures we are taking to manage our costs. But when this business comes down that steeply, the impact on profitability is reasonably high. So until we get back to flattish to upward growth, we will kind of have this. And important to note, and I think Frans mentioned it in his introduction, we are ensuring that our new product introductions remain on track. So we are not going to cut those because we also want to emerge from this crisis much stronger. So as let’s say, consumer activity returns, we also want to have our newer product proposition available so that we can come out strong. I hope this gives you a good picture, Veronika, on what is happening.
That’s very helpful. And if I can, just 1 quick follow-up. In terms of your conversations with hospitals, I’m curious. Obviously, the D&T order growth was still pretty robust, but a lot of moving parts in there. Are your conversations changing at all? Are you hearing from hospital administrators that they’re becoming more cautious on spending money given everything that’s happening? Or has that not yet entered the discussions you’re having in terms of orders?
Frans van Houten
The discussions are, first of all, focused on the immediate urgency of having enough diagnostic equipment and monitors and ventilators for critical care. And there are some changes — differences in the mix, depending on the country. For example, we have seen sizable CT interest in Europe and Asia, but less so in the United States as countries have their preference for diagnostic modalities.
The second thing that we observed is the postponement of installs that are not related to critical care. For example, IGT operating rooms, Azurion systems. Those orders were not canceled, they were postponed, right? And we assume that from Q3 onwards, that we can actually install that. The third remark is that we see a heightened interest in building telehealth and command centers as that will increase resilience of our health systems and allowing people to work remotely and to keep as many as possible patients at different locations.
And then, lastly, and I think that’s the brunt of your question, what about CapEx budgets? And what about cash flow of hospitals? I think this remains a bit the unknown. And this is also why we take a conservative view on our liquidity measures just to be sure that we are prepared. We don’t know how fast insurance companies will pay out to hospitals. And therefore, it’s difficult to gauge what credit crunch hospitals may find themselves in, in the near term even though they are very busy, right. So we think that if they are having to postpone payments, then it’s probably a temporary issue rather than a structural issue, but still, we need to be prepared for all contingencies.
The next question comes from Patrick Wood from Bank of America. Please state your question.
The first is on the E30 ventilator units, it looks like a very big run rate that you guys are gunning for in terms of absolute units. I mean how sustainable is that from a production standpoint? And is the pricing should be — is this like a $1,500 system? I’m just trying to get a sense of roughly how big that opportunity is. That’s the first question.
And then on the second side, is there any risk that people are putting orders in for ventilators in totality with multiple vendors because they’re desperate and then they end up canceling on them before they actually fulfill? Not meaning to sound downbeat on it, I’m just kind of curious.
Frans van Houten
Yes. Let me give a bit of color on the E30. It is an adaptation from a biplane ventilator to which we have changed the software, added sensors, added filters so that it is safe and suitable for critical care. But as it is derivative of a biplane, it comes from a high-volume platform. That also makes it easier to manufacture at high volumes. And without necessary — let’s say, without lots of accessories, it would be in the order of magnitude of €2,500.
The risk in — and then on how sustainable is it, we think that there will be a peak demand and then it will go down again. This, of course, depends on what will happen in the emerging markets. I think that’s the big unknown. This could be quite a suitable product for emerging markets. But we are not counting on that this would be a long-lasting, high-volume product. Since we are leveraging our other existing production lines for Sleep & Respiratory Care, we would then go back to producing other types of equipment there.
In terms of the order book, most of the orders that we have received are firm orders. I think what we can all observe from the dialogues from the medical folks is that this pandemic will be with us for quite a long time. It may have its resurgences. Therefore, we can expect that health systems around the world will want to have some spare capacity in their critical care equipment, in their ICU capacity. Call that stockpiling or call it something else, I think society will demand from these health care systems that they are prepared for a resurgence of cases. And therefore, I’m not that worried that orders would be canceled at this time.
The next question comes from Hassan Al-Wakeel from Barclays. Please state your question.
I hope you’re all doing well. Firstly, could you talk about the ventilator business and whether there are any meaningful price concessions, be it for the U.S. government contract or indeed elsewhere?
And secondly, on your China commentary and how this is recovering in Personal Health, are you seeing any meaningful differences between products within the portfolio?
