Welcome to the Royal Philips second quarter and semi-annual 2021 results conference call on Monday, July 26, 2021. During the call hosted by Mr. Frans van Houten, CEO and Mr. Abhijit Bhattacharya, CFO, all participants will be in a listen-only mode. After the introductions, there will be an opportunity to ask questions. [Operator Instructions]. Please note that this call will be recorded and a 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.

Good morning and welcome to Philips second quarter 2021 results conference call. Joining me today are 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 and the related information slide deck were published at 7:00 AM CET this morning. Both are available on our Investor Relations website. A full transcript of this call will also be made available today on the website. As mentioned in the press release, adjusted EBITDA 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. As of Q1 2021, the Domestic Appliances business is reported as discontinued operations. Sales and results from this business are no longer included in the results of continuing operations and relevant assets and liabilities are reported under assets and liabilities held for sale. All forward-looking projections exclude the Domestic Appliances business. Over to you, Frans.

Yes. Thanks. Hello everyone and thank you for joining us today. I hope that you and your families are keeping safe and well. Let me upfront mention the upcoming field actions related to the component quality issue in our sleep apnea therapy devices that we announced back in June, right. I shall to talk about that first, as you understand because of the impact that it is having on patients as well as their well-being which is at the heart of everything we do at Philips. And I want you to know that we have mobilized the necessary resources across the company to address this issue effectively and I will come back later in this call with more details. Zooming out, the COVID-19 pandemic is clearly not over and our teams are very focused on delivering against what we call the triple duty of care, of meeting customer needs, safeguarding their health and safety of employees, ensuring business continuity. Despite the impact of COVID, we delivered actually strong performance momentum in all our businesses except for the Sleep & Respiratory care business. This resulted in 9% comparable sales growth, an adjusted EBITDA margin increase of almost 300 basis points and a free cash flow of €167 million for the group in the second quarter. We are very encouraged by the close to 30% comparable order intake growth for the Diagnosis & Treatment business with all major markets contributing, driven by the improvement of hospital CapEx and elective procedures and the very positive customer response to our innovative products and solutions. Order intake for the Connected Care businesses decreased, of course, following the exceptional growth of last year as well as the headwinds in the Sleep & Respiratory care business. Personal Health delivered strong 33% revenue growth in the quarter. Now…

Thank you Frans and thank you all for joining us today. Let me provide some color on the second quarter comparable sales growth of 9%, which was even 17% if you exclude the Sleep & Respiratory care business. Let me remind you that our comparable sales growth does not include the double digit growth of BioTelemetry and Capsule which we take into the comparable growth only after one year after acquisition. The Diagnosis & Treatment business's comparable sales growth was 16% in the quarter with double digit growth across diagnostic imaging, ultrasound, image guided therapy and enterprise diagnostic imaging informatics. We look particularly pleased to see the very strong growth in our image guided therapy business driven by traction in both systems and the devices businesses. The volume of elective procedures continued to track above pre-COVID levels during the second quarter and we expect this to continue as hospitals normalize their operations and also work through the backlog of patients. The sales for the Connected Care businesses declined 16% in Q2, driven by a substantial decline in the Sleep & Respiratory care business on the back of a very strong Q2 last year as well as the headwind related to the field action. Patient Monitoring comparable sales grew mid-single digits as we continue to successfully convert the strong order book in this business and performed well above even the 2019 levels. Personal Health delivered a comparable sales growth of 33%, driven by consumer demand for our new product innovations with good growth momentum across all geographies. All Personal Health businesses grew strong double digit. It is important to note that two phasing factors also had a positive impact on the growth rate of Personal Health in the quarter. The first being the impact of the shift of Amazon Prime Day…

[Operator Instructions]. The first question comes from Veronika Dubajova from Goldman Sachs. Please state your question.

Hi guys. Good morning. And I hope you are doing well. Two questions for me, please. The first one is just an update. Frans, when do you think you will get the emergency use authorization in U.S. to commence the repairs? And I guess, maybe if you can comment on some of the other major markets and what the timeframe is looking like at this stage for you to commence that the work, that would be really helpful? And if you have had any feedback so far from the regulatory agencies on the repair process and their thoughts on that? Apologies, I know it's broad, but it's just a big theme of focus. And my question is on the guidance. Just, Abhijit, wondering if you can narrow it down for us, as low to mid single digit is a pretty wide range? So just would love to understand where in that range you feel more comfortable? And maybe the tweak to that margin guidance? You are no longer up to the 80 basis points. What has changed for you? Is it transport cost? Is it shortages? Is it raw materials? Or something else that's kind of leading you now towards the lower end of that 60 to 80 basis point range? Thanks guys.

