Alcon Inc Q3 FY2021 Earnings Call

Greetings, welcome to Alcon's Third Quarter 2021 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Karen King, Senior Vice President, Head of Global Corporate Affairs and IR. You may begin.

Welcome to Alcon's Third Quarter 2021 earnings conference call. Yesterday, we issued a press release and interim financial report and posted a supplemental slide presentation on our website to enhance today's call. You can find all of these documents in the Investor Relations section of our website at Investor.Alcon.com. Joining me on today's call are David Endicott, our Chief Executive Officer, and Tim Stonesifer, 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 if 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 and our earnings press release, and interim financial report, on file with the Securities and Exchange Commission and available on the SEC's website at 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 in other companies. These non-IFRS financial measures should be considered along with, but not as alternatives to, the operating performance measures as prescribed for IFRS. Please see our reconciliation between our non-IFRS measures with directly comparable measures presented in accordance with IFRS in our third quarter earnings presentation, which can be found on the Investor Relations website. As a reminder, for discussion purposes, we are providing comparisons of 2021 versus 2019, unless otherwise noted as we believe this is more operationally meaningful since our results were impacted by the pandemic in 2020. We will continue this practice through the end of the year. You will find a summary of results comparing 2021, 2020, and 2019 in our slide presentation, and a comparison of 2021 versus 2020 in our press release and interim financials. As usual, our comments on growth are expressed in constant currency. And with that I'll now turn the call over to David.