And then, finally, if I can, a longer-term question. Frans, do you expect health care expenditure to be structurally higher over the medium term as a result of this crisis and for this to translate to higher hospital CapEx, whether it be for diagnostics or intensive care capacity?
Frans van Houten
If we all had a crystal ball, Hassan, wouldn’t that be nice? On ventilators, our approach has been that we do not raise prices. We take our list prices, that’s the starting point. You can see at the HHS website, what the various prices have been for the different vendors. I mean if you take volume and divide it by the value of the contract, you will work out the prices from all the competitors. So we are not wanting to raise prices. We don’t want to take advantage.
At the same time, we, of course, are not giving big discounts either because we are incurring a lot of extra costs. We are investing over €100 million partly in CapEx, partly in expediting charges and higher component cost prices in order to ramp up fast and to get to priorities that we need. We need to take that into account. Nevertheless, the operating leverage that we will get from the higher volume will still make a positive contribution to the bottom line of Connected Care. So I think that can be then the takeaway that you’re looking for. I didn’t fully understand your China question.
In terms of — we see a different demand in products in China compared to the rest of the world.
Frans van Houten
Yes. Well, let’s say, we are not selling exactly the same ranges in the different geographies. For example, China is a high-end market for us and we’re selling predominantly oral care and shaving and beauty products, and to a lesser proportion, domestic appliances. Whereas in international markets, domestic appliances has a bigger proportion. And some of those emerging markets are not yet big on power toothbrushes. So the profitability of PH China is higher than our international market footprint for PH, if that’s behind the question. Maybe…
I guess, Frans, what I was trying to ask was if you’re seeing any deviation or if one of the businesses is slightly more resilient than others or if the impact is fairly uniform across the business within PH?
Frans van Houten
Yes. I was going to give you the fun part of the session is that, of course, we have seen demand for hair clippers and OneBlade go through the roof, right, as people are now involved in home hair care. But that’s — that doesn’t change the picture, of course. That’s more anecdotal, but I thought it was fun to mention. We have not seen a big shift in the demand.
Hassan, is your question only PH or is it broader? Just to be clear.
Frans van Houten
And then on your third question on hospital CapEx, well, at least in the 12, 18 months’ time frame, COVID will drive hospital CapEx up. We have not seen any order cancellations. And the patient base that — the severe patients will have some — it seems that they have some residual effect on their health. And net-net, those people will probably have a higher demand on the health care system than before. So we don’t see a reduction in the need of infrastructure and therefore CapEx will probably remain.
Now Veronika had a question around, I think, on the liquidity and CapEx of hospitals. We still need to see, of course, how hospitals come out of this pandemic from a financial point of view and to what extent they can afford to do what is needed. So I’m answering this first about what is needed. I think CapEx needs will be higher for a longer period. And then next comes the affordability question where we are — that remains to be seen.
Next question comes from Ed Ridley-Day from Redburn. Please state your question.
Can you hear me?
Frans van Houten
Yes. Go ahead.
First of all, I’d say fantastic to hear about all the stuff that Philips is doing to help your clients during this crisis. Very encouraging. So follow-up questions on a couple of areas. Just on China, to see your relative geographic exposure compared to some of your peers is quite marked there. In terms of Oral Care, I mean, one of your — your largest peer seem to report stronger growth in oral care globally. I was wondering if that was partially due to the geographic — relevant geographic breakdown and P&G relative to you. That’s the first question.
And secondly, on €100 million-plus investment, can you give us a bit more color between the split between D&T and Connected Care and to help our understanding of progression of that investment. If you can, Abhijit, how much you’ve already made and how much we should expect through the remainder of the year.
Frans van Houten
Let me — I’m not sure that we fully understand your second question. But let me first deal with the first question and then come back on the second. Philips with its Sonicare portfolio versus our nearest competitor, we always have a bit of a tech race, right, I mean — and we are about equal. So I feel that we’re holding our stance in Oral Healthcare. Before the crisis, we were back in high single-digit growth globally and double-digit growth in China.
