COVID-19
COVID-19 affected the company’s results, balance sheet and cash flows presented in these semi-annual condensed consolidated financial statements. The impact of the pandemic on significant accounting matters is disclosed below. Other areas have also been impacted, but did not have a significant impact and are therefore not separately disclosed.
Use of estimates
In preparing these semi-annual condensed financial statements, IFRS requires management to make judgments, estimates and assumptions. As a result of the uncertainty associated with the nature of the COVID-19 pandemic, and in line with existing policies, the company regularly updates its significant assumptions and estimates to support the reported amounts of assets, liabilities, income and expenses. In relation to those areas of judgment and estimates as disclosed in the Annual Report 2019, those primarily impacted by COVID-19 include impairment tests, measurement of financial instruments and the fair value of acquired identifiable intangible assets, contingent consideration and investments based on an assessment of future cash flows. In addition, valuation of inventories has been identified as an area of significant judgment. A further discussion of these significant judgments and estimates is included below.
Other significant estimates and judgements made by management in applying the company’s accounting policies and the key sources of estimation uncertainty not mentioned in this note were the same as those applied to the consolidated financial statements as at and for the year ended December 31, 2019.
Impairment testing
Impairment testing of goodwill and intangible assets not ready for use
Goodwill and intangible assets not yet ready for use are not amortized but are tested for impairment annually and whenever impairment indicators require such testing. For the Image-Guided Therapy cash-generating unit (CGU) and a number of other smaller CGUs, such indicators were identified as at June 30, 2020 because of deterioration in the economic environment or market in which these CGUs operate. Factors resulting from the pandemic that the company considered primarily included a decrease in demand and increased costs or business interruptions due to supply chain issues.
For those CGUs for which an impairment trigger was identified, an impairment test was performed at June 30, 2020. In determining the recoverable amounts, consideration was given to the uncertainties embedded in the discounted cash flow projections and the appropriateness of key assumptions used in light of the pandemic, which included increased uncertainties around forecasted revenues, higher volatility in applied discount rates and other factors. Further details on these impairment procedures and the results thereof are disclosed in Goodwill.
Impairment testing of non-financial assets other than goodwill, intangible assets not yet ready for use, inventories and deferred tax assets
Similarly to the above, for certain non-financial assets other than goodwill, intangible assets not yet ready for use, inventories and deferred tax assets, the changes in the economic environment provided an indicator that the carrying amount of the asset may not be recoverable. Uncertainties in the market and volatility in the financial markets resulted in increased sensitivity in both the value-in-use calculations as well as in determining the fair value less costs of disposal of such an asset. Further details on the results of these impairment procedures are disclosed in Intangible assets excluding goodwill.
Impairment testing of financial assets
The company recognizes an allowance for expected credit losses (ECLs) for trade receivables, contract assets, lease receivables and debt investments carried at fair value through Other comprehensive income (FVTOCI) and amortized cost. In line with the accounting policy disclosed in the Annual Report 2019, for all financial assets to which the company applies the simplified approach, an updated assessment was made on the lifetime ECL allowance. In addition, for those assets to which the company does not apply the simplified approach to measuring ECLs, an assessment was made whether a significant increase in credit risk was observed. In those instances, the allowance was updated to also reflect lifetime ECLs.
In making these assessments, all reasonable and supportable information was taken into account. Indicators identified included counterparties breaching their agreed payment terms, counterparties requesting extended payment terms or (partial) waivers and a deterioration of the credit rating of a counterparty. Because of these triggers, relevant financial assets were separately assessed and additional ECL allowances were accounted for in those cases where deemed necessary. The overall impact of the increase in the level of ECLs did not have a material impact on the company’s financial assets. The company further concluded that none of the agreed changes with counterparties resulted in a substantial modification of such instruments under IFRS 9 Financial instruments.
Fair values
Certain of the company’s financial instruments and other assets and liabilities are carried at fair value. The fair values included in these semi-annual condensed consolidated financial statements reflect market participant views and market data at the measurement date under current market conditions. This implies that due to the increased volatility and uncertainty in the financial markets, these fair values are subject to significant estimates, in particular for assets and liabilities for which the fair value is based on unobservable inputs (sometimes referred to as Level 3 measurements). Expectations around future cash flows, discount rates and other significant valuation inputs related to the asset or liability as at June 30, 2020 have become subject to a greater level of uncertainty. The fair values determined taking into account this increased uncertainty have been reflected in the Condensed consolidated balance sheets as per June 30, 2020.