Welcome to Alcon’s third quarter 2021 earnings call. I'll begin by providing a brief update on our third quarter, overall market dynamics, and our new innovative products. After my comments, Tim will discuss our third quarter performance and our outlook for the full year. Then I will wrap up with some closing remarks and we'll open it up for our Q&A. And we're pleased to announce we had another strong quarter despite markets that are still recovering. Similar to the second quarter, this was driven primarily by demand for new product innovation, solid commercial execution, and strong market recovery in the U.S. Recovery in our international markets remains mixed, although we're encouraged to see signs of recovery in select European markets late in the quarter. Other countries like Japan, which is our second largest market, continue to be impacted by the pandemic. Third quarter sales of $2.1 billion were up 13% versus 2019 with increases across all sales categories in Surgical and Vision Care. Core operating margin was 17.7% and core diluted earnings per share was $0.54. Customer interest and need for our new products are driving above-market growth. And in surgical, our portfolio of advanced technology intraocular lenses is driving increased penetration rates of HI wells. And we continue to see strong demand for cataract refractive equipment. In Vision Care, our new contact lenses are winning in the market and our sustained brand family is posting strong double-digit growth in all regions. Now moving to our end markets by franchise. In surgical, the global cataract surgery market was relatively consistent with last quarter. Excluding India, the global market was down mid-single digits versus 2019. While the U.S. showed solid mid-single digit growth over 2019, the international markets remained down high-single digits, primarily due to emerging markets in Japan, which continue to be suppressed. Against this backdrop, our plannable business continued to outpace the market driven by our strong AT-IOL performance. In Vision Care, the contact lens market was flat to slightly up versus the third quarter of 2019. Similar to surgical, the U.S. market has returned to growth, while international markets are approaching 2019 levels. Our contact lens business grew significantly faster than the market driven by the strong performance of PRECISION1. And moving to innovation in surgical, we maintained our strong market share and PC-IOL solidifying our position as the market leader. This is driven by strong demand for our new innovative products, PanOptix and Vivity, despite new market entrants. We continue to see AT-IOL penetration rates increasing sequentially as existing surgeons increase their use of advanced technologies and as surgeons who traditionally preferred Monofocals and Toric are now implanting Vivity. Vivity is the first and only PC-IOL with wave-front shaping technology and a clinically proven exceptionally low rate of visual disturbances. Surgeons appreciate the consistency of patient outcomes without the worry of halos and glare. In our equipment business, our products and innovations remain a favorite of surgeons; including our market-leading phaco equipment, the ACTIVE SENTRY hand-piece, the Luxor revalue microscope, and the ARGOS bio-meter. Earlier this week, we unveiled the latest evolution of cataract connectivity with Smart Cataract. Designed specifically for ophthalmology, this new cloud-based application delivers planning, connectivity, and analysis to improve cataract surgery efficiency, reliability, and accuracy. This is the next step in the evolution of our equipment ecosystem and further enhances the value of our new innovations. Installations of our first application, Smart Cataract, are underway with select customers in the U.S. In Vision Care, we're expanding our contact lens offerings to the premium and middle-market segments by launching a steady stream of new Silicone Hydrogel daily and reusable products. In the premium segment, we're building out our total brand with a complete portfolio of design options. In addition to our existing DAILIES TOTAL1 sphere and multi-focal lenses, we're now adding DAILIES TOTAL1 for astigmatism to capture the premium toric market. And also TOTAL30 to capture the premium reusable market. DAILIES TOTAL1 for astigmatism has been eagerly anticipated by eye care professionals for years. This lens provides a significant opportunity in a fast-growing segment where only 1 in 4 astigmatic patients are wearing Toric lenses. Select customers in the U.S. are already fitting the lens, early feedback has been very positive and we're excited for the broader commercial launch early next year. TOTAL30 addresses the large $4 billion reusable market, which hasn't seen any significant innovation in years. TOTAL30 is now available to wearers in the U.S. and Europe and early reception has been strong. This lens brings the water gradient feature of DAILIES TOTAL1 into a monthly lens, creating a comfortable lens which feels like nothing on day 1 and on day 30. Now moving to the middle market segment. The strong performance of PRECISION1 and PRECISION1 for astigmatism continues to drive our above-market growth in the total DAILIES market. Both the sphere and toric designs are currently available in the U.S. and Europe, and PRECISION1 sphere is available in Japan. As more international markets recover, we believe we are well-positioned to drive steady growth with PRECISION1. Finally, at Ocular Health, we're building out our eye-drop portfolio. Sustained sales continue to grow globally, reinforcing our leadership in artificial tears. If you recall, about 25% of the fast-growing U.S. market for artificial tears is the preservative-free category compared to over 50% in some international markets. Our multi-dose preservative-free formulation of SYSTANE Ultra and Hydration are now available in Europe and the U.S., where we're seeing favorable customer response. We also continue to see strong demand for the Pataday Family of Allergy products, which has been aided by our recent launch of Pataday Extra Strength earlier this year. And finally, this is the first full quarter where we've added Simbrinza to our growing portfolio of eyedrops. Now, before I pass the call to Tim, I wanted to touch on our recent announcement regarding our intention to acquire Ivantis. We're very excited about the opportunity to expand our glaucoma portfolio in this large $500 million market, growing in the low to mid-teens. Glaucoma is the second largest cause of blindness after cataracts and impacts more than 75 million people globally. Ivantis' flagship product is the Hydrus MicroStent, a Minimally Invasive Glaucoma Surgery device. Importantly, the Hydrus is unique as the only MIGS device with safety and efficacy data out to 5 years. The 5-year horizon clinical study of Hydrus is the longest continuous follow-up of a MIGS device. It demonstrated that 65% of Hydrus patients remained medication-free at 5 years. Hydrus has a combination cataract indication in the U.S., which means the device is implanted during cataract surgery, and both combo cataract and standalone indications in 5 international markets. And we intend to leverage our global commercial footprint and our development capabilities to create even greater value for existing and future advantageous products. In a few minutes, Tim will walk you through some of the financial aspects of that deal. Our third quarter performance demonstrates the resilience of our business, the strength of our innovation engine, and the expertise of our commercial organization. We are executing on our new product launches and growing faster than the markets around the world, even as they continue to recover. For surgical, we're expanding our leadership in equipment by developing an equipment ecosystem to improve efficiency and accuracy, while we're expanding our implantable business in surgical glaucoma. For Vision Care, we're using our water gradient technology to create differentiated new Silicone Hydrogel contact lenses for both daily and monthly use. With that, let me pass it to Tim, who will take you through our financial results.

