Alcon Inc. (ALC) Earnings Call Transcript & Summary

Good morning, everybody. I'm David Adlington. I head up the European medtech research team for JP. It's my pleasure to introduce David Endicott, CEO of Alcon. There will be a Q&A session afterwards. The company has asked me to remind you that they will not be making many specific comments around FY '23, given that they want to talk about that at their full year results in February. David, my pleasure. Over to you.

Thank you, and good morning. Let me start by giving a quick overview of Alcon. And just for those of you who may not be familiar with this, Alcon is a leader in -- really in a specialty market of ophthalmology. We -- in eye care broadly, it is a really, I would say, kind of dynamic and important and very specific market. And I think we benefit a great deal from markets that are quite resilient. So when you look at health care and you look at priorities of government, when you look at people's investments in their own health care, eye care ranks way up on the top of the heap. Almost 80% of what you take in comes visually. How you process comes visually. Governments understand, I think, directionally that if you can improve the eyesight of many, particularly senior individuals, you can improve the productivity of that individual and also the collateral productivity of household members who maybe caregivers. We benefit a lot from the resilient dynamics underneath all this, of course. There's an aging western population, there's an increasing wealth in many markets. The incident rate of myopia is epidemic. It's now estimated about 50% of the world will be myopic by 2050. There are a lot of new technologies, unless you think this is kind of a commodity market of certain kinds of products. It's not. There is a tremendous amount of basic research and application science going on around the advancements of visual correction or the pathologies that are most common in the eye. Those technologies, obviously, are delivering over long stretches of time and investments, but we feel really good about where the progress that we're making is, and also where the progress of the industry is. So, I think directionally, we like to point out that this is a people business, and we look to find the technical knowledge that can drive specific application of science in this area. We're not necessarily experts at broad topics, but we are experts on the eye. We do know the markets. We know whether they'll develop or not, and that is the comparative advantage that we try and represent. It is specialty market knowledge around what is needed and what markets will develop over what periods of time and it is specialty technical knowledge like material science, surface chemistries, fluidics and energy delivery, things that are critical to the nuances of doing surgery in such a small space or correcting access vision on the -- in the specificity of the eye. Directionally, we have a very specific hypothesis around our financial thesis, which is around disciplined capital management. We have been very much since the going out frame, talking about how do we drive revenue growth and then get operating leverage. And so, it has been a view that we can revitalize the company after spin by putting money into R&D, doing the very best we can to advance these important areas, and then particularly driving revenue growth through a more disciplined cost structure to try and drive bottom line growth. And of course, we feel very good about our progress. Just to give you some sense of productivity on that frame, we have put, as we said, 7% to 9% of our revenue back in R&D. We are -- made a lot of progress on projects over the last 4 years since spin. You can see a number of them denoted here. Directionally, I think, we feel good about both the productivity here, but also the long-term investments we're making for steady continued growth in a number of areas. So you'll see balance, I think, in the portfolio, of incremental advancements around IOLs, but really significant advancements, for example, in equipment, or significant advancements long-term in our contact lens business. So I think we see really interesting opportunities around the categories we participate in. We put that money behind directionally, and importantly, behind very specific criteria, where are the fastest-growing markets and where are our biggest share opportunities. We've done a lot in the zones of specialty contact lenses. I'll talk more about that. We've gotten ourselves involved in the MIGS business in the glaucoma frame. We've done a good bit of work around -- originally around PC-IOLs. We used to be a very small share player. We are now quite a significant player in the share as a consequence of the investments we've made in R&D, and obviously, we think a lot about how we continue to build our shares in markets that are continuing to grow quickly or where we're underrepresented in share. The productivity has been kind of represented here. We had a number of really great coming out products that we knew about, with PanOptix. We were a little bit surprised by Vivity. Vivity has been a terrific advancement for the advanced technology lens frame. I think in the most recent -- last year and then this year as well, we're now with our Clareon platform, which is a brand-new material for all of our lenses. And as we work our way through that process of transitioning all our optical designs onto that material, we're getting a really positive response, both in share and also ASP uplift. The long-term view, as we've said before, we're putting the right amount of resources, I think, behind new ideas like a next-gen diagnostic. We'll talk more about that at our Capital Markets Day in March, but there are really significant white space opportunities for us in the diagnostics space where we just don't play a lot. We've entered a product in ARGOS, which has been terrifically well received. We're winning a lot of share in that space. We feel good about that. We have another follow-on product that we will bring to market in the next couple of years, around the diagnostic space that advances that progress. We have a next-gen Phaco-Vit. We have a next novel delivery system for our IOLs. And so, I think you should expect steady progress over the next 5 years as we continue to bring incremental improvements, but also some real breakthrough ideas around how we do surgery in the surgical business. Same thing in Vision Care, I think maybe even a little bit more pronounced if you reflect on it. We started out with some kind of basic ideas. We've been able to put in enough capacity to produce new products on the same lines. And I think that's a misunderstood element of what our strategy is here. We have a very unique manufacturing capability that allows us to manufacture more than one kind of material, more than one kind of design, more than one kind of modality on the same line. So we don't risk stranding capital in manufacturing platform. So we have been doing a lot of investing on manufacturing capacity because we feel like we can produce a whole bunch of different products, which we have actually done. So you see now as -- in this last couple of years, we had a 0 share in the toric DAILIES business. We've never put one out. We got PRECISION1 out. We've got DAILIES TOTAL1 out now, both toric