Alcon Inc Q2 FY2020 Earnings Call

Good day. And welcome to Alcon’s Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Karen King, SVP of Corporate Affairs. Please go ahead.

Welcome to Alcon’s second quarter earnings conference call. Earlier, we issued a press release and interim financial report, and posted a supplemental slide presentation to our website to enhance today's call. You can find all of these documents in the Investor Relations section of our website at www.investor.alcon.com. Joining me on today's call are David Endicott, our Chief Executive Officer; and Tim Stonesifer, our Chief Financial Officer. Our press release, presentation and discussion will include forward-looking statements. We expressly disclaim any obligation to update forward-looking statements as a result of new information or future developments except as required by law. Our actual results may vary materially from those expressed or implied in our forward-looking statements. Accordingly, you should not place undue reliance on any forward-looking statements. Important factors that could cause our actual results to differ materially from those in our forward-looking statements are included in Alcon’s Form 20-F, our Form 6-K furnished on May 12, 2020 and our earnings, press release and interim financial report on file with the Securities and Exchange Commission and available on the SEC website at www.sec.gov. Non-IFRS financial measures used by the Company may be calculated differently from and therefore may not be comparable to similarly titled measures used by other companies. These non-IFRS financial measures should be considered along with, but not as alternatives to the operating performance measures as prescribed per IFRS. Please review the financial tables provided in the press release and our filings that reconcile non-IFRS measures to directly comparable measures presented in accordance with IFRS. For discussion purposes, our comments on growth are expressed in constant currency. And with that, I’ll now turn the call over to David.