Thanks, David. We're pleased to report third quarter sales of $2.1 billion. Up 13% versus 2019, driven by 14% growth in Surgical and 12% growth in Vision Care. Year-to-date sales were up 10% versus the first 9 months of 2019, with Surgical up 12% and Vision Care up 9%. Implantable sales were $375 million in the third quarter, an increase of 32% versus 2019. As David mentioned, we remain market leaders with our PC-IOL portfolio, and we continue to see adoption driving encouraging penetration rates above historical levels. On a year-to-date basis, implantable sales were up 28% versus the first 9 months of 2019. Consumable sales of $594 million in the third quarter increased by 3% versus 2019, with sales growth across all 3 categories of Cataract, Vitran, and Refractive. On a year-to-date basis, consumable sales were up 1% versus the first 9 months of 2019. Equipment and other sales were $192 million in the quarter, up 20% versus 2019. About 8 points of the growth was due to refractive sales, with continued demand for LASIK procedures. The remaining growth was primarily due to strong demand in cataract and new equipment. On a year-to-date basis, equipment and other sales were up 21% versus the first 9 months of 2019. Now turning to Vision Care, third quarter sales of $923 million grew 12% versus 2019. Contact lens sales were $562 million in the quarter, up 7% versus 2019. This was driven by strong demand for PRECISION1 and PRECISION1 for astigmatism, as well as continued growth from DAILIES TOTAL1. As David mentioned, we're also rolling out TOTAL30 in the U.S. and Europe where customer feedback has been extremely favorable. Based on the strong performance of our contact lens portfolio, we continue to add new manufacturing lines and assess the need for additional capacity to support product flow of our new products, especially PRECISION1 for astigmatism. On a year-to-date basis, contact lens sales were up 5% versus the first 9 months of 2019. Now, moving on to ocular health, where sales of $361 million in the quarter increased by 20% versus 2019. About half of the growth is attributed to Sustained, which grew double digits in all regions underpinned by the growing artificial tier market. This was aided by our new Multi-Dose Preservative-Free launches in Europe and the U.S. The other half of the growth is primarily due to new additions to our portfolio, including Pataday and Simbrinza, which had no comparable sales in 2019. On a year-to-date basis, our ocular health sales were up 16% versus the first 9 months of 2019. Now moving down the income statement, third quarter core gross margin was 63.7%, broadly in line with 2019. We continue to see inflationary headwinds related to raw materials, freight, and labor. Despite our best efforts to mitigate these pressures through active management of supply and selective price increases. Core operating margin was 17.7% in the quarter, driven by operating leverage as higher sales outpaced increases in SG&A. As we mentioned on our last call, we expect to see incremental margin pressure in Q4 primarily due to product mix and timing of spend as we continue to invest in our commercial activities and sales force as markets recover. Third quarter interest expense was $31 million, down from $35 million in 2019. While we've taken on incremental debt, we've benefited from lower variable interest rates and lower debt in affiliates. The core effective tax rate was 17.5% in the quarter, compared to 18.2% in the third quarter of 2019. The current rate benefited from a buildup of inventory in certain international markets that had a favorable product mix and a favorable mix of pre-tax income and loss across tax jurisdictions. For the first nine months of the year, the core effective tax rate was 17.5% in the quarter, compared to 18.2% in the third quarter of 2019. The current rate benefited from a buildup of inventory in certain international markets that had a favorable product mix and a favorable mix of pre-tax income and loss across tax jurisdictions. For the first 9 months of the year, the core effective tax rate was 19.1%. Core diluted earnings per share in the third quarter of 2021 were $0.54, up $0.08 versus the third quarter of 2019, driven primarily by operating leverage. Next, I'll touch on a couple of cash flow and balance sheet items. Free cash flow year-to-date was $578 million compared to $260 million for the same period in 2019. Higher core operating income and lower separation spend were partially offset by increases in capital expenditures and inventory to support new product launches and expected upcoming demand. CapEx was $380 million for the first 9 months of the year with the increase driven by our contact lens manufacturing expansion. As a reminder, historically, CapEx spend has been heavily weighted in the fourth quarter, and we expect that trend to continue this year. Transformation costs were $14 million for the third quarter and $141 million life-to-date. Turning now to business development. As David mentioned, we announced our intention to acquire Ivantis for $475 million in cash plus potential future payments contingent upon the achievement of certain development and commercial milestones. Ivantis offers attractive sales and earnings growth potential in a fast-growing category where we currently do not participate. We estimate Ivantis will have sales of approximately $60 million for the full year 2021. In 2022, we estimate that Ivantis will be broadly neutral to core operating income with some pressure on the core operating margin rate. We expect the acquisition to be accretive to core operating income in 2023. We anticipate closing the transaction in the first quarter of next year, subject to customary closing conditions, including regulatory review. As we discussed earlier in the call, we continue to see broader macroeconomic burdens such as inflation and tightness in the supply chain. We have been proactively working to manage these challenges, but we've seen pressure to date and expect that to continue going forward. In addition, the U.S. dollar has appreciated significantly since the first half of the year. If the U.S. dollar remains at current rates, we would expect to see FX headwinds in 2022 as compared to 2021. Despite that backdrop, and based on the strong performance year-to-date, we expect to come in around the higher end of our 2021 guidance. This outlook continues to assume that global markets return to 2019 levels by the end of the year. U.S. markets continue to grow above 2019 for the remainder of the year, and on an aggregated basis, international markets reach 2019 levels early next year, with emerging markets and countries like Japan remaining subdued. Now, I will turn it back to David for some closing remarks.