Yes. Hi Veronika. Good morning to you. Let me try to tell you as much as possible on all the ins and outs of the field action. First of all, you know we have engaged with all regulators throughout the world on the field safety notice. And it's interesting to their observed differences in the risk-benefit interpretation that regulators then take, right. And that's why we have included the page that some regulators were inspectional guide for continued use while waiting for the repair and others point to the doctor. Then on the repair procedures, let me point out that there's multiple devices within the platform family of DreamStation 1. We have submitted multiple packages to the FDA for regulatory approval, that's so-called 806.4 for the emergency field action. The FDA has engaged on these submissions and we have already had several rounds of queries on those procedures, was asked for more data and so on. I cannot exactly predict when we get approval. I can only say that FDA is on top of it and working very diligently. And let's say, experience would show that kind of an eight week approximate throughput time on an 806 could be expected, right, but that's out of prior experience not necessarily related to this case. In anticipation, we have already produced repair kits and we have also even placed stocks in bonded warehouses in a few countries in the world so that we can move quickly out of the gate, right. And so we are all ready to go, right. And I would expect that imminently we should be able to give updates on that. Does that answer your question on the upgrade process, Veronika? Maybe let you react immediately on that?

No. That's really helpful. Thanks Frans.

All right. Good. Then, Abhijit, the guidance with how many digits behind the comma?

Yes. Veronika, I would love to do that. We have six months to go. There are, as you have said, lot of uncertainties, be it COVID, e-component shortage, et cetera. We have a strong order book and good demand. So I think and yes, if you take low to mid single digit, it can be from zero to six. So I understand that range is wide but somewhere in between is, I think, a fair indication of where we are likely to end. The margin guidance is not really a change. So I have seen different people reacting differently. Look, you know, we have just seen where we are in the process. We are half a year down and we think the 60 basis points step-up year-on-year with the issues that we have in Sleep & Respiratory care, I think with what we know today is just a more accurate view of where we will end up. That's it.

Yes. Let me just reiterate. The whole company is completely geared up to compensate for the revenue loss in Sleep, right. And there are so many opportunities that we are chasing and pursuing that perhaps that creates the less, the lower than normal kind of ability to precisely nail. But don't read anything in it. We are all over it and we remain very confident around our ability to perform.

Excellent. Thank you both. And Frans, if I can just quickly on, you said you have had some conversations with the FDA on the EUA. Just kind of curious, anything surprising? I am not familiar with how much back and forth happened on these things. But I am just curious if you hearing anything from them that would make you less confident on that eight week timeline for the EUA?

I think all the questions are completely understandable and legitimate. And I think they point to the complexity of this whole area around VOCs, right. I am sure that we will get other questions during these calls but the FDA has asked us to provide data that the replacement material is safe and sound, right. I mean if boil it all down, then everybody wants to assure that if you go out with a repair and replace action on a couple of millions of devices that you do that in the full knowledge that it is a sound, is a good solution. I think that, in my own words, if I put it like that, it describes it. So I think it is diligent and the only unfortunate thing is it takes time. And patients are wanting to get this dealt with as soon as possible because not using the therapies is also giving a lot of discomfort AR.

Understood. Thank you guys so much. Super helpful.

Our next question comes from Patrick Wood from Bank of America. Please state your question.

Perfect. Thank you very much. I am also asking the two upfront, if that's all right. So I guess tediously on the Sleep side as well. Just curious how the order book developed through the quarter and the revenue line? Obviously, thank you, Abhijit, for commenting around the group numbers with and without Sleep. Sort of playing around with that, I get the sense that towards the end of the month, presumably the sleep hardware business was down like 90% or something. I could be wrong about that. So I am just curious, how that business developed through the quarter and whether you think that reflects just purely the repair actions or a little bit the consumer anger, I guess, on the issue? And then the second one, I am just curious, thank you Frans for your commentary around the group and the product qualities and those sort of things. But do you feel that may be internally how things are structured within Philips, how information gets fed up to the executive team, is that something you are looking at changing or considering to sort of help mitigate issues or surprises? Or is that an unreasonable expectation as you think you have got it working all right?

Okay. Abhijit, you take the first?

Yes. Overall, the Sleep business developed, as we expected, once we announced the repair actions, then basically we didn't sell any more of the systems, right. So the mask sales continued. Actually mask sales were pretty good. So there we don't have an issue. And you know, normally the sleep systems businesses towards the end of the quarter bulk of the deal that done. So yes, you are right, Patrick, towards the end of the quarter you really see the comparable decrease year-over-year. But not something that we were not expecting to happen. So no surprises there.