Good morning and good afternoon, everyone. I want to start out by acknowledging and expressing our gratitude to the healthcare professionals and essential workers who continue to serve patients every day. From the start, we’ve said that the health and safety of our associates, doctors, patients, and our communities is our top priority. As such, we continue to invest resources to safeguard their welfare. I also want to specifically thank all of Alcon’s essential associates who work tirelessly to ensure that we can supply our customers with the products they need as their businesses recover from this pandemic. For today's call, I'll start by providing a performance update and then comment on overall market dynamics and our innovation agenda. Tim will discuss our second quarter sales by business, financial performance, and provide more color on our outlook for recovery. Then, I'll wrap up with my closing comments and open up the call for Q&A. The second quarter will no doubt go down as one of the most challenging quarters in our history with conditions that demanded extraordinary focus on carefully managing our business. Despite the uncertainty created by COVID-19, we're encouraged that we're tracking to the recovery that we outlined in our last earnings call. First, we said that we believed April would be the low point for the quarter with modest improvement in May and June. April sales did mark the low point of the quarter. Sales were down close to 50%, with May slightly better. As ophthalmologists return to the OR and optometrists opened their doors for business, June sales saw a significant improvement, and we saw continued growth in the month of July. Second, we said that we were taking a variety of short-term actions to help offset some of the income lost to sales pressure. And these initiatives will result in approximately $200 million of savings in the quarter. We were able to do just that and decrease planned spending by approximately $200 million this quarter, despite unplanned COVID-19-related charges. Aggressive controls around discretionary spending included implementing a hiring freeze, reducing a meaningful amount of sales and marketing spending, and almost all travel, meetings, and consulting expenses were reduced. These actions resulted in a 20% reduction in our core selling, general, and administrative costs in Q2 alone. Third, we said we are aligning our production schedules to help us reduce some of our raw materials and labor costs. But, the decline in revenue and the fixed nature of some of our manufacturing infrastructure will have a negative impact on gross margin. While keeping our associates safe, we were able to maintain largely uninterrupted operations in our manufacturing and supply chain. However, we did see an impact on our gross margin as a result of unfavorable manufacturing absorption due to production lines operating below normal capacity. We expect this to improve as sales increase. Fourth, we said we're still committed to the long-term strategic initiative we discussed in our last Capital Markets Day. In the second quarter, we stayed on course for the separation and transformation activities. We finished commercial implementation of SAP, and we're now rolling it out to our manufacturing facilities. We've launched two new company-wide solutions for HR and document management, and we're ramping up global service centers to support our enabling functions such as finance, HR, and IT. We've also stayed on track with the expansion of our Vision Care contact lens manufacturing capabilities, and despite the significant challenges during the quarter, we continued to invest in our product pipeline. Next, let me comment on the market recovery for both Surgical and Vision Care, and then talk about market share. In Surgical, hospitals and clinics have gradually reopened and surgeons across the globe are focusing on rebuilding their patient flow. Ophthalmologists are managing evolving safety practices, and turnover time between procedures is improving. In discussions with our customers, we're hearing that countries like China, where the large majority of surgeries are performed in hospitals, procedure volumes are running at about 80% to 90%. However, in countries like the U.S., where the large majority of surgeries are performed in ambulatory surgery centers or private clinics, our customers are seeing procedures volumes running above 90%. This was due, in part, to doctors increasing the number of surgery days or extending their hours to increase capacity. While we believe we will return to more normalized market levels by the end of the year, there could be some variabilities as doctors exhaust the backlog of pre-COVID patients and work to refill their pipeline. In Vision Care, most practices are back open, but optometrists are still adjusting to new safety procedures such as spacing appointments, cleaning their trial spectacle frames between uses and limiting foot traffic. Recent survey data indicates that