Thanks, Tim. To briefly wrap up, we're pleased with the strong results we saw this quarter with sales up in every category, exemplifying the resilience of our business, the strength of our innovation engine, and the expertise of our commercial organization. Our new product launches are gaining momentum and taking share as markets around the world continue to recover. We're pleased to be expanding our surgical portfolio both through our smart solution ecosystem and through our intended acquisition of Ivantis. In Vision Care, a robust pipeline of innovative products are bringing new options for doctors and patients in contact lenses, dry eye, allergy, and glaucoma drops. We're pleased with our ability to deliver growth and outpace the market, and we are well-positioned to capture an outsized benefit as the global markets recover, delivering long-term value to our shareholders. And with that, let's open up the line for Q&A.

Thank you. At this time, we will be conducting a question-and-answer session. One moment, please while we pull for questions. And our first question comes from the line of Brian Zimmerman with BTIG. Please proceed with your question.

Thank you for taking my questions, and congratulations on the quarter. Tim and Dave, reflecting on last year during the peak of COVID, the ophthalmic markets experienced a significant slowdown. However, they now appear to be demonstrating greater resilience. Could you elaborate on that shift? Additionally, we've heard from several of your colleagues about expected staffing challenges for next year. Are you also anticipating these challenges, particularly in the U.S. market, which seems to be showing more resilience? I would appreciate your thoughts on this.

We have observed considerable strength in the markets, indicating solid underlying fundamentals. As we navigate this situation, we weren't entirely certain about how it would unfold initially; our early guidance was somewhat off. However, we believe that cataracts are not a temporary issue and are indeed re-emerging. Currently, if we reference 2019 as a benchmark, we find that the market is not fully back to its growth potential. For instance, in the U.S., the number of procedures has reached 4% compared to 2019, and if we consider that this figure still reflects a slight lag from expected normal growth of about 3%, we recognize that while there has been notable recovery, it has not fully returned to pre-pandemic levels. In Vision Care, despite a pause last year, underlying metrics have outperformed our expectations. While the number of visits hasn't returned to ideal levels, revenue is rebounding, partly due to an increase in remote prescription renewals and larger purchases per patient. There are specific unique circumstances at play, but fundamentally, the eye care sector seems resilient. We anticipate that these markets will largely recover by the beginning of next year. Currently, in the U.S., we are witnessing growth, but the international market is expected to recover more gradually, likely extending into the middle of next year for some regions. Collectively, international recovery is projected for early next year, but it will likely involve a slow and steady ascent rather than a rapid rebound.