Yes. Then Patrick, on your second question. Already several years ago as we moved from a conglomerate organization with a holding model towards an operating company focused on health technology, we did change our Q&R organization. At that time and think of it, I don't know what we call it exactly but think of it like five years ago, we moved the reporting line of all quality and regulatory people to the functional leader of Q&R, right. So we have a Chief Medical Officer. We have a Chief Quality and Regulatory Officer. And the Chief Quality and Regulatory Officer reports directly to me, right. And all the resources, all 4,000 of them, in the company functionally report in to the Head of Quality and Regulatory. So that's my first point. Second point. The learnings out of previous audits, 483s and inspections, have pointed to the need to strengthen what is called post-market surveillance, right, PMS. And here, we have made actually a ton of progress. We have also implemented a companywide information system called TrackWise where all complains are registered and thanks to IT can also be analyzed more easily, right. Now we get a couple of million data points into that system per year, right. So you need to do a lot of analytics. The post-market surveillance process has led us to detect the issue at hand here, right. So remember, we have, since inception, sold more than 10 million or 12 million of these devices. We track complaints coming in and then at some point in time you notice that there is a pattern instead of just incidents, right. So in the beginning, you get one complaint here or one complaint here, it's not a pattern. It doesn't get recognized as a pattern. But as an more recently,…

It does. Thank you for the commentary, guys.

The next question comes from Hassan Al-Wakeel from Barclays. Please state your question.

Hi. Thanks for taking my questions. I have three, please. Firstly, could you talk about current manufacturing capacity within Sleep and where they fit relative to your 3.5 million installed base? What are cost to increase capacity here? Secondly, could you talk a bit about the momentum in North America? How did order intake within D&T fare? And what about MRI, where I believe the number was with plus-45% in Q1? And the finally, following up on the guidance, could you talk about your confidence around topline guidance based on where your order books sits today? And then also on margins, given the quantum is of higher margin Sleep sales that you will lose over the course of the year and do you assume any impact to the mask business as part of this year's guidance? Thank you.

Great questions, as usual, Hassan. But let me first to reiterate what I said about manufacturing capacity and I mentioned that we are ramping up capacity for the replacement and repair actions from 30,000 to already 55,000 a week currently, aiming at 80,000 by the beginning of the fourth quarter, right. And if you multiply that times the number of weeks, then you get to somewhere between 3.5 million to 4 million units, right And hence the 12 months expected throughput time on this. We have not, let's say, specifically mentioned the cost of increasing capacity but I would reassure you that that is not the big issue here. We would be able to go faster, if from a supply constraints point of view we would get our hands on the scarce materials from some of our suppliers, right. So we have been helping our suppliers with mould capacity, et cetera, so that they can ramp up faster. And if we see that they can go faster, then we aim to shorten the 12 months, right, if possible. It's too early to speculate on that. But certainly, that would be our aim because that's better for patients. But obviously, the sooner we can resume sales, that's better for our own business. Maybe on the back of it, I would like to share with you the feedback that we have been getting from distributors and doctors. They all say that the manner in which we deal with this issue is more important than the issue itself, right. They realized that a technical component issue can happen, right, but the way we deal with it is important. And so far, we have only been getting positive feedback in the way we have been able to handle it. Also the supplemental clinical information that was provided to doctors a couple of weeks ago, I assume that you have seen it, it was very much appreciated. What we also hear is that nobody has appetite for a monopolistic market situation and they expect Philips to be able to quickly recover its position in the market and resume, let's say, our strong preference. What doctors also point to is the strong analytical capacity of our systems, helping them to understand the trend line of patients. So the whole informatics part of our devices and as they provide information to the doctors is quoted as a strength, right. So we are under the conviction that we will regain our market position or at least close to pretty fast after we are able to resume production for commercial purposes. And I said, we will do that as fast as possible. Now, in the meantime, I think I have given my colleague Abhijit some time to look up all the numbers of the other questions. Abhijit?

Yes. I think overall for North America, the order intake, especially in Precision Diagnosis was very solid, upwards of the 40%. MR was lower because you know, Hassan, we had a big order intake in Q1. So Q2 was low single digit. But for the first half, very strongly in double digit territory. Our X-ray business had huge order intake. Our CT business huge order intake and very nicely the ultrasound business also had a very, very strong order intake. So I think momentum in the U.S. is very good for us at this stage.

And then the margin composition?

If you look at the impact on masks is to the extent that the masks went with the systems, we lose some of those sales. Although we have programs in place in the third and fourth quarter to see how we can compensate for that. But it does have overall a negative impact on the mix in Sleep & Respiratory because, of course, Sleep is a high margin business and some of the compensation is coming through oxygen concentrators, et cetera, which is a lower margin profile. But overall for CC, that is a relatively small impact because Patient Monitoring is also growing.