optometry practices in the United States are down approximately 20% in visits, despite 95% plus being reopened. Assuming we do not experience further disruption from COVID-19, we believe Vision Care will return to more normalized volumes by early next year. Moving to market share. Global cataract procedures were cut approximately in half this quarter after a high single-digit decrease in the first quarter. Second quarter market data shows us gaining share in the U.S. PC-IOL category where Alcon now has over 70% of the market. We're very pleased with the continued strong demand for PanOptix and our market-leading position in the PC-IOL category. In Vision Care, the contact lens market declined a little over 20% in the second quarter after a relatively flat trend in the first quarter. The fast-growing part of the market historically has been the daily SiHy, which declined around 12% versus growing 22% in the first quarter. We're gaining share on the strength of our Dailies Total1, our newly launched Precision1, and our multifocal lenses. We continue to be excited about the potential for Precision1, based on the feedback from ODs who have returned to fitting a lens in their clinics. And in ocular health, Pataday strengthened our leadership position in the U.S. OTC ocular allergy market, where we gained over 10 share points in the quarter, bringing Alcon’s share to over 50%. We believe our product development is directly addressing current and future patient needs, including those created by COVID-19. Social distancing requirements have separated family members that have previously served as caretakers and put a heavier burden on our elderly. For many of our elderly, visual impairment can compromise their ability to live independently and manage their own needs. In addition, for people pursuing everyday activities, we see an increased desire to be independent of spectacles. Glasses can fog up when wearing facial protection, people are experiencing screen fatigue after spending more time at home in front of the computer, and exercise has taken on increasing importance. These behavioral insights continue to inform our product innovation and we remain committed to leveraging our development expertise to address these eye care needs. For example, our growing IOL portfolio gives physicians more options to treat a broader range of patients. PanOptix, the AT-IOL leader, not only restores visual acuity but also enables spectacle independence by offering good performance at every distance. PanOptix continues to see encouraging adoption following its introduction in the U.S. and Japan mid last year. And in July, we began launching PanOptix in China with key opinion leaders, and initial surgeon feedback in that country has been very strong. We believe this advanced lens will play an important role in our global surgical recovery. Vivity, our patented first-of-its-kind non-diffractive PC-IOL, offers a greater range of vision yet is as simple to use as a monofocal IOL. This lens may enable patients with otherwise disqualified conditions, such as retinal disease, to benefit from an AT-IOL. We received very positive feedback during our pilot with KOLs in Canada and select European countries, and we're expanding our launch into most of the major European markets this year. In contact lenses, we’re focused on three major programs. As optometrists return to their offices, we’re regaining momentum for Precision1 with a variety of promotional programs in time for the seasonal back-to-school period, including one program directed at eye care professionals who utilize our online platform. This program helps optometrists address their patient needs through Alcon’s direct-to-consumer fulfillment capabilities, which contributes to patient satisfaction and strengthens the doctor-patient relationship. We also continue on plan with our manufacturing expansion, which will enable us to introduce new options for people with astigmatism with a much-anticipated launch of Dailies Total1 toric and Precision1 toric later this year. In ocular health, we received U.S. FDA approval for Pataday Extra Strength, our third Rx/OTC switch in the past six months, which was formerly Pazeo. Pataday Extra Strength contains more than twice the amount of olopatadine as PATADAY, enabling customers to experience full 24 hours of eye allergy relief. Customers will be able to purchase online this year and at U.S. retailers in early 2021. We also received CE Mark for Systane Ultra Multi-Dose Preservative-Free or MDPF. The MDPF category is particularly important in Europe. And this is our first entry into a large and fast-growing international segment of artificial tears. Systane MDPF will open the doors to exciting share opportunities that build on Alcon's dry eye leadership in this important region. So, as you can see, we continued the momentum with our investments in innovation. With that, let me turn over to Tim, who will review our financial results and provide more color on our outlook.

