Alcon Inc. (ALC) Earnings Call Transcript & Summary

Thank you for joining us for the fourth day of the 2021 Morgan Stanley Healthcare Conference. I'm Cecilia Furlong, medical device analyst and a member of the health care research team here at Morgan Stanley. It's my pleasure to have Alcon with us today, David Endicott, CEO and Director; and Tim Stonesifer, CFO. And before we begin, I'll run through our disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, David, Tim, thank you for joining us today.

Thanks, Cecilia. It's been a pleasure to be here. A couple maybe just introductory remarks, if I may. I think we're really pleased with the quarter. I think it was strong growth, and it was largely driven by demand for new innovations. And our thesis kind of from the beginning after the spinout was if we could get the R&D engine moving, we could drive revenue. If we drove revenue, we could drive leverage and that ultimately is the plan. We're starting to see that kind of as we'd expected come through. So we had certainly new innovations driving revenue but also a very good solid commercial execution, and at a high level, that's coming from our lenses, in particular. So our presbyopia correcting lenses and U.S. contact lenses were leading the growth directionally. Our new product, Vivity, has been a real positive for us, seems to be additive to our PanOptix business. PRECISION1, the sphere and the toric now out are giving us a lift, I think, in the DAILIES SiHy business. And obviously, we had a nice quarter on equipment, which was a little bit of a surprise to us, but I'd say that a nice positive that goes along with the other underlying positive performance. The growth in the markets were a little bit slower than we expected outside the U.S., but the U.S. was very solid. So I think more than making up for the international slowness, and I do think there's going to be an ongoing, I would say, varied rate of recovery outside the U.S. We anticipate though that as we get through this year, 2019 levels of revenue should be achieved in the markets by the end of the year, but that will probably be a mix of the U.S. overachieving the back half and the international groups underachieving with international probably coming back more early next year. So I think we feel good about where we are right, mostly because the share performance seems to be reading through even as the markets return a little bit more slowly than we had hoped for. But again, I think we're in a pretty good place moving forward. As a consequence, obviously, we changed guidance. We improved that a little bit. We took revenue from where we were to $8 billion to $8.2 billion, core operating margin to about 17.5% and EPS to $2 to $2.10, somewhere in that range. So I think we feel really good about the quarter, and we're off to a good start this year.

Okay. No, that's a great overview. And I want to just jump in on guidance. And you were talking about a bit weaker or slower recovery OUS, and you raised guidance despite really pushing out your expectations for OUS recovery. But I'm just curious kind of as you have seen Delta play out in the U.S., kind of how is your view on the recovery you can see in the U.S. over the next few quarters shifted, if at all? And has anything shifted in terms of how you're thinking about at this point? And the relative rates of U.S. versus OUS recovery as we look through the back half of this year?

Yes, it's a good question. And we've shifted like everybody has, expectations as Delta had come out. I think we've been relatively in the mainstream on what we thought was going to happen. We thought we'd see kind of by the end of last year back to 2019 levels, then we thought it was going to be middle of this year as the Delta variant slowed everybody around the world, but in particularly our international businesses. We have a very changing view that's going to take into next year before we're going to see 2019 levels. Now the U.S. is slightly different for us, and it may not be that case for everybody, but a lot of our business is done in ASCs. And so those ambulatory surgery centers are not shutting down during Delta like they did in the original April-May frame of 2020. And so in the United States, surgical business is much more stable, I would say. And I think we're benefiting a little bit from that. And this version of COVID is just being handled differently, I think, relative to our business. And again, I think Vision Care probably is still a little bit slower than we'd like. I would say that in the United States, the numbers were quite good in terms of the market. It was up mid-single digits or high single digits, I think, which is surprising, those are over '19, by the way. But I do think that the market for the United States is robust and will probably stay that way even though you're going to see that it isn't quite as good as it might be were we not in the -- going back through this Delta variant. Internationally, it just looks like it's going to be slower. And that's a combination of just -- there's a lot of markets that are in different places. Japan is still struggling. That's a big market for us. Eastern Europe is struggling. India, struggling. And then yet, there are other markets that are showing signs of life. And I think Europe in the June frame, I think, looks pretty good or look better, and I think we're encouraged by what we see there. So we'll see that. I mean Europe is a big market for us as well. So we'll watch those carefully. But just the nature of -- and complexity of international, I think, is going to drag that out into probably, we see it kind of right now as sometime beginning of next year, somewhere in the first half of next year, let's just say.