lenses. And now you'll see this year, we'll produce the T30 toric as well, all in the same lines, by the way. So importantly, we're getting great productivity from the R&D folks, but also really good efficiency coming out of our manufacturing groups. A number of other ideas in here. The -- our eye drops business continues to evolve. We're looking to move the market to non-preserved multi-dose. That's a really big idea, I think, particularly for North America. It's very common rest of the world, but it is a new phenomenon to try and get the preservatives out of these drops. SYSTANE, in particular, has been a big move forward there. Pataday, we moved it Rx-to-OTC. You can see a number of other products that -- recently we've acquired some eye drops in the pharmaceutical space, again, to continue to build on a capability that we've long had. As you go forward, we'll obviously continue to build out new and specialty-oriented lenses, and I think the message in the contact lens business tends to be multifocal. So if you think about -- we've really gotten ourselves into the toric business now in most of our modalities. What we really need to do now is -- next is look at the multifocal space because multifocality is the easiest way to keep people in lenses. You drop out at 40 because you either got dry eyes or you're starting to use reading glasses. Keeping people in lenses is a multibillion dollar idea. What we need, though, is better multifocal designs. The designs today, generally speaking, trade off near vision for far vision. You don't get the best of both. We can do better than that. And I think as you look at where we're going, that will be one of the core ideas that we chase. Importantly, if you think about our IOL business, we start with sphere, we moved to toric, we went to multifocal, we went to multifocal toric. That's the same cadence that we're working through right now with our Vision Care business. Think about it as sphere, finish up the sphere modalities, add the torics, finished, done, put in multifocals, then we're going to work on multifocal toric. Again, that's well within our capability to do. It's all within the same kind of design, optical engineering frame that we're excited about. So directionally, if I double-click a little bit into the business, I would just say that the really unique part of Alcon's business in surgical is the breadth of our portfolio, and particularly the impact of our Phaco machines and our vitret machines. So our consoles that do the surgical work are without a doubt the market-leading consoles, and I think best in the world, best-in-class. To that, if you add things like now ARGOS, which we believe is best-in-class on a biometry basis, you're getting now diagnostic through 3-dimensional imaging at the microscope level. We've got a new analog scope called Revalia. We've got 2 world-class machines for cataract and retina. And obviously, the consumables are where we make a great deal of money and that is built on all of the prior equipment. So that piece of work and then integrating all of those things with data, moving data from the ARGOS into the cloud planner down into the OR and then back to get -- capture post-op refraction and then create a learning environment for the surgeon and the lens selection, improves outcome, creates better efficiencies. And that ecosystem that we have created uniquely will be, I think, the real powerful part of this next generation of wave of growth for us. Importantly, too, it enables us to be in almost every OR in the world. So I think when you think about our footprint -- our commercial footprint or our service footprint, one of the big ideas is, of course, if your console goes down and you're out of business for the day, that's a real problem. If you're out of business for 2 days, it's a real problem. If you're in refractive surgery and your wave light goes down, we're there the next day or we're there almost the same day. So we have 3, 4, 5, 6 people in almost every OR around the world in ophthalmology. We have a big footprint. As a consequence, we see the opportunities very clearly. We've obviously done a lot with Clareon. I mentioned it earlier. I won't dwell on it, other than to say this is the premier material in the market right now, and this material change along with our edge design is giving us a nice lift on even our monofocal business. So anybody who -- we used to have some -- people would worry a little bit about small speckles you can find in some of the acrylic materials around there. It was always a cosmetic flaw. That's gone. But more importantly, the pristine clarity when you look through the scope into the eye for the surgeon, is powerful. And I think that is playing very nicely for us going forward. We continue to do real well in the PC-IOL business, but of course, our monofocal business is also market-leading. We said, and talk a lot about penetration. The penetration of the advanced technology lenses is a big deal because it's valuable. And I think this is kind of the multibillion dollar idea over some stretch of time, is, how do we move from monofocal into the multifocal products. They're obviously better for the patients, we believe. We think it's a great value. We think it's a great opportunity for patients to see brilliantly all over at every distance and every focal point. And today, in the United States, it's about 19%. As you look at that and you think about where it could go, we've done quite a lot of work on headroom in this space, what patients are willing to pay. We think that hovers in the 35% to 40% range. And obviously, every point being $100 million, you can do the math on this. That is directionally what we're trying to drive right now, is penetration of the monofocal market with advanced technology lenses. Obviously, challenges in that we can talk about, but importantly, we're making good progress in the United States, but also internationally, where again, I think the -- this last year, we peaked out, I think, about 12%. So still plenty of room there, plenty of room in the United States. If I switch to Vision Care real quick, I just would say, I mentioned more about the torics. We have some really unique technologies here that, when you look at what winning with toric looks like, it is about comfort and basically settling time or wearability. So when you blink does the lens spin, when it settle -- how fast does it settle when it goes in the eye. These are design issues that you can work on, that create clarity very quickly for the contact lens wearer. Our PRECISION BALANCE 8|4 design is a really important advancement for wearing design, and PRECISION1 has done terrific. TOTAL1 we knew would do quite well because the underlying brand performance for sphere has been strong. We've been surprised by both and how positive the response has been. We're launching the TOTAL30 toric at the beginning of this year all over the world. So I think in -- as expected, I think, we've been able to leverage the manufacturing to get ourselves in a position to make torics on all different modalities and in all different materials. What that's looked like for us has been very positive on share. So I think, when we look at our progress, what we're looking at generally is -- speaking is new end, switch fits and [ TOTAL ] share. And so, I would say that our view on the market