Staffing.

Okay.

On staffing, I think it remains challenging, particularly in optometry. The surgical centers are managing reasonably well, but it's hard for them to significantly increase their operations. Initially, we expected a sharper recovery, but that's not materializing, primarily because it's difficult to increase throughput with our current capacity and there are staffing shortages in Vision Care as well. If you were seeing 20 patients a week before, you might be down to about 16 now. It's tough to get back to that previous number without more staff. I believe things will improve gradually, and over time, these markets should be returning to historical growth rates as we look ahead to next year.

Okay. Regarding cataracts, there have been some new product launches in the market. What are your expectations for the impact of these? It appears that PanOptix and Vivity are performing well despite these new entries. I assume you are factoring this into your expectations. Could you elaborate on that a bit? I would appreciate it.

Sure.

Thank you for taking my question.

We have observed this market with products available globally for some time. The only new market for us is the U.S. We expected to have a very high share in the 80s, but that will likely decrease. The key question is whether the decline will be more or less than we anticipated, and so far, it seems to align with our expectations. People will likely try the lens because it is a good product, and particularly, Vivity has minimal halos and glare. In essence, it is quite similar to a monofocal lens while also providing intermediate and near vision. This lens has proven to be a much better option for many compared to other newer lenses, which tend to present more visual disturbances. For those needing guaranteed near vision, PanOptix would be the choice, but Vivity also offers significant benefits. Our focus is shifting towards increasing market penetration. We are exploring ways to engage more patients with AT-IOLs and to enhance patient flow through ophthalmology practices. This approach is crucial for our long-term strategy. Historically, for every 100 basis points of penetration, we can realize an additional $100 million, making penetration rates a priority as our market shares remain strong. I feel optimistic about the competitiveness of our current position.

Thank you.

And our next question comes from the line of Julien Dormois with BNP Paribas. Please proceed with your question.

Hi. Good morning, Dave. And Tim, thanks for taking my questions. I have two. The first one relates to Vision Care, and most precisely, the launch of TOTAL30. If I'm right, you currently have a share in the mid-teens in that category of premium reusable. How do you think what's the reasonable share objective that you have for this specific segments, and how long do you think it could take to get you there? And my second question is on surgical, and I know you have already asked the question on other calls, but I've seen very puzzled by the very different growth patterns that we still see between consumables on the one hand, and implantable and equipment on the other hand. And obviously compared to 2019. So is it just a function of implantable and equipment growing above their historical trends, or do you still expect to share a catch-up effect at some point in consumables, for example, in 2022.

Sure, Julien. Let me start with the first one. We are very excited about TOTAL30. It is a unique product that incorporates a water gradient into a durable material designed to last 30 days. This means you get the two best aspects of what we aim for: a durable material that lasts 30 days and a sensation that feels almost weightless on day one and remains comfortable through day 30, very similar to the experience on the first day you wore it. This represents a significant advancement over the current products available. We are pleased with the early reception it has received. The contact lens market typically has a slow share movement. Ideally, you would prefer a quick rise, but in reality, you can only capture a small portion of the market each year. Remember, for customers satisfied with their lenses, approximately 70% will likely stick with what they already use. Those who are dissatisfied, whether due to discomfort or other issues, represent the opportunity for new customers and account for roughly a third or less of the market that actually switches. This opportunity for gaining market share only arises slowly over several years. For instance, we've had medications like DT1 in the market for nearly 10 years, and it continues to gain share. Generally, the growth for these products is stable; they do not show steep increases but tend to grow consistently each year. This provides a promising financial outlook because of its stable growth potential. While I cannot provide a specific forecast for market share for this product at the moment, we are excited by the early indicators. On the surgical side, we approach implantable devices and equipment differently, starting with market growth. Historically, the growth in procedures closely aligns with unit growth in implantable devices, typically falling between 3 and 4 percent globally. It's occasionally stronger, but that has been the norm. The number of implantable devices is likely to grow in line with the rate of procedures, as one procedure necessitates one implantable device. Consumables should grow similarly, where each used unit accompanies the surgical procedure. In implantables, there is a trade-up in volume and value. We're moving from basic units that might have cost a dollar to those priced between $600 to $900 in some cases, driving the difference in value. Equipment growth has been uniquely robust; we typically anticipate that equipment sales will grow slightly faster than procedural growth. On average, one would expect around 10 to 20% of the old equipment to be replaced annually, alongside new market growth driven by procedures. This way of thinking about growth is usually slightly more favorable than procedural growth, depending on equipment pricing. However, I do not foresee a significant catch-up in consumables because the growth in procedures will correlate directly to the growth of consumables. Part of the variation you’re observing in our markets is due to a heavier reliance on regions that have recovered, compared to the global markets. For instance, we often exclude India, as its recovery in procedures has not seen a significant uptick, and we are not currently benefiting from that situation.