And on that maybe, if we take the question wider, Hassan, then of course the Patient Monitoring is a very beautiful, profitable business and that continues to grow strong throughout the year. It continues to grow. Also some governments are doing stockpile programs on monitoring and we continue to see the application of Patient Monitoring in other care settings. And also in D&T, strong growth in image-guided therapy and the devices with a very strong margin profile by now also helps us to continue our margin trajectory, right. So that's it.

The next question comes from Michael Jungling from Morgan Stanley. Please state your question.

Thank you and good morning. And I have two questions, please. Firstly, on the recall, you highlighted in your slide deck that 2.2 million people have registered out of the 3.5 million machines. Do you know what proportion of those 2.2 million are in the U.S.? How many patients highlighted that they actually have an issue with their DreamStation 1? And are you surprised that it's no higher than the 2.2 million at this stage? And then question number two is also on the recall, but really focused on the foam of the DreamStation 1. Was that foam FDA approved by the vendor who you sourced it from? And are you able to tell us who the manufacturers of that foam? Thank you.

The 2.2 million registrations are more in the U.S. than the normal proportion of our business was, right. So over, what was it? 65% of the expected to be affected devices are in U.S., but the proportion of registrations in the U.S. is higher. That's also because we were out of the gate faster with the patient engagement program and the network of DME is very strong in the U.S. whereas in some of the international markets it takes a bit longer to reach people, but we expect that to catch up soon. Obviously, most of the reports are with DS 1 because that's, by far, the vast majority of devices affected. So, unless I misunderstand your question, it's logical that the vast majority of these registrations are DS 1 users. On the foam, I value to state that when the product DS 1 was released, it was tested against all the standards in place including VOC standards at that time, right. And the product, of course, met all those standards otherwise it would never have been released. The foam has been used for over ten years and we never had any issue with it. But whether the manufacturer itself had its own approvals, I am over asked here at this moment, but I repeat that we have been using this foam for ten years in DreamStation 1 and prior generations and never had issues with it.

Okay. Thanks for that. Kind of a follow-up on the question that I asked about. Of the 2.2 million patients who have registered, have you been able to collect data to see what the issue is, why they have filed or to register?

We are still doing analytics on that database. So I cannot give you more data than that. We have just on the first pass of analytics to take out duplicates because that was the first issue that we needed to deal with. And now we are mapping it on registrations and when the products were produced and so on. I prefer to do a thorough job on analytics before I answer your question.

Okay. And Frans, you didn't answer the question about who the foam manufacturer is? Can you highlight that, please? Could you mention that?

Yes. I realized that I didn't answer that. So I am not going to answer that.

Okay. Thank you.

The next question comes from Kate Kalashnikova from Citi. Please state your question.

Hello. This is Kate Kalashnikova from Citi. I have got three questions on Sleep, I am afraid. So firstly, Philips supplemental information sheet sent to doctors in July, it mentioned that the toxicity was noted for the extraction concentration and also that two genetic test assays show the positive mutagenic response. What chemical specifically is the document referring to, because the chemical is specifically mentioned in the release such as CG, CGI and GEG, they are not proven carcinogens in human? So would be very helpful if you could clarify this? And secondly, Phillips changed the sound abatement foam in DreamStation 2 to silicon. Why have you made this decision if there were no safety risks identified for PE-PUR in DreamStation 1? And finally, what proportion of patient normally start sleep therapies and then discontinue perhaps even while they source this device? And what proportion of users in the U.S. regularly use ozone cleaner? Thank you.

Wow. Hi Kate. With regards to the characterization of the volatile organic compounds, that is a very complex matter. And the supplemental information that we refer to indeed mentioned several gases and we also observed that some people have misinterpreted the type of gases and therefore took a more, let's say, serious interpretation than perhaps was justified. We have also, on request of the regulators, started a slate of additional tests to further characterize what gases are to be determined and to how to characterize them. I can tell you that we have not detected TDI or TDA in those samples that were tested in the lab, right, but as I said further research is ongoing. Now, with regards to the change of the foam from DreamStation 1 to 2, you may recall that in June 2018, a new standard was published that had, let's say, heightened or different requirements on VOCs than the previous standard. The new standard did have a grandfather clause for existing equipment and therefore products that were already being produced in the past that were approved and passed did not have to be retested against the new standard. Of course, that is provided that you don't have data and insights that your device would not be safe. I can tell you that at the time of the release of that standard and that we did not have in fact, the complaint rates coming out of our post-market surveillance. And therefore, we did not initiate a design change of the DS 1 at the time because there was no reason to, right. And let's say routinely in the medical device industry, yes, you are faced with new standards being applied to new generations of products and you are not going to retrofit all old systems because that will be an impossible task, right. You only do that when there is a safety concern. And as I said, when this new standard came out, we did not have that and therefore the grandfather clause in the standard of June 2018 applied. Then the proportion of people using ozone cleaning is, of course, we don't know that exactly, but we can tell you that aggressive marketing has taken place even to the extent that the FDA issued their own warning in the beginning of 2020. Now if we look at the correlation or let's say when did we start seeing complaints coming in the United States then the vast majority of the complaints are in 2020, right. And therefore and also geography wise, we can, let's say, correlate to the regions where ozone cleaning was marketed more strongly. So that is where we stand. Obviously, to the question of Michael, as we get more data from the registration, we will be able to do more analytics and then maybe, Kate, we can come back to your question in due course.