Okay. And you talked about in the U.S. specifically, site of care being a bit more insulated from some of the COVID dynamics that you'd see if you're in an inpatient setting. But this time around, this wave of COVID, what have you seen just from a patient reticence standpoint to really engage, even if it is an ASC setting versus what you saw play out in the first and second waves of COVID last year and into this early year?

Yes, I don't -- look, I don't think we're back to kind of normal behavior, if you will. And even in the United States, I just think that it's -- it's just -- there was a very dramatic shutdown of ambulatory surgery centers. And I think when the site of care in the United States is about 85% ASC, that is a big problem for us. That's just not what's happening right now. Now the patient reluctance, I think, is probably also in a much better place, partly because I don't want to say we're getting used to it, but I think most -- if you look at the vaccination rates amongst seniors and then you look at the preparations that most of these offices have taken and are kind of portraying to folks, there is -- I think there's still a small reluctance, but I do think that cataracts are things that are kind of significantly affecting quality of life. And so to a large degree, that part of our business is recovering nicely. I wouldn't say recovered per se entirely to where it might be, but it is better than '19 at this point and continuing to grow in the back half. Outside the U.S., slightly different because, of course, it's hospital-based -- largely hospital-based. And I think we're -- we don't see the same kinds of capacity and interest in trying to get that back open in a way that is as easily accessible to seniors as it might be in other markets. But I do think that you're seeing some -- as vaccination rates go up, you're seeing more increasingly -- increasing willingness to kind of take care of things that they have wanted to take care of for some time. I think we've lost 1 million cataracts or so in the United States. And I think we've talked about something on the order of 6 million outside the U.S., albeit there's a big bunch of those in India and a couple of developing markets. So I think there will be -- as we've said in the past, I think there'll be a slightly warmer-than-normal growth rate over some stretch of time. You just can't recover all that, and a [ bolused ] capacity doesn't exist to do that. But I do think that you're going to see a nice, steady growth in the market that is probably a little bit better than what we've traditionally said was a 3% to 4% growth market. It could be 4% to 5%. And that, again, is going to be positive for the next several years.

Okay. I also wanted to ask, your second half margin outlook, you updated your operating margin guidance 17.5%, but implied margins stepped down about 100 basis in the second half versus the first half. You called out 3 main drivers: increased investment spend being the primary driver, but also sales mix and anticipated inflationary pressure. I'm just curious, what have you seen from an inflationary pressure standpoint since the time of your guidance? And have your projections around the relative impact of the 3 drivers shifted since the time of your 2Q print?

Yes. I don't want to get into inter-quarter movements. But to your point, those are the 3 pressures that we're seeing in the margin. So you're absolutely right. We're going to continue to invest behind these new launches in the second half. So you're going to see about half of that pressure, that point that you were talking about, that's going to show up in SG&A. So that will show up in the overall margin rate discussion. And then the other half is really to your point, inflationary pressures, which we're seeing like many other companies. We're seeing it in labor. We're seeing it in freight. We're seeing it in some of the raw materials, if you think about resins, the impact on microchips and just getting those has been very challenging. So we are seeing some pressures. We saw some pressures in Q2 as we talked about. We were able to mitigate those, but we're not anticipating being able to mitigate all of the inflationary pressure in the second half of this year. And then there's a little bit of a mix pressure as well. So we continue to monitor it very closely. It's not a material impact at this stage. But as I said, the teams are working diligently to try to get the right material in place and make sure we don't have any supply chain disruptions, and we'll keep you posted if we see any change to that view.

