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Phillips (PHG) Reports Dismal Q2 Earnings on Weak Operations

Koninklijke Phillips Electronics N.V. (PHG) reported net income of €243 million ($328.54 million) in the second quarter of 2014, compared to €317 million in the prior-year quarter. Phillips reported second-quarter earnings of €0.26 (35 cents), a decrease from €0.35 (47 cents) in the second quarter of 2013.

The year-over-year decline was primarily due to lower operational results, adverse currency impact and the ongoing sluggishness in the key markets among others. The company had also made a voluntary suspension at its Cleveland healthcare production facility in the prior quarter which remained a headwind in the quarter.

Quarterly Details

Revenues for the quarter declined 6% to €5,293 million ($7,156.14 million). On a nominal basis, the group sales declined 6% year over year, whereas revenues remained flat year over year on a comparable basis.

The company reported adjusted Earnings before Interest, Tax and Amortization (:EBITA) of €225 million ($304.20 million) or 10.5% of sales compared with 17.8% in the prior-year quarter. The growth was driven by higher gross margin in the quarter.

Segment Details

Healthcare sales for the quarter were down 10% year over year to €2,137 million ($2,889.22 million). The segment revealed a comparable sales decline of 4% with Home Healthcare solutions increasing in mid-single-digit and Customer services in low-single digit. However, the Patient Care & Clinical Informatics reported a mid-single-digit decline along with a double-digit decline in Imaging systems.

The Consumer Lifestyle segment revenues declined 1% in the quarter to €1,073 million ($1,450.70 million). However, on a comparable basis, segment revenues increased 7% year over year aided by a double-digit growth in Health & Wellness and high-single-digit growth in Domestic Appliances. Sales in the Personal Care business remained flat year over year.

During the reported quarter, the Lighting segment’s sales decreased 5% year over year to €1,943 million ($2,626.94 million). On a comparable basis, segment revenues increased 1% driven by double-digit growth at Lumileds and Automotive whereas the Professional Lightning Solutions witnessed a low-single-digit growth. However, Light Sources & Electronics and Consumer Luminaires exhibited a mid-single-digit decline.

Revenues in the Innovation, Group & Services segment increased 1% to €140 million ($189.28 million), driven by the strong operating performance and increased royalties from the segment’s intellectual properties.

Geographical Growth

Comparable sales in the growth geographies increased 4% in the quarter on a comparable basis. The increase was driven by strong growth in Consumer Lifestyle and Lighting businesses especially in regions like Central & Eastern Europe, Middle East & Turkey, India and Africa.

The company’s growth markets exclude the U.S., Canada, Western Europe, Australia, New Zealand, South Korea and Japan.

The abovementioned geographies are classified as mature markets for which the comparable sales decreased 2% year over year. The decline was primarily owing to the sluggish performance of the Healthcare and Lightning sales despite an improvement in the Consumer Lifestyle sales.

Cash and Balance Sheet

Cash flow from operating activities came in at €487 million ($658.42 million), a significant increase from the prior-year’s figure of €141 million ($190.63 million). The growth was primarily driven by increase in the accounts payable coupled with the reduction in the accounts receivables.

During the quarter, the company’s cash balance decreased to €1,435 million ($1,940.12 million) from €2,307 million in the prior year.

Gross capital expenditures for the quarter were €128 million ($173.06 million) versus €145 million in the year-ago period, primarily due to lower investment in the Lighting business.

At the end of the quarter, Philips had a net debt of €2.3 billion ($3.11 billion), compared to €2.1 billion at the end of the prior-year quarter. The increase in the net debt was largely due to transactions related to treasury shares along with distribution of the annual dividend.

Business Update

On Jun 30, Philips announced that it will be initiating the process to integrate its Lumileds (LED components) and Automotive lighting businesses into a stand-alone company within the Philips Group. The process is scheduled to be completed by the second-quarter of 2015. The company expects the setup cost of about €30 million to be incurred in the second half of 2014. This restructuring is a strategic move by the company to attract investment into the business for driving further growth in LED luminaries, LED lamps and LED lighting systems and services. The business will cater to both professional and consumer markets.

Looking Ahead

Though the headwinds are expected to continue in the rest of the 2014, the company expects an improvement in adjusted EBITA. Philips remains optimistic about achieving its 2016 targets as per its Accelerate! transformation program, which was introduced to improve its overall performance and reduce costs for the company. The project is expected to be operational till 2017 and has five streams to enhance customer relevance, change company culture, reduce overhead costs, streamline the End2End customer value chains, and reallocate resources to profitable growth opportunities.

Zacks Rank

Phillips currently has a Zacks Rank #5 (Strong Sell). Better-ranked stocks that look promising at the moment include Enersys Inc. (ENS), Franklin Electric Co., Inc. (FELE) and Emerson Electric Co. (EMR). While Enersys sports a Zacks Rank #1 (Strong Buy), both Franklin Electric and Emerson Electric carry a Zacks Rank #2 (Buy).

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