Thanks for that. Just to clarify your answer to the first question. As you hopefully saw the TDA and TDI, they were not detected in the test done to-date. GEG would detect it, but it's not cytotoxic. So what chemicals were responsible for the potential, report of potential cytotoxicity, if not TDI, TDA and given that DEG is not cytotoxic? I am just trying to understand if you can help us a bit would be really helpful.

I am now getting assistance here from Steve.

Hi. We need to further identify those compounds. So this was done on lab-degraded foam, so that the foam was not, let's say, aged in the field. We artificially aged it to simulate the degradation. And we did an extraction and we analyzed all the compounds in there. We could detect diethylene glycol. There were a number of unidentified compounds that we are now further investigating. But we did not detect TDI or TDA.

Okay.

So let's say, rounding it up, Kate. I think it is way too early to conclude that the gases have really a severe health impact. We took a worst-case approach back in April and June because that is what is expected from, let's say, a responsible manufacturer, right. If you don't know all the finite consequence, you go out first with a reasonably worst-case scenario. And then as data becomes available, later you can always reduce that rating, right. But that's what we need to do according to our own quality management system, right. And the supplemental medical information already, let's say, gave a more balanced view on it. That was appreciated. And the further tests that we are conducting on a far bigger sample and also on aged, normally and naturally aged products, will also determine whether the VOCs are more initially coming out of the machine, when they are coming from the production line or whether in the installed base is still an issue, right. I think this is one of the critical questions to answer, right, whether patients are really exposed to VOCs or not. But taking a reasonably worst-case approach is, I think, the responsible way to go about it. And then we will deal with the further information as it comes.

Thank you very much, Frans. And just very briefly, if I may. Have you got any data that shows how ozone is accelerating foam degradation perhaps?

Yes. That we do. We have tested that and we see a 40 times factor of acceleration of degradation when ozone is being used. And that's on an average use of ozone cleaning. And if people do that every day, of course, it goes even faster, right. But the acceleration factor caused by ozone cleaning is very, very significant, right. And otherwise, we would not call it out. It's a very aggressive cleaning method that should not be used on medical devices at all.

The next question comes from Scott Bardo from Berenberg. Please state your question.

Yes. Thanks very much, guys. Sorry again to focus on the Sleep & Respiratory business, please. Frans, you mentioned a lot of volatile organic compounds and I understand why. I think this is potentially the bigger consideration as compared to particulate matter. The MHRA in the U.K. conducted a biological safety assessment and highlighted that they did not see any volatile organic compounds of concern after 24 hours, suggesting that this was a first out-of-the-box usage issue rather than something that was sort of sustainable over prolonged periods. I wonder if you could confirm in your initial safety assessment and clinical studies whether you would agree with that observation, please? Second question please, Frans. I wonder if you could provide a little bit more details about how you intend to repair and replace? Can you give us some sort of split between repair and replacement? And does that alter between geographies? Perhaps give us some sense of what you expect the profit impact as a result of no sales for CPAP devices to be for Philips including mitigation factors? And last question, please. Frans, you seem confident and pleased to hear about the ability to remediate this issue within 12 months or so. Am I right in saying then, Frans, there's no reason at this point to deter from your 2022 provision or outlook for, let's say, 5% to 6% topline growth, 60 to 80 basis points margin expansion? Thank you.