Could I also ask to just provide an update on your ophthalmology sales force buildout and additionally, further expenses you'd expect as you scale the team over time?

The ophthalmology sales force and the cost of that are really not material for this year. I mean, we've anticipated it and included it in the guidance as we've reflected on it. I think the exciting part of that build-out was we needed to get to the prescribing audience that -- to prescribe Pataday as a prescription product and that has the potential to affect probably about half the market of artificial tears. And so direct marketing to ophthalmology, general ophthalmologists or people who do primary care ophthalmology was a big part of our strategy for our eye drops business. And that eyedrops business, we think, is a nice growing market. It's kind of a 5%, 6% growing market that we have a very substantial share in. But today, it is only about 25% preservative-free, and markets like Europe and international markets are largely 50% or 60% preservative-free. So we see a significant opportunity to change that market dynamic and move to a more preservative-free formulation. We're launching 2 or 3 products in those areas that are going to be preservative-free. And we know that the ophthalmologist is going to be the primary idea behind that. So the Simbrinza acquisition was largely just an economic play for us to deepen the bag. We know that product. We make that product. It gets us back into glaucoma, which is interesting for us. We like that space. And it gives us 3 eyedrops to sell in the office, making that critical mass very economical for us. Product has 8 years of patent life, sells $50 million a year. So the deal itself to us was very profitable. We feel good about where we're going with that as a consequence because it accomplishes what I think strategically we want long term, which is we want to get back in ophthalmology and make sure we're taking advantage of the eyedrops market that's there, but we also have some near-term stuff to do around making sure we can build-out -- economically build-out a sales force. So we see that as a real positive.

Can I ask, too, just why now? What made the most sense at this stage of the business, as you've continued since the spin to really refocus in this area, bring the sales force on? I'm just curious kind of what drove your decision to really move now versus some time in the future?

Well, it's just a practical thing really. I mean it was -- we had the products ready to go. We got the preservative-free product approvals, I think, early this year -- late last year and early this year. We've been looking at how to get those to market. We really had a -- as we finished up a lot of the separation work, it also frees up a lot of opportunity for us to do other things internally. And I do think that, over the long stretch, this is -- it's not a distraction to us really because we've got -- this is a very small part of our business what we're doing, what we're talking about right now. The device businesses are very substantial to us. And again, I don't think we believe this is going to be anything other than an additive kind of vector against which -- again, long term strategically, right, there's $20 billion of pharmaceuticals sitting in every office we walk into. So again, we'd like to participate in that. We want to be smart about how we do it. We're not anxious about it, but we had products already ready to go. So we thought we should start that process now. We'll be careful about how we move forward.

Okay. I wanted to ask to, just turning to AT-IOLs. You've talked about, as of your last call, having over 80% PC-IOLs share in the U.S., up from over 75% as of your last call, over 55% globally. Just looking forward, how much further share capture contributes to your growth as you look out today versus overall PC-IOL market expansion?