Thank you, David. Results this quarter demonstrate strong execution, despite the COVID uncertainty. We continue to implement measures to protect our associates, support our customers, and further strengthen our liquidity. We exercised heightened financial discipline in discretionary spending, production planning, and managing our investment priorities. Starting with the top line, we saw a 34% decline to $1.2 billion in the second quarter, with double-digit declines in both Surgical and Vision Care, as we had anticipated. On a year-to-date basis, we saw a 15% decline. Surgical sales were down 42%, reflecting the slowdown of surgical procedures globally. On a year-to-date basis, surgical sales were down 21%. Implantable sales were $176 million, down 40% versus the prior year. Sales were down in monofocals, despite an increase in share during the quarter. This was partially offset by PC-IOL growth due to the strong adoption of PanOptix in the U.S. and Japan, which will wrap around their launch date in the second half of the year. On a year-to-date basis, implantable sales were down 15%. Consumable sales were $320 million, down 45% versus the prior year, which is driven by the slowdown in surgical procedures. As surgery levels increase, we anticipate we'll see continued improvement in consumables aligned with market trends. As expected, vit-ret procedures held up better than cataract, given the urgent nature of retinal surgeries. On a year-to-date basis, consumable sales were down 25%. Sales from the equipment and other category were $106 million, down 32% versus the prior year. We're seeing limited major capital purchases as customers manage their capital budgets. However, revenues from equipment service and procedural eyedrops held up better than equipment in the quarter. On a year-to-date basis, equipment and other sales were down 18%. Turning to Vision Care. Sales were down 25% in the second quarter, reflecting the impact of COVID-19. On a year-to-date basis, we saw an 8% decline. Contact lens sales were $329 million, down 32% from last year. COVID-19 impacted growth in all products and regions, driven by the decline in traffic and widespread closures of optometry practices. As offices began to reopen, we saw an encouraging recovery in June, driven by a higher lens consumption and larger order volumes among distributors and retailers. On a year-to-date basis, contact lenses were down 15%. Ocular health sales were $267 million, down 14% versus the prior year. Sales pressure was driven by store closures due to COVID-19 and the impact of Q1 stocking activity, which we expect to normalize by year-end. We were pleased with the ongoing momentum of the OTC launch Pataday in the U.S., and on a year-to-date basis, ocular health was up 3%. Now, moving down the income statement. As expected, core gross margins were 54.6% this quarter, down almost 10 percentage points year-over-year. This was primarily driven by lower sales and $64 million of unfavorable manufacturing absorption, which we expect to incur to a lesser extent in Q3, and even less so in Q4 as the market starts to normalize towards the end of the year. Core operating margin was negative 6.6% this quarter, compared to 16.6% last year. Lower sales were a primary driver of the margin pressure, combined with the unfavorable manufacturing absorption and provisions related to the pandemic. As we discussed on our last call, we made significant cuts to discretionary areas such as marketing and sales support, travel, meeting expenses, and consulting while protecting our associates and sustaining R&D. Going forward, we expect R&D investments and marketing and sales to increase in the second half of the year, as compared to the first half as sales improve. Foreign currency had a negative 70 basis-point impact during the quarter. Second quarter interest expense was $30 million, down $35 million from last year due to more favorable interest rates in the current period, partially offset by the interest expense from the newly issued senior notes in late May. The core effective tax rate was a 10.4% benefit in the quarter compared to a 13.5% expense last year. Year-to-date, our core effective tax rate was 20.5%. The decrease in the tax rate was primarily due to the mix of pretax income and loss across geographic tax jurisdictions and the impact of COVID-19 on profitability. Core losses per share were $0.21, down from income of $0.47 last year. Lower sales were the primary driver along with approximately $0.14 per share of COVID-specific charges and costs, driven by lower manufacturing cost absorption, provisions for expected credit losses, and higher inventory provisions. We ended the quarter with $1.3 billion in cash and cash equivalents at the end of June and $1 billion available in our revolving credit facility. We successfully raised $750 million in late May that enabled us to further strengthen liquidity at a competitive interest rate. We do not have any major maturities before 2024 and we do not have financial covenants or material adverse change clauses on any of our existing facilities. Free cash flow for the first half of the year was negative $110 million compared to positive $95 million last year. This year-over-year decline is primarily related to the impact of COVID-19 on our operating results. Given near-term operating income and net working capital pressures driven by COVID, we expect free cash flow for 2020 to be lower than 2019. Separation costs this quarter were in line with expectations of $62 million, primarily driven by IT projects. Life-to-date separation costs were $370 million. We expect to substantially complete our separation process this year. The successful implementation of SAP has given us better visibility to real-time conditions against the broad landscape in which we operate. Transformation costs this quarter were $13 million, primarily related to third-party consulting fees and restructuring. Life-to-date transformation costs were $72 million. Looking forward to the second half of the year, we expect the path to reopening will vary based on country and local mandates. The pace of the recovery will depend on the capacity of public versus private channels, and the ability of the ECP to incorporate new safety procedures and rebuild efficiency and patient flow. We were encouraged by the June rebound and the favorable trend in July. Although we're not counting on a linear trajectory, we expect the markets to return to more normalized levels by the end of this year or early next year. And this macro trend gives us confidence to invest in customer-facing programs and ramp up strategic investments in the second half of the year. By franchise, we believe surgical may recover slightly faster than Vision Care. Surgical practices are accustomed to the adoption of safety protocols. So, they're quickly adapting to their new measures. While demand for vit-ret and cataract is durable and patients cannot postpone procedures indefinitely without additional health risks, I want to remind you that the solid rebound we’ve seen to date was primarily driven by patients that were booked pre-COVID and are now returning to complete their procedures. It remains to be seen how quickly the ophthalmology community can refill their pipeline of patients, which could result in variability in the coming months. Absent another pandemic shutdown, we expect the surgical markets will return to normal levels by the end of the year. In the optometry channel, we expect traffic to return to normal by early 2021. We believe more customers are placing value on the comfort and convenience of contact lenses with increased screen time and the need to wear masks outside the home. Furthermore, the greater need for hygiene may create an opportunity to accelerate the switch from reusable to daily disposables. We've been encouraged with the continued improvement in Vision Care, but we're cautious to extrapolate, given the variability of stocking activity and foot traffic. One thing is certain, more than ever, doctors and consumers want comfort and visual acuity. We will continue to drive effective customer engagement, and we're investing in the new activation and marketing campaigns to help ECPs rebuild their practice. Given this backdrop, our fundamentals remain strong, and we'll continue to execute on our strategic imperatives. That includes completing our separation, continuing our multiyear transformation into new Alcon, accelerating innovation and R&D, and expanding our Vision Care manufacturing capabilities to fuel our product pipeline. With that, I'll turn the call back over to David for some final comments.