Yes. Brilliant questions, Scott. Let me indeed cover them. Look, the MHRA test in the U.K. is very encouraging, right. And as I said, we have taken an initial worst-case approach to it, because in the lab tests, our resident lab, well, not resident, but our partner that does the tests for our Sleep & Respiratory Care business, this is where we discovered the VOCs. And that's on a relatively small sample size, right. And on that basis, we took the action, right, because we could not do otherwise, right. We have found those gases in that limited sample and consequently we took a reasonable worst-case approach. I told you that we have initiated a much wider sample of testing, but also we have asked multiple labs to do the testing, because we want to know the repeatability of the test in different test environments to exclude that potentially this one lab has a different approach, right. So all of that is still in the making. Now you may say why does it take so long? Well, these tests run for multiple weeks and then on multiple devices. And then, all the molecules need to be characterized and measured for their, let's say, of the quantification. In a way, that frustrates me as well, because I would like to do this much faster and much better. Steve also just mentioned that in the initial tests, we have taken an accelerated aging approach which these are also the message that regulators will challenge us on, to say, you know maybe you should also consider other simulation environments, right. So in a way, it doesn't surprise me that if you, let's say in the U.K., this sample test was done and I find it encouraging that no VOCs were found, right. But as I have not seen the raw data of the test, I mean not me, not personally of course, but our specialists, we cannot just draw conclusions on such a high level statement. We need to go into the reads of that assessment. But rest assured that we are throwing all our analytics capacity to this because clearly we need to characterize the risks and hopefully also come to insights that the worst-case approach was indeed what the word says, worst-case. Then the repair and replace split, when we built the provision on the basis of our estimates of repair and replace, we assumed approximately 60/40.

Two-thirds, one-third.

Two-thirds. Thank you, Abhijit. Two-thirds, one thirds of replace versus repair, right. And part of the 806 approval that we need from the FDA relates to the repair procedure and not just to the repair material, right. The repair procedure needs to demonstrate that after repair, you have a safe machine, right. So, you can imagine that the amount of work that you need to do on a repair action is also to validate that after the repair, the machine is good to use. And if you give the machine back to the original user, the standard there is lower than if you give a repaired machine to a different patient, right. So all of this goes to the complexity of the repair process. And if we are optimistic, then all our proposals on the repair procedure will work out and then the proportion of repair can actually go up, right. And we have also heard from DMEs, the distributors that they actually prefer repair over replace in many instances. And you can imagine, you can make your own interpretation why they want that, but I think it's quite obvious. Then the revenue impact, right. So we are dedicating our production capacity in Sleep to the repair and replace action, right. And that takes also then into account it's assumed proportion of repair and replace of replace two-thirds, repair one-third. If we can go faster there, of course, that would be helpful. But for now, we have taken into account that we would lose the revenue for at least 12 months after the start of the field action. And Abhijit has, I think, at some point already said that or we have said that the Sleep business is €1.1 billion, of which approximately 60% is systems and 40% is masks and consumables, right. So then you can do your math and take out 60% of the systems as lost revenue. And of course, we compensate that lost revenue by strengthening our other businesses. On your last question, we believe that in 2022, we can maintain our Capital Market Day guidance of 5% to 6% revenue growth and 60 to 80 basis points of profit expansion.

Very fair. Thanks, Frans.

You are welcome.

The next question comes from Ed Ridley-day from Redburn. Please state your question.

Hi. Good morning and thank you for the detailed answers. One follow-up please on cost and obviously related to supply and freight. We have heard that some of your peers who have reported regarding the rising costs, particularly with freight. Abhijit, can you speak to that a little? And while it seems that second quarter wasn't too badly affected, how do you see that panning out over the third and fourth quarter both, as I say, with regards to freight but also electrical components? Thank you.

Yes. Ed, the second quarter was affected. Now we have offset that with the productivity program, right. So the freight costs are at a heightened level in the first half. We will also continue in the second half. But we are trying to mitigate as much as possible through our productivity programs. So that's why you don't see a big dent in the overall profitability. So if you look at, but also in the e-components, we have been hit by higher spot buy prices which is also impacting profitability. But we try to offset that and a little bit more through productivity so that the profit trajectory keeps improving. That's how you should look at it. And in our guidance for the year, I think we have taken all these factors into account.

Thank you. And just one quick follow-up, you gave us some color on the growth in BioTelemetry. And I don't know if you can give us more color on the growth that you are seeing in that business this year?

They still remain strong. Actually, they performed slightly better than the plans that we had when we acquired the company. So both are in strong double digit territory with good profit expansions. So, so far we are very pleased with the way it's progressing.

Maybe that's a good segue also to mention that early indications are that CMS comes out with an upward reimbursement on part of the monitoring in the mobile continuous monitoring. The MCOT, yes. Sorry, I got the abbreviation wrong. Whereas, let's say, some analysts are worried about our reimbursements being cut. Here actually on MCOT we see the opposite, with a small, let's say, increase, but at least it can put some worries to rest. Of course and earlier in the year we already saw that the long term holter was reinstated as a reimbursement. So overall, the platform of BioTel looks very exciting and we are adding, let's say, therapies to it. We are growing this internationally. It looks very good.