Helpful. Thank you very much.

Our next question comes from the line of Scott Bardo with Berenberg. Please proceed with your question.

Yes. Thanks, guys, for taking the question. So I have 2 questions. I'll start with the first, please. Just on guidance. The obvious question would be, why didn't you include any comments on guidance in your release? I think that confused quite a bit of the capital markets this morning and I thought that we've seen it before. I appreciate, Tim, also you highlighting comments about inflation and the logistic customer side. What I'm trying to understand is, are they significant enough to drive the 16% margin in Q4 implied by your guidance? And do you still hold your 20% margin by 2023 despite this acquisition? That's the first question. Thanks.

There are several points to address in your question. Frankly, I was somewhat taken aback by the reaction to our decision not to provide guidance in the press release. Our usual approach has been to refrain from updating guidance unless there is a significant change. While we did offer some additional context regarding expectations, we have not modified the overall guidance, which remains at a 16% perspective. There are a few factors to consider. Historically, Q4 tends to be lower than Q3 due to seasonality, primarily influenced by Vision Care and a few other factors. Additionally, some spending has been delayed; we expected to spend certain amounts in Q3, but that has shifted to Q4. As you project into 2020, I want to share a few insights. First, I would advise you to consider the high end of our guidance. For example, if you start with revenue at $8.2 billion, we have indicated previously that we anticipate mid-single-digit growth. It's important to acknowledge the momentum we're experiencing as we finish 2021. Looking at implantables, as David mentioned earlier, Vivity is performing strongly, and we plan to launch it in new areas next year. This upward momentum is likely to persist. In the contact lenses segment, there is a lot of positive movement with P1 and two new lenses, P30 DT1 for astigmatism, set to launch. Thus, further growth is anticipated there as well. For Dry Eye, our sustained family positions us well. The only caveat I would give relates to equipment; I don't believe that equipment demand will remain as high next year as it has this year, as I expect refractive demand to decline. However, that frames my thinking about revenue. Regarding gross margin, I do anticipate some year-over-year pressure due to inflation. Similar challenges with raw materials, such as resins and electronic chips, persist. Freight costs continue to be a concern, and labor rates are also experiencing upward pressure. Therefore, we expect to see some gross margin pressure next year. Regarding R&D, we previously stated a range of 7% to 9%, and we've been operating at the upper end of that range. However, due to the current status of our innovation pipeline, I expect next year to fall more towards the midpoint of that range. As for SG&A, we believe we will continue to achieve favorable operating leverage.

If you focus on the G&A area, we expect modest increases due to the transformation work we've undertaken, and we will also invest in growing markets. Additionally, regarding currency exchange rates, as of last Friday, compared to the average rates for September year-to-date, we see fluctuations in all currencies. The dollar has decreased by a couple of percent against the euro, roughly 2% or 3% against the pound, and 4% against the yen. If these rates remain stable, we anticipate ongoing pressure into 2022. For 2023, we feel confident in the guidance provided during our Capital Markets Day, allowing us to meet our commitments for both 2023 and 2025.