Well, I think as you go forward, it's obviously going to -- more and more, we're going to be leaning on expansion because, I think, in the United States, the share will inevitably come down a little bit because you're going to see some competitors launch and we anticipate people will use those products as they do in other markets. But I do think that fundamentally, we're in a very different position than we were when we went into Europe, for example, with PanOptix the first time. We were third or fourth in depending on the market and then we became #1. Coming into the United States, we were the first in, and we obviously garnered a great deal of share. So I suspect we'll find that we hold that share much more successfully than some of the other markets who had to climb back into that share position. But I would say that Vivity has given us kind of a new view on -- we've solved the problem that has been a big issue for physicians, surgeons who want to use AT-IOLs, but haven't really been comfortable with the halos and glare for their patients. And -- so we think that, that is largely additive to our PanOptix business. And PanOptix still hasn't been -- we haven't got the toric in China. We haven't launched Vivity in China or Japan yet. We've just gotten Vivity out in Europe really in the last year. So I think you're going to see, we can grow share probably for several years in aggregate. It may not be in the PanOptix brand. It might be that Vivity is adding to it. But we'll see, I think, overall, that we have good share opportunity, good market growth in this. And by market growth, I mean, just simply people are moving nicely into AT-IOLs, and there's plenty of headroom there. And then the penetration has been more positive lately than we thought. And I've been a little bit careful about articulating penetration as a definitive view because historically, it's always been it bounces up when you launch new products and then it kind of settles back a little bit in the future years. We're seeing kind of a different look right now. And it may be that the denominator is not correct because, of course, we're still missing a lot of cataracts that are going to be monofocals. So if you think about adding that back in, it would change the percentage rate. But we are also seeing changes in the complexion of individual practices. So surgeons who used to do 30% of AT-IOLs are now doing 35% or 40%. And I do think that's real. So there's a sense that penetration is moving to our advantage. I do think that Vivity makes a big difference in this. And I do think that we'll see an increasing amount of advanced technology lenses going forward, and that will contribute, to your point, a good bit more growth than perhaps it has in the past. Remember, 1 percentage or 100 basis points of penetration is worth about $100 million to the market as you go forward. So this is -- we think today, I think the global number is 10%, U.S. is 17% in terms of penetration. This is a multibillion dollar kind of transition if we move from monofocal to these lenses over the next many years, I would say. We are excited about the next 3, 4, 5 years with AT-IOLs.

I wanted to ask, too, monofocal recovery being a little slower in some markets. You talked about obscuring kind of your visibility on to kind of what's happening on an underlying level? But as you speak with physicians, are these trends -- we've seen it seems like more patients opt for PC-IOLs. But is this more of a COVID-driven kind of dynamic at play? Or as you speak with physicians, is this something that they view as a durable trend? And also on top of that, just are you seeing patients be the drivers of this more so than the physicians? Just curious how you're seeing that kind of play out all of those dynamics throughout COVID.

Well, all of them, I think, play a part. And I don't know how to dissect them exactly, but I think every one of those is in a positive frame. I don't think any of those that you mentioned are moving the wrong way for us. So I would say that my opinion, again, I'd be careful with this because it's just an opinion. But I think as we talk -- I came out of the American Academy of Cataract and Refractive Surgeons listening to surgeons talk about using Vivity and PanOptix more than they used to, and I don't think -- and I think patient -- we've always known that the patient headroom for wanting advanced technology lenses was much higher than the actual rate. We've had a hard time convincing some surgeons to offer those lenses because they weren't comfortable with the follow-up requirements and some of the challenges that they've had with halos and glares in some patients. And -- so I think that what you're hearing is much higher confidence in outcomes in both of our lenses, and I think that's driving the surgeons more than anything else. Because I think the patient desire has always been there. If the surgeons were willing to really represent it, right? And I think that is increasingly a positive for them. But is this a COVID phenomenon? It's hard to say it's not. Because people have a little bit more money than they had last time around. People have a little bit more time on their hands to kind of think and research. The marketing is much better than it was in those days. And so I think we're seeing a combination of things that are moving the market correctly. Again, I would be sanguine about how fast this is going to move. I don't know that it's really -- it's not going to take off on us. I do think that it could be moving a little bit faster than it has historically. I think that's probably what we're seeing.

And Vivity, to your comments on just what you've seen transpire since launch, some of the areas of upside that you would highlight versus your expectations as you walked into this launch? And you've talked about it largely being additive also to PanOptix. So I'm just curious, as you look back at launch time versus what you're seeing in the market today where it's being adopted, what are the biggest differences that transpired?