And then, of course, when the crisis hit, that got deprioritized by consumers. But our competitive position is strong. Our product range extensions are doing very well especially since last year, as you know, we broadened the range with also more modestly priced products. I’m not aware of a specific geographical footprint difference between our nearest competitor and ourselves that would explain a difference of performance.
Maybe one thing, Ed. If you look at our Oral Healthcare portfolio, we have power toothbrushes whereas the competitor you mentioned has not only power toothbrushes, but also toothpaste and other — and manual toothbrushes as well. So that, of course, comes with a completely different market split. If you look at power toothbrushes, there are 5 big markets in the world whereas, of course, people all over the world are brushing. So that is this, let’s say, geographic footprint difference between us and them.
That’s helpful. And just on…
On the €100 million investments in Q1, yes, it was, let’s say, the smaller part of that, most of it will come in Q2 and then in Q3 as well. So let’s say of this €100 million, of course, we have spent some of it in the accelerations, et cetera. But large part of that is commitments that we have made for deliveries that are yet to come.
The next question comes from Scott Bardo from Berenberg. Please state your question.
First question, please, just relates to Personal Health. I wonder if you could comment actually as to whether the channel mix in Europe and the U.S. is materially different from China? I know you mentioned that retail was a far more significant drop in China. Just wondered if you can relate those comments to the West.
And I just wanted to understand is it a reasonable expectation for you to be loss-making in Personal Health in the second quarter? Perhaps then further just sharing some thoughts about your history with respect to recovery of this business. I know there’s been no economic crisis similar to this one, but would you expect this business to rapidly snap back aligned with economic development or maybe share some perspective there, please.
Second question set just relates to Diagnostics & Treatment. I’m just trying to square the significant order book that you have with the indication of a high single-digit decline for this business in the second quarter. Is this all interventional imaging or are there portfolio-related effects that we should be aware of?
Just lastly on this topic, please. Amid this uncertainty of the global capital market this year, perhaps next, are there any efforts in place to extend your enterprise service relationship agreements with hospitals or take the use of the low interest rate environment to strike capital deals?
Frans van Houten
Yes. Let’s first talk about the channel mix. China is way ahead of the rest of the world when it comes to proportion of online versus off-line revenue, okay? Off the top of my head, over 50% in China is via online channels.
It’s close to 70% even now.
Frans van Houten
And that shifted further online as online is back to growth. So now we are over 70%. That proportion is much lower in Europe and in the United States. That also means that we expect that the recovery of consumer demand in Europe and in the United States will be a bit slower than in China as not all consumers will as readily go online to buy their appliances. Of course, we will see an acceleration also to the channel mix shift in Europe and in the United States. Also, as Amazon has now entered Mainland Europe in a much broader sense in many countries, we can expect that shift to further accelerate. The — your question on profitability of PH in the second quarter, we — despite the steep decline in top line, we plan to make a small profit in Personal Health in the second quarter.
And then the last part of that first question, SARS and — post SARS and post the Great Depression, we saw a fairly rapid recovery whereby you could say consumers may postpone big expenditures, but many of the personal health products are relatively small expenditures and still within the discretionary budget possibilities for consumers, and therefore, we expect to get back to a more normalized situation by the end of the year.
Then on D&T, we saw order growth, of course, especially in Connected Care. Also in DI, less so in Ultrasound for cardiovascular and in IGT, nevertheless, across-the-board, we have a very strong order book, but hospitals are postponing the installation of anything that is not immediately critical. And that’s why we expect, still, in the second quarter, a negative revenue growth for D&T and only a resumption of positive growth in the third quarter onwards.
The last question, the interest in solutions remains, but it has been more complicated to do sophisticated deals in the first and in the second quarter because all commercial efforts now go through Skype and Teams and Zoom and whatever else we can lay our hands on. And the focus of hospital administrators is to deal with the crisis, right? I’ve been personally in touch with CEOs of hospitals who say despite the crisis they want to continue the dialogue on transforming health care, preparing for things like command centers, community care, telehealth. So I expect also the adoption of solutions to come back the moment, yes, people can spend their time on these kind of deals again.
The next question comes from Max Yates from Crédit Suisse. Please state your question.