That's a very comprehensive answer. Thank you. And maybe if I can just sneak in a quick one. David, I'd love to hear your thoughts about Ivantis in the acquisition here. I'm just curious to understand why you decided to buy this business. You could have arguably acquired the market leader with 4 times the revenue. Just share with us what it is about this business that particularly fills.

We have given considerable thought to the market needs based on our experience in this area. The team at Ivantis has done an excellent job with the data they have generated and the safety of their product, which is also uniquely effective. We have always believed that the market requires something that has long-term effectiveness. The data indicates that 65% of patients are medication-free after five years, demonstrating significant efficacy. If we support this with our resources and more data, along with our commercial reach, we see a lot of potential for growth. The opportunity here presents a better value for each dollar spent.

Our next question comes from the line of Veronika Dubajova from Goldman Sachs. Please proceed with your question.

Good morning, guys. And thanks for taking my questions. 2 please. 1. Just on the IOL or PC-IOL momentum, David, I was hoping you could talk about to what extent the growth that we saw in the quarter is being driven by the Vivity versus PanOptix? And maybe just give us a little bit of flavor for the type of market share that you've seen with the Vivity in Europe and kind of how, how you think that informs your views going forward. If I can interpret your comments on continued higher penetration and uptake of Iowa, I think I ask you this question every quarter, but just your degree of confidence that that continues as we move into next year, has it increased or decreased? And then my second question is a bit of a financial one for Tim. Tim, just thinking about the bridge from the '21 margin to the 2023 margin, and would love to get your thoughts to what extent do you think that margin progression is '22 versus 2023 weighted? Is this an even keel or should we be thinking about some element of phasing, especially in the context of the Ivantis deal, as well? Thanks.

It's great to hear from you, Veronika. Regarding the PC-IOLs, the Vivity product is experiencing significant growth, outpacing PanOptix due to its current low volume. PanOptix is still growing in the double digits, but as we mentioned earlier, we expect that once PanOptix reaches its peak and stabilizes after a series of launches, Vivity will become our next growth driver. We're optimistic about Vivity's potential and its effectiveness, especially since many surgeons appreciate its capability to treat patients without halo and glare, which is encouraging transitions from monofocal Toric to multi-focal Toric—an important shift that provides a great opportunity for our business. Presently, Vivity is a key contributor to our growth globally, while PanOptix shows stable, albeit modest, growth. Several international markets have yet to launch Vivity, and we believe its growth trajectory will mirror that of PanOptix over the next 12 to 18 months. There's still potential for expansion, particularly in Japan, China, and other regions where we haven't launched the Toric product yet. On the competition front, we acknowledge that there are other players in the market, but we hold a significant share, which we don't foresee changing drastically as a primary growth factor. Addressing your second question, we’re enthusiastic about the current demand for Vivity, especially as more patients from monofocal and monofocal Torics are becoming interested due to its reduced halo and glare effects, as well as its comparable characteristics to monofocals. However, my confidence in penetration rates is tempered; while it seems that we're currently increasing penetration, we must remember that the current calculations do not fully account for many monofocal procedures. We're still observing recovery internationally, particularly in regions like India, Brazil, and Russia, where numerous procedures have yet to be performed. Adding these units back to the overall figures may lower the current penetration rate, so we are waiting for the market to stabilize. That said, we do see consistent growth in individual surgeons’ penetration rates year over year, and we're confident that our presence is strengthening. The long-term durability and overall size of this growth are still to be determined, but we believe tracking these trends is essential for our strategy.

Hey, Veronika. Regarding the margin profile, our position remains consistent. The improvement in margins is approximately 80% due to operating leverage and about 20% from gross margin enhancement. From an operating leverage standpoint, this process should be quite linear, as revenue will primarily drive the advancement. As we continue to grow at a mid-single-digit rate while maintaining our cost base at levels consistent with inflation, we expect this to progress linearly. On the gross margin front, I believe there has been somewhat more improvement in 2023 compared to 2022, largely attributed to two factors. I’m unsure how long the inflationary pressures will persist; it’s possible we won't experience the same level of pressure in 2023 as we did in 2022 or 2021. We’ll have more time to implement mitigating actions and assess market reactions. Additionally, there will be less strain on the P1 line installations in 2023 than in 2022 and 2021. That’s how I view the progression. Regarding Ivantis, as we mentioned during Capital Markets Day, our guidance did not factor in any acquisitions, so we remain optimistic about our commitments for 2023 and 2025. Ivantis is significant enough to influence those commitments in the long run.