Well, I don't -- I think it's gone pretty much as we had expected. Now to be fair, we were very patient with that launch. I mean we actually had it in Europe for almost a year before we launched it anywhere else. We were very careful with it. We only probably introduced it to 100 to 200 surgeons. But we collected data very carefully. We repositioned that product very carefully. And I think we knew there were going to be 2 buckets of patients that were opportunities. They both turned out to be true. One is that if you take 10 patients who might come into an office that were eligible for an advanced technology lens, probably 3 of them had a comorbidity that was problematic in a way that the doctor would not want to use one. So that means retina disease or an irregular cornea or a refractive surgery before. These -- because this is a nonrefractive lens, it actually is suitable for patients like that. So that has added patients in who would have been excluded before. Additionally, I think there's been this halos and glare phobia from some physicians who just don't want to deal with that 1 or 2 in a 100 who can't tolerate it and they have to take the lens out. That's -- that was an unacceptable level of outcome for some doctors. And those surgeons basically now are saying, look, I can use Vivity and get a great intermediate vision and about half of them are spectacle-free, and that's a terrific outcome, and I don't have to worry about halos and glare. That's all of a sudden brought some new patients who were fussy who they would exclude from these before and also some new docs in. So I think those buckets, if you will, of folks we had always thought would come to us, I think it's been a little bit better than we thought in terms of just being additive. We were a little bit afraid in the beginning that we'd see a little bit more cannibalization, we assumed that actually. And we haven't seen quite as much. We're seeing some, of course. But I think what you're really seeing is upgrades from our monofocal torics. You're seeing new patients come in and you're seeing a few new docs coming into presbyopia-correcting lenses.

Okay. I wanted to ask just on turning to contact lenses, DAILIES TOTAL1 toric. You've talked about a limited launch in the U.S. this fall, followed by a full market launch really in 2022. But as we look to 2022, how much of an accelerant to your business and really DAILIES TOTAL1 adoption in the toric launch drive?

Well, I think the way to think about next year is we have a number of products that are either kind of into launch phase or just beginning. And I would say that DAILIES, in particular, and DAILIES toric, in particular, are a big deal to us because we started with kind of a 0 share. I used to -- I've joked this a little bit around, which is there's no place to go but up for us. We never -- we don't have DAILIES SiHy toric until now. Now we have 2. So I think we are in a very good position to gain share in the toric space. But I would broaden that expectation a little bit because I think our intent right now is to continue to maximize PRECISION1 sphere, which has done very well. The PRECISION1 toric has done very well. DT1 toric, we expect to do quite well because it's our best product and now its toric version, which people have been waiting for, for 7, 8 years. And then we're launching our Total 30, which is -- has got all the water gradient effects of DAILIES TOTAL1, but in a monthly lens, which is, a, more economical, and b, 2/3 of patients -- or about 60% of patients start in a monthly lens. So on a market basis, we've got a lot of products entering that are now going to have an opportunity to build share in all the categories we'd like. So again, I'm excited about the aggregate view of DAILIES, in particular, but also in our Total 30 launch. Now again, we're seeing such response that we're going to have to look at capacity again, and we may stagger these launches along the way here just to make sure that we can keep up with demand. But we're doing a great job, I think, of [ guess ] that we've given in the past.

On Total 30, too, just getting into that, the reusable segment of the market, you've talked about $4 billion market today, limited high-teens market share. As you look about at the launch and kind of the trajectory post launch, where can your share go longer term? And then just kind of a market question as well, but how do you look, at least from your standpoint today, just the segment of contact lenses going forward split between dailies and reusable, just -- what are the drivers one way or the other where you expect to see growth over the longer term?