has been very positive overall. So the dynamic for the value growth in this market is probably in that mid-single digit. If we can gain share faster than that, and we are, we should perform quite well. It looks like we have the products to do that. They're performing quite well. You can see the subgroups on the right, and again, the total market share for us over the last 2 years here on the left. With that said, I think it shouldn't be lost on anybody that we are making some moves in ocular health. The eye drops business for us, we think, is a big opportunity. We have great manufacturing capability today. We still continue to make all the products we made for many, many years. In our facilities, we make them for Novartis, we make them for other people. We have all of the capability and capacity to make our own. So as we kind of migrate from the OTC brands of Pataday and SYSTANE into the pharmaceutical brands, some of the new ones that we've picked up, Simbrinza, obviously, with the area acquisition and the Kala product, EYSUVIS. We're making calculated moves into large markets. So we've purposely gone after dry eye. We've purposely gone after glaucoma because they are the 2 largest of the drop markets that are out there, and we have very low penetration of that in our own hands. So from our perspective, this is a really opportune moment. I think if you reflect on where some of the major competitors have been, Allergan got bought by AbbVie, Novartis buys Alcon. Both of them, I think, have taken what they wanted from those and left behind what they didn't. At this point in time, it gives us an opening, I think, to be very assertive in the space with technical expertise that is world-class. And so, I think where we are is right on the cusp of beginning a new white space to expand our eye drops business. And again, I'm excited about Rocklatan. If you think about the Rocklatan, put it with Simbrinza, you've got 4 mechanisms of action, maximum medical therapy in 2 bottles. So for those of you who are familiar with glaucoma, these patients sometimes have 3 and 4 and 5 medications all in a bottle. I'm not sure which one they use which day and what time it is. It's not only a convenience, but it's economically valuable to put these combinations together. I think from both a efficacy perspective, a patient compliance perspective and a reimbursement perspective, I think we feel like we've got a very cool proposition here for about half of that glaucoma market that is the moderate to severe. So a very interesting opportunity for us there. Importantly as well, I think, is the dry eye space. And I do think that we bought the EYSUVIS piece because we thought the reimbursement could be improved meaningfully. And again, the reimbursement there has been a challenge for that brand. But it's a dry eye product that treats flare, and it's a really important concept because dry eye is an agitating chronic disease, but it has flares. And in this case, a product like this can really benefit in that space. But it's also complementary to what we picked up with Aerie, which was the AR-512 product. So when you look at that product, that's a chronic use dry eye product that has a different mechanism of action additive to almost every other product and indeed complementary to EYSUVIS. So now you have 2 products in dry eye -- you have 2 products potentially in dry eye, 2 products already in glaucoma, both of which, I think, give us a really profound opportunity to get back into and meaningfully impact some big markets. So exciting for the drops business. And again, we continue to believe that there's a lot of opportunity out there. Let me give you just a little bit of color on our IFRS margin or our constant currency margin. I'll just say that we're getting good leverage, and I think the leverage story here has been something people are very curious about. I think we feel very good about the progress we've made. We have done better than I think we've articulated in the past. Whether you look at it in the reported number or more accurately, I think, in the constant currency frame for this year, 9 months in this year we've got better than 200 basis points of growth in our operating leverage before currency. So the currency is obviously an impact. And as it returns -- it's returned a little bit in the fourth quarter, hopefully, we see some more movement towards a more normalized currency. But I do think we're already in that 20 frame that we've talked about in the past and we will continue to move that way next year. That is something we said on the last call. We feel very comfortable at our ability to get there, particularly having also made some cost moves to improve 100 basis points of cost for next year on the restructurings that we've done in the late last year. So I would say that our thesis that has been, get revenue going by building R&D and building products and get back into the specialty space, that has been vacated by a lot of people, and then drive revenue faster than you drive cost and be smart about your cost and your capital deployment. That's really what we've done, and that's what's delivering this leverage right here. Our capital allocation priorities reflect that understanding. So it reflects the notion that we are going to continue to invest in capacity and manufacturing and R&D organically. We will do some BD&L stuff. We've said kind of 50 to 500 is our comfort zone. We like technologies in that zone that we can add value to, either through commercialization or through access or through just pure leverage. But I do think that there are -- we could do bigger things. We tend not to want to do them, but I will just tell you that the source of innovation for us is agnostic. I mean it really is -- we're going to do our own stuff, but we are going to keep looking for stuff out there that we think we can add value to. And then, obviously, we continue to pay out a dividend at 10% of core net income. I think if you reflect on where we are in our journey, and I think that's fun to do a little bit, because if you followed us since the spin, we had a thesis coming out. I think we've delivered on a lot of it. I think as you think about this first frame of 3 or 4 years, we said we were going to put money back in R&D. We said we're going to put it back into manufacturing. We did those things. Those have driven new product flow, that's driven revenue growth, that's driven leverage. And we're getting exactly what we said we would. We're a little bit ahead of that plan even at this moment. I suspect we'll continue that way. We are a leader in some very resilient markets. So if you're looking for things that really don't go away, eye care is one of those ones that people don't scrimp on, even in the recession times. People -- you can see it, they stay in their lenses. They don't trade up. So there is some effect, but they stay in their lenses. And so, we think these are good markets, high-growth areas that we're investing in. Importantly, we've got a scale business in surgical that is a powerful asset to us. And I think, as we look forward, we expand our ocular health presence. We've got some new opportunities to drive margins. So all in, I think, a really good start to this journey that we took on several years ago. So with that, let me pause there, and we'll start with some questions.