Thanks, Tim. In this environment, our talented employees and deep customer relationships give us confidence to steer a steady course back to growth. June and July are providing encouraging data points that we’re on the road to recovery and we expect the markets to return to more normalized levels by the end of this year, really next. It’s important to remember, our fundamentals are strong, and we continue to steadily deliver on our product pipeline that benefits our customers as they rebuild their practices. PanOptix and Vivity bring new advanced lens options for cataract surgery. Precision1 and our new Dailies Total1 and Precision1 lenses for astigmatism expand our contact lens portfolio to a broader consumer population. And our new Pataday family of over-the-counter allergy drops has brought new prescription strength relief from ocular allergies. These are just a few examples of what we can achieve. And we stay focused on our commitment to help people see brilliantly. This commitment is secured by 70 years of experience and our dedicated associates who work every day to sustain Alcon’s ability to serve eye care practitioners and their patients in the post-pandemic world. And now, let's open up for questions.

Thank you. We will now begin the question-and-answer session. The first question today comes from Veronika Dubajova of Goldman Sachs. Please go ahead.

Yes. Good morning, good afternoon. Thank you for taking my question. If I can start with just a little bit of color, David, on sort of how you're thinking about your competitive positioning in contact lenses? It's sort of notable that -- I think this is the second quarter in a row that you’re starting to kind of outperform the market a little bit. Just curious, how your thoughts are on -- is this just a function of your mix, either in terms of categories or geographies, or are you starting to see some green shoots from a competitive perspective from Precision1, and maybe if you can comment on durability of that as you move into the second half? That would be really helpful. And I will sneakily ask as well, if you will, very helpful, if you give a number on procedure volumes for cataract or if we can get a similar kind of metric for the contact lens market in July? That would be super helpful.

Thanks, Veronica. Let me start with the competitive position. I think, look, we've been very pleased with the development of our product line in contact lenses. Obviously, we've been by design targeting the fastest growing sections of the contact lens market. So, think about the SiHy market in particular, being considerably faster growing than the base market of contact lenses. Inside of that, really when you think about it, the SiHy toric and SiHy multi-focal growing even faster yet. So, DT1 has benefited from that quite a little bit and so does Precision1. It adds for us an accessible lens that has a terrific kind of DT1 quality to it, but at a price point that is affordable to a lot of folks. So, we feel good about the share gains, we’re making the progress, we're making new fits and then switch fits around Precision1. And I think importantly, going forward with the torics, it puts us in a position to really benefit from the growth in that market, we have almost a zero share; we have a zero share I think in SiHy torics. We look forward to gaining kind of an appropriate share, commensurate going forward with our DT1 and Precision1 product torics. So, that's kind of exciting. So, I think the durability of that is pretty good. I think we see that going forward. On the contact lens piece, visits I think is really what we would comment on more than anything else. I think visits have been kind of 80% of normal is what the physicians have been reporting to us. So, optometry, we use the Jobson survey, I think a lot of people do. That study I think showed 80% were back fitting lenses. Average patients per day were down 20%. So again, I think it's not back to normal. And you can see how that works, because of course they're having to limit flow through the office, they have to clean the frames after everybody touches them. So, it's just -- it's still going to be a while I think before we figure out how to get patient flow back. And on the contact lens side of that, and I think, 96% of docs reporting, they're seeing new patients and they’re back fitting lenses. But again, I think, we think that's going to continue to be slow and kind of a slow, steady grind back to normal. So, again, we think probably normal looks like, beginning of next year.

That's helpful. Thanks, David. And Tim, can I just -- a follow-up please on the provisions you took for inventories and accounts receivable, if you can quantify that number? That would be super helpful.

Yes. Veronica, this is Tim. It was about $0.04 between both the credit losses and the inventory provisions.

The next question comes from Matt Miksic of Credit Suisse. Please go ahead.

Thanks so much for taking the question. So, one follow-up on PC-IOL and cataracts, and one on vit-ret, if I could. So, on PanOptix, really impressive share at these levels because the obvious question is, where can we go from here? How do you defend that? How did Vivity play into that strategy? And then, as I mentioned, one follow-up vit-ret.

Yes, Matt. We're encouraged by the performance of PanOptix. I think, maybe we thought -- we've always thought it would do well. I think the question we always had was at what pace would it get up the curve. And we've obviously been excited about seeing what's gone on in the U.S. and in Japan in particular. I think there's two things to think about when you think about the PC-IOLs. One is, just what's the wraparound look like and how much do we have room for growth. And I think, remember that exiting fourth quarter last year, we only had a 50 share. So, we're going to have growth year-on-year, probably into the middle of next year, even on U.S. and Japan. And importantly, when you kind of add in China and some of the other markets that we're just launching now, I think we see steady growth from PanOptix through the end of next year, for sure, and then really more market growth, I would think in ‘22 going forward. But, we're clearly going to be pushing on Vivity as we had planned. What we’re trying to do is make sure that we embed PanOptix, get our share to where we're comfortable that it's maximized with that product. And then, we'll bring Vivity into the market. We're starting that now in Europe, where we've had a good run with PanOptix. And I think we're seeing some positive additional patients coming into practices that are using AT-IOL. So, if you're already an AT-IOL surgeon, there are some patients who you may exclude from giving an AT-IOL because you can't see through a diffractive lens as easily to the retina. So, people with retinal disease and wish there are many as you get a little bit older, a lot of people have retinal disease, are people with irregular cornea, where you've got a problem, a lot of times the surgeons will exclude them from AT-IOLs. And we think Vivity provides an alternative here that could add some patients into the market. So, we'll see how that takes shape, but, we think the performance of lens is quite good. And I think we were initially trying to figure that part out. Feedback from the markets in Europe and Canada have been terrific, so, we're feeling good over the long term there.