Just my first question is on the Connected Care order growth. Could you talk a little bit about the growth of monitors versus ventilators in Q3 — sorry, in Q1? I just wanted to understand sort of whether we — the extent to which we’re also seeing a very significant step-up in monitors as well as ventilators. So perhaps if you have the monitors growth rate in Q1 in order intake, that would be helpful.
Yes, I just need to look it up. Both were strong growth. I think monitors was also very, very high, close to the average of what we said so would be around the 70% plus for monitors and overall 80%. So both monitors and ventilators very strong, Max.
Okay. And just on that, I mean would you — you’ve talked about a kind of 4x increase in your ventilator business by Q4. Is the CapEx that you’re spending and your plans for the Monitor business is also of similar magnitude, of similar proportions based on the CapEx that you’re spending and the conversations with customers?
Frans van Houten
Yes and no. So we expect a strong demand and growth in patient monitoring, for sure. For the ventilator production, we really have to set up additional factory lines and also outside of our own facilities, which requires more CapEx and also invest in more tooling, in more test equipment. So relatively speaking, there is a somewhat larger amount associated with ventilators versus monitors.
In monitors, we can handle the growth of demand within our existing factories in Böblingen and South China. It’s a more complicated story because the product range is wider. And of course, it was politically less in the spotlight, so to speak. So everybody talks about ventilators, not everybody talks about monitors. But yes, we expect also to significantly increase production in monitors also during the second quarter. We will also have extra cost there. Yes, so maybe I’ll keep it at that.
Okay. And maybe just 1 follow-up on Personal Health. I think you talked about, Abhijit, having done some scenarios around Personal Health and where we were in February and March in China and I think you mentioned the sort of 62% decline in sellout in week 4. But could you just clarify some of those numbers? So maybe what you were seeing in China in February and March. And then if in April, what we’re seeing in U.S. and Europe is comparable to what you saw in China in February, or whether because of the differing channels, it potentially troughs at a lower level before recovering.
So a couple of things. One is the online-off-line mix in China is much ahead of the rest of the world. So if you look at PH, I think about 40% of our business is online, whereas in China, it’s above 70% right? So then, of course for Europe and the rest, it is lower than the 40%. That should also tell you that the hit in Europe and North America will be higher because it’s the off-line, which basically comes to a bit of a grinding halt. So I think that’s the color I can give you, matching exactly week by week, what we are doing with online and off-line in Europe is still a bit too early to have that information now.
Okay. I mean, would you be able to give the February and March numbers for China in terms of how much…
That’s what Frans mentioned it right? So he said in the peak, it was down 62%. That was in February. And we exited — when we exited March, overall sales were still down 20% as Frans mentioned. But off-line was still down 50% and there was a slight growth in online.
Okay. So April looks to be better now than the…
Online sales grew, off-line sales still down 50%. But because of a further mix shift because more and more is shifting to online, you can’t really say that the online growth in the last week of March is on a similar base to 1 year ago. That’s also what Frans explained.
The next question comes from Kate Kalashnikova from Citi. Please state your question.
This is Kate Kalashnikova from Citi. Frans, following up on Scott’s question on Personal Health earlier, could you talk about how this accelerated shift to online will impact the consumer business, medium and longer term in your view?
And specifically, could you talk about Philips’ position in the online channel compared to its competitors and how margins in the online channel compare to margins in the traditional store channel?
Frans van Houten
Philips has been on a path to shift to digital marketing already for quite a while. And our digital team works closely with the online retailers to analyze data and to hone our skills to target consumers online. So the more sales will go to online, in fact, the richer the data analytics becomes and the more precise our marketing can become.
I don’t expect a significant product mix change for Philips as we shift from off-line to online. And in terms of margin or earnings capabilities, I also don’t see a significant difference in performance between the channels. Of course, there’s a difference in marketing expenditures. I mean, in retail brick-and-mortar, you have more floor stands and so on, whereas in digital, you have to pay more for search terms and so on. But that’s all part of the game. Net-net, profitability is comparable.
We have seen here in Europe that a store like Media-Saturn, which is still very dependent on brick-and-mortar, is making a lot of efforts to move to online sales, trying to accelerate the shift. Nevertheless, for, I think, both U.S. and for Europe, the impact on high street shops is profound, right? And I think that’s also why we expect it, at least it will take a bit longer for the recovery to happen in Europe and the United States versus Asia.