Great. Thanks, David. I'll kick off here maybe with a couple of openers and then we open up the floor. You addressed the FY '23 margin, which has been a big sort of focus certainly for the back half of last year. You addressed it reasonably directly on the Q3 call, but -- at least at a high level. And I know you want to give a lot more color on the full year results call coming up. But maybe you could just talk a bit more, maybe not just the '23, but beyond that, the pushes and pulls on the margin and what's going to drive us to that longer-term margin target?

Tim, why don't you take the [ headwind ]?.

Sure. So, as we said in Capital Markets Day last year or the year before, the whole thesis is really driven by growing revenue faster than the market, so we called out mid-single digits, managing our cost envelope in a responsible way. Now we've done some restructuring to take costs out of the back room, if you will, and apply it to more customer-facing activities to drive that revenue growth, and that should provide nice operating leverage. So that is the key to the thesis. We've seen a lot of operating leverage this year. David alluded to it in the opening remarks. As you think about the longer-term plan, we will continue to see operating leverage on the SG&A front. We're going to continue to invest that 7% to 9% in R&D, so we should be getting a lot of leverage from that because again, that's key to that revenue growth. And then in the back half of the plan, we should see some gross margin expansion. So to date, we've had a lot of gross margin pressure. If you look at this year, we've had roughly 100 basis points of net inflationary pressure. As you go out the back half of the plan, the other thing that's going to happen is those DSM flex lines that we've been installing, that have created some near-term gross margin pressures. Those start to work their way through the system. They run up at an optimal capacity, and we should see some gross margin expansion there. So the key to the long-term goals is really that operating leverage with a little bit of gross margin expansion.