Well, let me take that second one part first. I mean, we expect DAILIES to continue to be the preferred product. We're going to stay in that space. We launched all of the products first into that space that we had because we know that's where the growth is. And so we have always prioritized growth in that segment first. So we're going after specialty lenses, DAILIES and DAILIES SiHy, in specific. So that's PRECISION1, DAILIES TOTAL1 toric and PRECISION1 toric. So we expected that the reusable market will continue to be flattish to declining around the world. And I think we'll see that DAILIES is going to continue to grow back where it used to grow in that 6-plus range for value. And so with that shift in mind, and that's principally because they're more convenient, they're healthier for you. They are better. Patients like them better. Docs make a little bit more money selling them. So all the arrows kind of point towards continued DAILIES expansion, which is great for everybody because there's plenty of room for everybody to grow in that space. We have had -- one of the big things we've been trying to do since we spun out was rejuvenate the whole of the product line. And so our Vision Care business, in particular, was tired. We had a lot of older products, which really haven't had much promotional intensity behind them because they weren't real sensitive to it. So you take a product like AIR OPTIX, which was quite large for us that used to be the #1 reusable lens out there in the market. But again, refresh that product in forever. So for us, that was a pretty big anchor in a category growing negatively losing share. So that -- we needed to do something about that in order to allow for growth in the whole of our Vision Care business. Now what we've done is we've created an incredible technology, leverage off of DAILIES TOTAL1 that gives us that kind of a water gradient surface, which uniquely can make people feel as though on that 30th day, after you've been scrubbing that lens, even though the -- and most lenses will accumulate deposits and feel scratchy, we still feel like in that 30th day, it feels like the first day you put it on. So I think we feel really good about what we can do to improve the wearability of a reusable lens. That's not going to change the world, and it's not going to change the reusable to DAILIES move, but it will change our share. And so I think what we're trying to do is go get some of our share back. This is very good margin for us, and it's a real upgrade to our AIR OPTIX business.

Okay. Last few minutes. I wanted to ask about equipment. We've seen strength there. And part of that you've highlighted, stemming from centers looking to expand their capacity to capture pandemic-driven procedure backlog or higher consumer discretionary spend. But just from a long-term capital sales outlook, how are you looking at capacity in the field today and the potential impact on future capital demand?

Well, look, I think it's been encouraging to see that capital didn't go the way we thought it was going to go. So I was wrong on this one from the start. I mean, we assumed that hospital budgets would get tight, that there would be reluctance to invest and that was built off of our experience kind of in the 2009, 2010 frame, kind of coming out of that period of time that was difficult. And we saw a big contraction of refractive in that stretch. And we went from 1.5 million procedures down to about 700,000 in the United States. We've seen the opposite in both of those circumstances. What's been weird is that refractive surgery for us is just, I mean, it's just booming. I think it is for everybody. The procedural growth is substantial, but the equipment growth was what was surprising. There's a lot of footprint in the United States that we've had -- we had very good uptake in -- we're kind of -- we're the world leader in refractive surgery, people forget that. But it's not a big part of our business. It's a smallish part of our business. But half of our growth was in refractive in our equipment category. So if you look at the growth year-on-year -- sorry, '21 over '19, it is really half of refractive surgery, which was all in the expansion of footprint. That's people getting back into refractive surgery. Now I don't think that continues because we've always had a pretty -- we'll have an upgrade process for most of our aging equipment. But people buying new equipment and new centers is unusual, and I don't think it continues. I think, overall, that's probably a headwind going forward into the future years as it begins to stabilize. So I think you're likely to see -- and again, I'm not trying to be too pessimistic, but I just think realistically, seeing a 23% growth over '19 in the second quarter is a big equipment number. I think much more likely to be a headwind going forward than a tailwind, but we'll see. It's a very interesting time. The reason I say we'll see is because it may be that our mix shifts, so it could be that refractory comes over the top, but cataract continues to grow because we're seeing a really strong response to our new cataract equipment, which again is the world's leader in cataract and retinal machines. Again, we had an amazing growth in our base business of Centurion and CONSTELLATION. We're very excited about what that's continuing to do with our fluidics. Our machines today are unsurpassed by anybody in the world and will continue to be for many years to come, and people know that. So the surgeon community continues to buy what we have sold to them, which is superior fluidics, superior safety, best efficacy out there. I think that's, I think, unchallenged at this point.

Okay. I know we're out of time, but I wanted to thank you all, Alcon team, for the time today. I appreciate getting to have this discussion with you. And thank you.

Yes. Thank you, Cecilia.

Thank you.