The next question comes from Lisa Clive from Bernstein. Please state your question.
I had a question on the different types of technologies that are being used to treat COVID-19 patients. Clearly, it’s helpful to have both invasive and noninvasive modalities on the same ventilator, which appears to be one of the attractive features of the model you’re selling to the U.S. government. But we’ve also seen impressive reports on hospitals using CPAP machines sort of in a pinch. What is happening with your Sleep division? And do you think that could likewise see an uptick in orders?
Frans van Houten
Yes. Well, when patients are in respiratory distress, hospitals will do anything to help these patients, including using CPAPs. However, that is not a recommended treatment modality. You need to have ventilators that measure the distress the patient is in that can react to that. So there needs to be sensors and analytics. Moreover, there needs to be filters adapted to the machine to avoid virus spreading through the exhaust of the machine. And moreover, the insight is that even non-severe cases still need higher saturated oxygen levels to help them with their recovery and a CPAP machine cannot do that, right?
So our E30 and the EV300 can all deliver higher oxygen levels as they can be connected to oxygen supplies whereas the CPAP machine just takes normal air out of the atmosphere and blows it into the lungs. So it’s quite a different therapy. Now the E30 that’s derivative of the biplane comes out of our high-volume production lines. We are redirecting some of the capacity from our Sleep business for that. But the factory lines that we have in that business, we can ramp them quite easily, and therefore, we do not see — expect a big impact on our Sleep business.
By the way, the Sleep business had a positive growth in the first quarter, which was of course rewarding to see. I know that many questions were there with regards to how we are performing in Sleep, and so first quarter positive growth.
Okay. Great. And then just 1 follow-up question. Of the €100 million incremental CapEx for manufacturing capacity, could you give us an indication of the geographic split of that spend?
And then just a second question on manufacturing in general. Are you comfortable with the geographic distribution? And do you feel like you have enough redundancies in place if any country gets particularly hard hit that you’ll still be able to manufacture through this?
Frans van Houten
Well, the €100 million is not all CapEx, right? It’s partly CapEx, partly extra costs that we need to make to operate in 3 shifts to expedite, to do the fast logistics and to pay premium prices to some of the component vendors that need to distribute faster. Part of it is, indeed, geographically related to the United States, part to Europe, but also some of our contract manufacturers that support the U.S. expansion are also located outside of the U.S. So it’s a difficult question. I don’t have a top-of-mind split in my mind to give you.
Of course, we will take a careful approach and look at an accelerated depreciation of any investment amount so that we don’t have residual risk after that volume would normalize. The — many of the suppliers are in distressed countries. And we’ve had to help them get government permissions to open up while the country is in lockdown. And we’ve also helped suppliers with, let’s say, health and safety measures to keep their people safe whether that was in the Philippines or in other countries in the world where we had certain components that we needed for the ventilator ramp-up, right? So does that answer your question, Lisa?
Yes, that does.
The next question comes from Julien Dormois from Exane BNB Paribas. Please state your question. Apology, it seems he may have stepped away. We will take our next question from Dan Wendorff from Commerzbank. Please state your question.
Two, if I may. The first one is can you talk a bit more about the service revenues within your D&T division? Were they impacted at all during the crisis so far?
My second question would be a follow-up on the E30 ventilator. What regions or what customer groups are you primarily targeting for placing the modified E30 ventilators?
Frans van Houten
Okay. Service impact was slightly impacted in the first quarter. We have some 3,000-plus field service engineers heroes because they have been going into hospitals that are affected using PPE protective gear servicing X-ray, CT machines, ventilators. Incredible. I have huge admiration for these people. Hospitals have postponed, let’s say, certain services as they didn’t want to, for example, do a major overhaul of an informatics installation during the crisis.
But all urgent services have continued, and of course, as you know, many of our service revenue is under service contract and therefore not immediately impacted by variations in demand peaks. Service order intake, you could say some hospitals are not spending time on negotiating contracts at this time and they are focused on the prices.