Property, plant and equipment
In addition to what has been described above in terms of impairment testing of non-financial assets, the COVID-19 pandemic triggered a significant increase in demand for our products mainly in the Connected Care businesses. As a result, investments were made during the half-year ended June 30, 2020 to allow the company to meet this demand. These investments include, amongst others, additions to existing production lines, establishing new production lines and investing in company-specific tooling used in the supply chain. Assessing the useful life of these new investments includes a significant amount of judgment, due to the volatility in the demand forecast impacting the expected period over which these assets will be used. In certain cases, this has resulted in new machinery and installations being depreciated over a useful life that is less than three years. In addition, the volatility in markets in general increased the level of judgment involved in determining the residual values of certain of these assets.
Employee benefit accounting
COVID-19 affected the company’s long-term employee benefits, including defined-benefit plans. Volatility in the financial markets following the COVID-19 outbreak resulted in an increased volatility in key parameters used in determining these benefits, including discount rates, mortality rates, retention rates and other expectations supporting the actuarial calculations. For our funded defined-benefit plans, increased volatility in the fair values of the plan assets during the half-year ended June 30, 2020 meant further volatility in the net obligation.
We assessed whether the above volatility in assumptions resulted in a material change in the company’s balance sheet position for long-term employee benefits. Based on updated actuarial results, we concluded no material change occurred as at June 30, 2020.
Inventories
The company’s inventories are stated at the lower of cost or net realizable value. In determining the appropriate level of provision for obsolescence, changes in the aging of inventory items in certain businesses and markets due to COVID-19 were taken into account, primarily within the Personal Health businesses segment. In addition, current and potential excess stock levels were analyzed, incorporating revised expectations of future demand for these items. No material change in the provision for obsolescence was identified as a result of these procedures.
Due to the changes in demand and therefore production levels within several of our businesses, the company evaluated its standard cost prices, in particular in relation to the absorption of overhead costs and additional costs. The company assessed, based on currently available information, that the change in demand and production levels is not expected to be a sustained change and therefore the standard cost prices were not updated relating to those elements.
Taxes
In response to COVID-19, many governments have changed tax policies aimed at deferring tax filings and payments, providing tax relief, and offering financial assistance. The company assessed the impact of the legislative changes and concluded that apart from applied payment deferrals on corporate income taxes and other taxes/levies, there is no material impact.
Treasury and other financial risks
Philips is exposed to several types of financial risks. In terms of liquidity risk, the company has taken a number of different measures to manage this risk. Apart from the successful placement of EUR 1,000 million fixed-rate notes in March (of which EUR 500 million Sustainability Innovation notes), the company also completed the remainder of the EUR 1.5 billion share buyback program through individual forward contracts, with settlement dates extending into the second half of 2021. In addition, the 2019 Annual Incentive of the Board of Management was settled in shares instead of cash, and the Extraordinary General Meeting of Shareholders held on June 26, 2020 approved the distribution of the final dividend out of the profit of 2019 to be made in shares only. Overall, the company has a solid liquidity position and the company’s liquidity risk management procedures have not changed significantly because of COVID-19. No significant concentration risks have been identified as a result of COVID-19 and the company continues to have access to its existing lines of credit as disclosed in the Annual Report 2019.
In addition, Philips is exposed to other financial risks as disclosed in the Risk management note.
Seasonality
As reflected in the semi-annual management report, COVID-19 affected the company’s business results significantly during the six-month period ended June 30, 2020. Under normal economic conditions, the company’s sales are impacted by seasonal fluctuations, typically resulting in higher revenues and earnings in the second half-year. At Diagnosis & Treatment businesses and Connected Care businesses, sales are generally higher in the second half-year, largely due to the timing of new product availability and customers attempting to spend their annual budgeted allowances before the end of the year. At Personal Health businesses, sales are generally higher in the second half-year due to the holiday sales and events. The segment Other is generally not materially affected by seasonality; however the timing of intellectual property transactions causes variation over the year. With the continued uncertainty for the remainder of the year, we expect that the normal seasonality patterns will be affected.