Royal Philips (PHG 1.77%) is promising a turnaround from its bottom-line woes, which began with one of the largest medical devices recalls in recent history. The recall is a high-profile problem that has affected millions of patients in the U.S. and other countries for almost two years, and those effects have directly translated to the company's significant net loss.

Two major factors explain the softness in Royal Philips' 2022 results: the ever-expanding recall of its subsidiary Philips Respironics' ventilators and sleep apnea masks, and continuing supply chain problems in the wake of the COVID-19 pandemic.

Losses reflected on the company's 2022 balance sheet

There may be little the Netherlands-based company can do about component shortages, but the high-profile issues it faces due to defective sound abatement (noise reduction) foam in its breathing devices have no clear end.

In full-year 2022 results, the company reported an operating loss of 1.53 billion euros ($1.63 billion) on sales of 17.8 billion euros ($19.03 billion), with a 3% comparable sales decline that it attributed to "operational and supply challenges, lower sales in China, the consequences of the Respironics field action, and the Russia-Ukraine war." Comparable order intake dropped 3% year-over-year in 2022, compared to 4% growth in 2021. The decline was due to a double-digit decrease in Royal Philips' "Connected Care" businesses, which allows hospitals and other healthcare sites to share health data securely with doctors and nurses.

A wait-and-see approach

Not surprisingly, given all this turmoil, Royal Philips got a new CEO last October, Roy Jakobs. Jakobs has been with Royal Philips since 2010, serving before that as managing director of academic and government markets at scientific publisher Elsevier, and before that as a retail manager for Belgium and Luxembourg at oil company Shell. Royal Philips touts this varied resume as having given him experience driving "digital transformations in energy, scientific information publishing, and health technology in multinational companies," a hint at the company's aspirations for a digital future.

Jakobs vowed to help the patients impacted by the ventilator recall and address the component shortage, measures that he said will be "a step-by-step improvement journey supported by our leading market positions, extended customer base, meaningful innovations, ecosystem partnerships, strong brand and talented employees."

The market is taking a wait-and-see approach, with PHG stock price flat at around $17 since the Jan. 30 annual earnings statement. That can only be a relief for the company, which saw its stock price lose more than two-thirds of its value in the last two years, sliding from highs above $56 a share before the recall began in mid-2021 to a low of $12.65 on Oct. 1.

Person sleeping with a CPAP machine.

Image Source: Getty Images.

Not breathing easy with defective breathing devices

The sellers certainly had their reasons. In a Feb. 9 update on the breathing device recall, the Food and Drug Administration said it had received more than 8,000 reports of problems with them in the last two months of 2022, including 82 deaths. While the reports flooded in somewhat less rapidly than they did from Aug. 1 to Oct. 31, when there were more than 21,000 reports and 96 associated deaths, the lawsuits and other regulatory concerns the company faces are set to continue. Affected devices include ventilators for hospital patients who have difficulty breathing, as well as continuous positive airway pressure (CPAP) and bi-level positive airway pressure (BiPAP) masks for sleep apnea.

The central problem with all these devices involves the disintegration of sound-canceling polyester-based polyurethane (PE-PUR) foam in them, which can release toxic, cancer-causing volatile organic compounds. Since July 2022, Royal Philips has been defending a consolidated class action lawsuit by patients and their families in the U.S. District Court for the Western District of Pennsylvania.

On the positive side, Royal Philips said in its 2022 annual report that it had signed approximately 100 long-term strategic partnerships with hospitals and health systems in various countries over the course of the year, and pointed to the debut of a new ultrasound system and strength in its medical imaging and radiology segments. For 2023, the company is braced for a slow beginning but hopes to pick up steam later on from improvements in productivity and pricing. Leading in the end to "low-single-digit comparable sales growth and high-single-digit Adjusted EBITDA [earnings before interest, taxation, depreciation and amortization]." The company's reluctance to provide specific numbers even as an estimate is telling, as is the fact that the ranges it did provide exclude the possible effects of a proposed consent decree in one of the breathing machine lawsuits, other ongoing litigation, and an ongoing U.S. Department of Justice investigation.

Long-term investors may want to hold onto PHG shares since the company has such a major presence in the international medical device market. The cash dividend of 412 million euros ($440 million) paid to investors in 2022 should help them wait. However, it will require patience since the return to strong revenue growth is likely to be slow, and it remains to be seen if the company's focus on productivity and pricing can improve margins.