Then your second question, the E30 is really targeted to support and augment capacity of hospitals in the crisis. It’s not intended to replace intensive care ventilators as such, but more to support those patients that are already having respiratory distress but are not yet in the intensive care unit.
The product is just launched. So it’s early days to say how much uptake there will be. We expect, certainly, emerging markets to have a strong interest. The E30 can support both invasive as well as noninvasive ventilation. And so it was approved under the FDA emergency regulation. So it is a versatile product and it is at much lower cost. So early days, but we expect high demand. And as we have shown, we can quickly ramp up, and if necessary, we can also ramp down if the product would have less uptake. But at this time, we expect a big uptick.
Next question comes from Julien Dormois from Exane BNB Paribas. Please state your question.
Can you hear me?
Frans van Houten
Yes. Okay. So I will try to be quick and I know you guys don’t have a crystal ball and you might not be willing to give much more around the 2020 guidance and the specifics, but I just have 2 questions. One is on Connected Care where you had to cut your midterm margin guidance at the end of last year moving it to 13% to 15%. Given the sales trends and the order book you have in that business, is it fair to assume that could actually bring it back up to the former level at least for 2020?
And the second question is on PH.
Frans van Houten
Yes. That is a fair assumption.
That’s a fair assumption. Okay. And then the second one would be on PH and on the sales trends for PH. I mean you’ve given a lot of information across the call, so thank you for that. From what you see today, are you assuming an organic sales trend for that business for the full year ’20 to be in the mid- to high single-digit decline or would that be too pessimistic in your view at this stage?
So we expect a strong decline in the second quarter and, let’s say, assuming that consumer demand starts coming back in Q3, Q4, maybe around flattish in the second half, so then you can do the math for the full year.
The next question comes from Sebastian Walker from UBS. Please state your question.
Two from me as well. So on ventilators and monitors, clearly, we’ve seen shortages there but a lot of manufacturers have announced increased capacity. So would you say with the newly announced capacity, supply and demand are more balanced or broadly in line? And then a question, just what recurring revenues do you have attached to those products?
Then the final one on Image-Guided Therapy, so just if you could remind us what proportion of that business is consumable sales? What proportion of procedures done in cath labs cannot be delayed? And then are you hearing about any early indications and presumptions of those procedures?
Frans van Houten
Yes. Lots of people are increasing capacity. Of course, there’s lots of companies that claim to be ventilator manufacturers. That doesn’t mean that they’re all going to succeed. So the jury is a bit out what will materialize. And from what I hear is that all professional ventilator makers, of course, struggle with their ramp-up and are having to put in a lot of extra work to make that happen.
At this time, there is more demand than supply, right? Of course, the theoretical supply, if you add up all the announcements, looks high, but the factual supply is still much lower than the demand, right? And this is, I think, a situation that is likely to stay at least for the next 2 quarters.
The recurring revenue, I think it’s a fair question. We expect providers to want to maintain their installed base of ventilators. However, we have not yet made, let’s say, the contracts for service in the long term, right? That was not the priority of the providers. They first wanted to get their hands on ventilators. So that’s something that we will be working on and see what we can accomplish over the next months.
Yes, IGT, the decline in elective procedures is really steep, right, and therefore, the revenue of IGT devices will go down substantially in the second quarter. Of course, some interventions will still happen. If the patient has stroke, then that patient will be helped by the hospital. But if the patient has a stent to be placed, that can perhaps be delayed. So it’s a mixed situation. We use the word for a steep decline in the elective procedures because that’s what we’re seeing.
At the same time, it’s the likelihood of the interventionists, the cardiologists, they need to earn their bread and we all hear them talk about that they want to restart as soon as possible. And of course, the pent-up demand of patients who need care, that doesn’t go away either. So our current expectation that already in the third quarter, we see demand quickly restore for IGT devices. And of course, then the IGT systems installations to resume as well.
The next question comes from Falko Friedrichs from Deutsche Bank. Please state your question.
Firstly, can you share a bit more color on the growth and order intake you saw in CT scanners? And how is your capacity level for CT scanners currently? Do you think it is enough to meet the high coronavirus-related demand?
And then, secondly, can you potentially give more color on the margin profile of hospital ventilators and patient monitors and whether these are above or below the Connected Care segment margin.