That's helpful. And then on vit-ret, you mentioned that there may be sort of a slowdown in new procedures because you sort of moved through the backlog, as some of these clinicians completed their predicted schedule of patients. Just maybe if you could talk a little bit about that business and what drives the patients into the initial -- to clinic visits that puts them on schedule for surgery and what you can do to support that or just because this is kind of the acute end of the spectrum of things that need to be done for these patients, what can you do to support or accelerate those clinic visits? Thanks.

Well, vit-ret tends to be a pretty emerging category. So, there's not a ton of stuff that gets delayed truthfully. Obviously, when we shut down for the month of April and for part of May, depending on where you were in the world, that had a material effect on the sales. But, vit-ret consumables for example for us was pretty solid. I mean, it was the best -- it was better than cataract and better than an equipment and better than refractive. So, I think we feel good about what was going on there. I think, the only real effect on vit-ret was OR time and availability. There's probably a little bit of a delay in certain kinds of procedures. But more or less, we feel like that's a pretty good business moving along for us pretty well. It's really cataracts that you can kind of defer for a while. And I think that's been the concern as to what's the pace at which this will come back. What they’re doing at cataracts is they're rescheduling kind of at 90-day intervals. So in April, they probably take the folks from April that were shut down and they moved them 90 days out. That's about the scheduling interval. And those will fill up the June-July registers for patients. And so, that will be the best way we can think about refilling the pipeline going forward. But, I think the market for vit-ret looks pretty good.

The next question comes from Jeff Johnson of Baird. Please go ahead.

David, just want to follow-up on the cataract comments. One, did I hear, market share this quarter for PanOptix in U.S. and Japan -- and I know it was 65% last quarter. I'm not sure I heard that. And any additional color you could give on that funnel filling up those cataract surgeries? I hear you on some of the backlog coming out. But what are you hearing about clinic visits? Are clinic days for these ophthalmologists, are they filling that funnel back up at this point? How is that going versus the backlog just coming out? Thanks.

Sure. It's a little tricky to do that because we're using survey data. And I'll give you what I know or what's been published and we can go from there. But let me start with the market shares. We were 70-plus in market share in the U.S. and Japan. We are doing quite well in that metric. I think, what you're going to continue to see is launches around the world, including China in the third quarter, which we're excited about as well. So, we think PanOptix will continue to do well, as we kind of move forward through the next year, so. On the office and rescheduling piece, I think what we do know is that 98% of surgeons right now are reporting they’re open. They're -- 93% have started some -- are reporting kind of normal -- some to normal surgery, 80% of the ASC based surgeons are basically saying they've got time that is available and probably 30% of other surgeons are saying they've got a greater than 30-day backlog. So, I think that's probably the metric that's most useful in thinking about this, which is a lot of -- there's a little bit of a Pareto principle in the surgery with our customers. So, 30% are saying they've still got a 30 or greater day of backlog, I think says we've got some room to go in terms of filling this out. But, we saw good June, we saw a pretty solid July. And I suspect that this works its way through the system over the coming months. But, we'll just have to see, because it's very difficult to kind of tell and tease out how much is rescheduled versus how much is refilled.

The next question comes from Matt Miksic of Credit Suisse. Please go ahead.

Thank you. So, one follow-up on PC-IOL and cataracts, and one on vit-ret, if I could. So, on PanOptix, really impressive share at these levels because the obvious question is, where can we go from here? How do you defend that? How did Vivity play into that strategy? And then, as I mentioned, one follow-up vit-ret.