And maybe just kind of picking up on the gross margin point. What's your ability to put through larger-than-expected pricing or better price increases going forward? And similarly, the cost inflation that you've seen, how you're seeing that evolve from here?

Yes. As we said before, we -- at the end of '21, we announced some price increases that were effective in February 1, 2022. They were roughly in the contact lens business, as an example. I'll call it mid-single digits. We were the leaders in that. I think if we were to reflect back, we may have been a little bit more aggressive there. Obviously, it depends on what competitors are doing with the marketplace and how consumers are responding. But net-net, we had roughly net inflationary pressure. So price offsetting that inflation was about 100 basis points in 2022 and -- so that kind of gives you a flavor. We're not able to offset everything, but we were able to offset some of it.

And then maybe -- you obviously acquired Aerie through the middle part of last year. Maybe you could just give us an update on what you're seeing sort of post integration? And maybe more specifically, I just wondered, when you look at the acquisition, how much were you attracted by the 512 assay in dry eye? And how should we sizing that opportunity as we go forward, because we expect some Phase III data there later this year [ earning]?

Yes. I mean the Aerie acquisition was -- we had thought about for a long time, and it was built largely on the market performance of Rocklatan. So I think our view is that the deal sits on itself between consolidation value and the Rocklatan performance. That in and of itself, we think made sense. The 512 was upside to the business case. And so, I think, to the extent that it's approved, we get excited about that. We also believe that we wanted a capability that they had, and they've got a very good group in pharma development in North Carolina that we were pleased to acquire as well, which gives us a little bit more of what we lost in the spin to Novartis. So we felt like it gave us a couple of things, the capability, importantly, that we needed. We had a lot of synergy on the commercial and infrastructure stuff, so that helped us a good bit. And then, of course, we think there's growth in Rocklatan when you put it together with our commercialization effort and mechanism. The other part of your question was...

Yes, [indiscernible] sort of sizing the opportunity in dry eye?

Yes. We're still working through that because it's still pretty fresh for us. But I do think that the way to think about that market, it's $1.7 billion in the U.S. It's going to shrink because RESTASIS is going to go generic. But dry eye is the large -- second largest in visit that happens in ophthalmology. It's a very, very big category. A lot of it's going to depend on genuinely how the product performs. We'll see that data, I think, in the -- late this year. We'll have an opportunity to kind of release that next year and give you a sense probably as we go through the year this year on how we're thinking about the market. But we're still learning a little bit about it, and I want to be clear about it as we get there.

Great. Well, I'll open that to the floor, that there's any questions from the floor, please raise your hand, and we'll get a mic to you. Over there would be great.

Can you talk a little bit about the dry -- beyond just what you're doing in dry eye? I mean it's a pretty big market. Is that something you want to establish a deeper R&D division in or do more acquisitions? It seems like a really big market that Alcon should dominate over time if you put in the effort.

Yes. Well, I mean, we like all the disorders in eye care, and I think about them as all kind of broadly things we're interested in. It's one of the bigger ones for sure. There are different approaches to it. We've tried different things. We've tried devices. That's been tricky. We've tried -- there are other mechanisms around this. So the drops have been a big mainstay on this market. And I do think that our interest in drops here is meaningful. But again, I don't know that it's the only thing we'd be looking at. I think we're looking at kind of everything that makes sense, and in particular, how competitive is the product and is it adding real value into the market, can we extract a meaningful price for promoting it. So I do think there are some things in kind of quasi dry eye called meibomian gland disorder, which is kind of a subset of dry eye, if you will. I think there are several things in those spaces we're aware of. We watch a lot of it. We probably won't build our own capability. We're not intending to go after new molecular entities. If you remember, Alcon -- for years and years, we basically had a $4 billion pharma business made up of $2200 -- $200 million products, and we still think $200 million is sexy. There's a lot of pharma that doesn't and -- doesn't want to do it, and that's in essence the opportunity size. So I think we'll find that there are lots of opportunities to repurpose things. Timolol was a Merck product. The prostaglandins were from Pfizer, the VEGFs were from Genentech and then the like. So ophthalmology has repurposed those and we'll get good at formulations, drug delivery. That's the capability we want, which is what Aerie brings us. And I think there's some other ways we'll do that. But largely, these will be already characterized molecules that we'll license from other people, if we do the development ourselves. And then secondarily, we're always interested in licensing things that are further down the path, preferentially Phase 2 forward.