Frans van Houten
We are looking here.
So on CT, we had a very robust order intake growth. I think it was well above the 30%. In terms of growth also, it was a high double-digit growth if I remember from the top of my head, but I can quickly check and get back to you. What was the second question?
Frans van Houten
Margin of ventilators and patient monitoring. Yes, for the sake of this discussion, let’s say, is more or less comparable. What is difficult to gauge here is with the operational leverage of the higher volume, that will have, of course, a margin effect, right, and which could be different from the normal margins of the running businesses.
For CT, it was a high single-digit sales growth and a very strong order intake growth.
And your capacity levels are fine for now in CT?
Yes, yes. For the year, yes. So this is quite heightened demand shorter term, but we — based on current plans, we have enough capacity.
We will have a follow-up question from Michael Jungling from Morgan Stanley. Please state your question.
Great. I have 2 more. Firstly, on the government support packages that we’re seeing in some of the countries that you have a material presence, are you taking advantage of putting some of your employees on furlough? And if not, do you intend to do so?
And then question number two is, again, on ventilators. Can I just confirm that the orders that you are taking in come with the natural deposits that you would expect if someone places an order? So I’m just trying to understand the quality of the orders and the deposits that may be associated with those orders.
Frans van Houten
Let me first take the first question. We are not taking advantage of the government support packages at this time. Of course, we have talked about reducing costs where possible. Some factories with less demand, we have asked our people to take voluntary vacation. We have some what’s called workday banks where we can play with capacity fluctuations. But we also have a social responsibility and we don’t believe in furloughing at a big scale at this time. It all depends, of course, how severe the situation will develop. But — so for now, that’s not the case.
On the ventilator orders, do you mean deposit and advance payment?
Yes. I mean as far as I — the answer is yes, the advanced payment to I suspect — I’m not an expert of ventilators, but I suspect that people normally put a 10%, 15% deposit on an order to make sure that…
So we have standard terms for deposits against orders and it differs in geographies. In certain geographies, we take actually a very high percentage of sales in deposits. In some, it is lower. But let’s say, we have — there is nothing out of the ordinary in the orders we have booked. In fact, there is a substantial amount of orders that we have, which are cancelable, which are not in the order intake number. So what we book in the order intake number are the fixed orders, which are not cancelable. So yes, you can still potentially have a cancellation if something dramatically changes. But right now, the orders that we recognize are the orders that have no cancellation clause.
The last question comes from Scott Bardo from Berenberg. Please state your question.
Yes. Just wondering if you could share some comments, Frans. Obviously, it’s remarkable that Philips has adapted to meet the current demand for CT, monitoring, ventilation. But as we think about the future, is a benefit of revenues today a problem tomorrow for Philips? Do you see the prospect that you front end-loaded supply of these solutions such that the end market demand for these solutions is materially impacted over the medium term?
Frans van Houten
Yes. Well, to some degree, that may be the case. I mean if people load up on monitors or ventilators, then likely that demand will slow down next year or the year after, although I think we should also expect that hospital systems, governments need to see the ICU bed capacity to double in the world, right? Now if you analyze that deeper, doubling ICU bed capacity would put a lot of us to good work for quite a while, right, because that takes a lot of effort.
At the same time, as potentially then monitor and ventilators go down, you get the opportunity for service contracts of what we have just delivered, right? That was an earlier question. We get an opportunity to add informatics and analytics or the monitoring, which for much of these rush orders were not always included. Then we will see IGT resume, we will see Personal Health resume, we see the heightened interest in command centers, telehealth and all those things, right? So that’s the validation of the strategy that we referred to.
So overall, I would say the growth profile, the growth potential of Philips should be well supported also post pandemic. Now you know that we have postponed our Capital Markets Day, but I’m sure that this will be the mainstream discussion, what’s our growth potential. And we have always said we want to be gradually moving towards the higher end of our 4% to 6% range. So that ambition, of course, stays. The question is timing and underpinning, but we will have plenty to talk about in the next time we see each other physically instead of remotely.
For now, as this was the last question, I would like to thank everybody for your attendance, your interest. And I know that you care on how we are doing, and I appreciate that very much. Thank you. Take good — be safe.