Great. Frans, thanks very much.

The next question comes from Julien Dormois from Exane BNP Paribas. Please state your question.

Hi. Good morning Frans. Good morning Abhijit. Thanks for taking my questions. I will actually try to give you a break from the sleep care business. Could you just help us understand what was at stake in the margin trajectory for D&T in Q2, because when I compare the margin achievements to 2019, the gain you posted in Q2 was significantly below the gain you posted in Q1? So I am just curious whether there is a phasing issue here or anything related to the product or the geographic mix maybe?

So tell me once more, Julien. When you say, you compared D&T?

Yes. The margin in D&T, in comparing that to the last normal year, if I call it that way, which is 2019, if I am right, the margin gain was about 100 bps in Q2.

Yes.

While it was 250 bps in Q1. So it seems you can see it also. I am just curious whether there is something here? Or it's just phasing in the business.

I think agree you should look at it as primarily phasing. I think, overall, for D&T we are on a very good trajectory. You see that the bulk of the growth, of course, that comes, is in equipment sales. So that, to an extent, comes at a lower margin than the service business. So the disproportionate growth in equipment has a slight dampening effect now. But of course then, going forward, once we get the service contracts, you see then that the overall will keep improving.

And Q1 2019 was relatively low, right.

Yes.

Okay. Thanks for that. And maybe just as a follow up in the broader approach or your discussions with hospitals at this time and maybe on a geographic basis, how do you see things evolving? I mean, you obviously posted a strong order book development in Q2. But how would you qualify the current discussions you have and how willing the hospitals are from spending more on CapEx?

A great question, Julien. Look, hospitals are in much better shape than half a year ago. Elective procedures are back. Hospital finances are improving. Backstops are being put in place. So we have seen a strong willingness to invest. And that, of course, represents itself in the 29% order growth in our D&T business. Much of that is market. Although, we don't have market share numbers for Q2 yet, but I would expect perhaps some market share increase, but it also generally reflects the strength in the market. Besides capital equipment, we see strong interest in telehealth and informatics. So that is also tracking very well. The stockpile programs that we referred to is more with regards to acute care and ICU-related equipment, especially patient monitoring, which is good for us given our market-leading position there and higher margins. The geographical angle is basically, all three market clusters for Philips do very well. So we see strength across the world, North America is particularly strong. But Europe's strong. Asia, China are strong. And I would also say, hospitals are now much better able to cope with the COVID pandemic. So it looks good. I think we are on a good path for the rest of the year.

Okay.

And I would like to also clarify that if you look at Q1, the growth in our sales from 2019 was about €134 million whereas in Q2 it was €54 million. So that also explains a bit the operating leverage between the two years.

Makes sense. Thank you very much.

Okay. Thank you.

Please limit your questions to one question with one follow-up only. The next question comes from Falko Friedrichs from Deutsche Bank. Please state your question.

Thank you. Good morning. I keep it to one question. It's on the share buyback program. So what led you to the decision to spend these €1.5 billion now for this program rather than use it for bolt-on acquisitions to strengthen your business? Is there simply a lack of good acquisition targets you currently see? Or what's the reason for that?

Yes. Hi. Good morning, Falko. Well, you know that in our Capital Markets Day, what is it, one-and-a-half years ago, we reiterated that in fact we have a balanced capital allocation policy, right. Now, what does balanced mean? Organic growth, M&A, dividend and share buyback. Now I have always said we will allocate a fair bit of capital to M&A and we did that, right. In Q1, we closed two acquisitions with approximately €3 billion worth of acquisitions, BioTel and Capsule. We continue to see good M&A opportunities. The share buyback program does not limit our ability to do acquisitions. In fact, it leaves us plenty of room for further acquisitions and bolt-ons and we have every intention to also continue to evaluate opportunities as we go, right. Now, the share buyback program follows previous share buyback programs. The size is about the same as what we have done previously and we have also astutely noticed the decline in the share price, right, which makes this an opportune moment to actually go into the market with a series of forward buys to take advantage of the situation, right. And finally, we can say that we have confidence in our ability to perform and to generate strong cash flow, strong profitability and therefore the share buyback program is a normal action in the sequence of things. And if you judge us over the last five to eight years or so, we have been doing this.

Okay. Thank you.

You are welcome.

The next question comes from Wim Gille from ABN ODDO. Please state your question.

Very good morning. This is Wim Gille from ABN AMRO ODDO. I have got two questions. First on, let's say, the provisions that you have taken here, about €511 million to-date. Can you give us a bit of a feeling how that number is split between repair, replace and any other cost, including legal and regulatory cost there? And as a follow up there, the ozone is clearly a part of the problem, the ozone cleaning. Is there a case to start legal action against the companies that have marketed ozone cleaning and try to recoup some of the costs that you are incurring for this thing? The second question is on the margins in Connected Care. If I look at kind of, you know, the revenue levels that we see in Q2 2021 versus Q2 2019 and then look at the margins, the margins are about 100 bps lower than two years ago. How should I look at it? Can you maybe split kind of the impact from the acquisitions that you did? And what's the impact on the margins that we currently see versus kind of the normalized levels in 2019? Thank you.

You want to take that?

I can take all of them. So the provision, as Frans mentioned, we have taken two-thirds, one-third on a repair, replacement basis. And in that we have not included any provision for legal cases, right. So, we are not able to estimate that. So, we cannot take any reasonable estimate at this stage. In addition to this, there are multiple other costs. A big chunk of that pertains to the whole communication cost, as well as the follow-up and managing the database that will cost us a lot of money. There is, of course, within each of those categories there is material cost, there is labor cost and all of that. So, it's quite an extensive calculation, but it does not include any cost taken for legal claims. On the margin split between 2019 and 2021, if you look, the sales levels are roughly the same, I think maybe €10 million more or so or €20 million more. If you take the percentage, 100 bps more. Maybe we should have made €10 million more profit. But as I explained earlier, there is a mix effect and there are certain fixed costs which you cannot reduce or, let's say, adjust out of the costs, which has a small dampening effect. So I think overall, if you look, Patient Monitoring continues to do extremely well and actually grows profitability. The acquisitions continue to do well. They were not in. They help to mitigate some of the lost sales in Sleep. So that's why you see, from a sales line, we are flattish. So maybe we are missing about €10 million and that could come largely from the mix.

And then on the question of the ozone manufacturers, really not this time and place to discuss our legal actions. Maybe somewhere in the future, when we have studied it more and we know more of the details.

Thank you very much.

Unfortunately, we only have time left for one more question. The last question comes from Sezgi Ozener from HSBC. Please state your question.

Hi. Thanks for taking the time to take my question. My question relates to, again, the first batches of repair and replacement kits that were shipped or already shipped out. As we are still waiting for the EUA to be approved, which material was used and are you able to estimate a cost based on the replacement and repair costs in these devices? And how do these compare to the €500 million, roughly, of provisions that you set aside? And my second question is about, we saw a few positive one-offs this quarter, like a remeasurement of environmental liabilities and the favorable results in legal matters. I was just going to ask if you could elaborate a little bit on both. Thank you.

Yes. Hi. Good morning. With regards to your first question, I am afraid you may be reading too much into the first batches of repair kits that were shipped. I called it bonded warehouse because it's an extension of the Pittsburgh facilities in a foreign location, right. That is the only way to do it under the regulations. And, yes, we are obviously not kind of measuring cost on a per batch basis. I mean, that would go too far, right. And certainly we have no intention to disclose the cost of every batch of repair kits. So sorry, I can't do much with your first question. The second one, I think, Abhijit, do you want to talk to the provisions?

Yes. I can. So, two things. We had a legal case for which we had taken a provision in Q3 last year and that case was actually ended up being withdrawn against us. So we had to release that provision. So that came as a goodie now. But it came as a hit last year in Q3. And on the environmental provisions, these are long term environmental provisions. We used to provide them on a 60-year basis and then you have to do a fair value calculation on those. And it causes a large amount of volatility given the change in interest rates. We have done an extensive benchmarking and actually most companies provide that for a maximum of 30 years. So in consultation with our auditors, we have aligned to the market practice and now we have it for 30 years. So therefore some of the provision was released. That's it.

Okay. And specifically against what were these, against what kind of environmental threat or risk were these provisions taken?

These are largely for businesses which we have sold actually many, many years ago, where there were factories and we had to do clean up in the land and those kind of things. So it takes years to do that and therefore you have to have a provision in your books to do those clean-up actions.

Thanks very much, Abhijit.

You are welcome.

Thank you, Mr. van Houten and Mr. Bhattacharya. That was the last question. Please continue.

Yes. Thanks very much, everybody. Look, I fully appreciate the concern around all the open issues. I want to assure you that we are on top of it, that we are taking all the appropriate actions to deal with the patient situation as fast as we can. In the meantime, the business goes on, right. There is a lot of resilience in our other businesses and that's also why we can maintain our guidance and we look with optimism to the future. I thank you very much for staying with us and covering us. Have a great day.

This concludes the Royal Philips second quarter and semi-annual 2021 results conference call on Monday, July 26, 2021. Thank you for participating. You may now disconnect.