Fabulous. Thank you guys.

Our next question comes from the line of Larry Biegelsen with Wells Fargo. Please proceed with your question.

Good morning. Thank you for the question. David, regarding Ivantis, it seems you believe you can continue to grow the product from its current $60 million despite the changes in reimbursement. Do you anticipate growth for this product in 2022 and beyond? Additionally, could you provide details on the breakdown of U.S. and international sales? Tim, can you help us understand the impact of currency fluctuations, the headwinds from Ivantis, and inflation for 2022? Thank you for addressing these questions.

Hi, Larry. Regarding Ivantis, we believe we can achieve long-term growth for this product. We were mindful of certain situations that needed resolution before we moved into a more aggressive acquisition strategy with Ivantis. The CMS ruling was one of those situations, and as you know, that was resolved last week. The outcome was significantly better than the unfavorable price we initially received. However, it is expected to exert some downward pressure on what we initially saw as a low-to-mid-teens growth rate for the market. Despite this, we believe the market will continue to expand, and we think this specific product can capture more market share. We view this as a rapidly growing market, and with the right focus and messaging, along with the extensive data the Ivantis team has assembled, we are optimistic about our potential. This aligns perfectly with our capabilities, as we are actively involved in surgeries with these surgeons performing this procedure, making it straightforward and essential for us to enhance our service to them. As for the U.S. versus international sales, the current emphasis is primarily on U.S. sales, with limited international presence at this time. We aim to change that, but our initial step will be to focus on securing reimbursement before deploying a sales force internationally. Currently, Ivantis is in five countries, and we are exploring opportunities in several other markets.

Sure. Regarding the quantification Larry, let’s start with foreign exchange. I mentioned a few currencies that have been rising. If we consider all the key currencies, it could impact us by 2 or 3 percentage points. However, that's based on the rates from last week, and we will keep monitoring them as we move forward before providing guidance for next year. When it comes to inflation, I’m somewhat cautious about stating specifics since we are implementing pricing actions and our manufacturing team is working on several productivity initiatives that are still in development. This is something we will keep an eye on. I anticipate some pressure, but we will provide more details when we issue our guidance for next year. As for Ivantis, it will create slight pressure on our margins. I would recommend considering the $60 million in sales and projecting growth for next year, although we might not see significant core operating income from that, which will contribute to margin pressure.

Thank you guys.

Our next question comes from the line of Daniel Woodstill with ZKB. Please proceed with your question.

Thank you for taking my two questions. First, regarding the Vision Care margin, it was encouraging to see a relatively good margin in Q3. We know you are adding capacity to address closing operating margins. Can we consider Q3 a turning point, suggesting that as we move into 2022, Vision Care will improve and show increasing margins? My second question pertains to the impairment of $178 million. Could you provide more details about what this was related to? Additionally, you mentioned $60 million in legal expenses; what does that cover and what are the associated risks? Is there a possibility of larger expenses arising in the near future? Thank you.

Sure. Thanks for the question, Danny. We were pleased with the Vision Care margins in Q3 and are making progress. However, I want to note that Q3 is affected by seasonality. We had a strong revenue performance, partly driven by allergy season, leading to a heavier revenue mix in Q3 compared to Q4. The back-to-school programs in the U.S. contribute to this stronger Q3 performance. Operating leverage has significantly improved our results, and we are satisfied with the Vision Care business's performance. Regarding impairments, we did take an impairment on a surgical asset we purchased in 2017. As we manage our investment portfolio continuously, we've made some successful strides in other areas of our surgical business, prompting us to suspend R&D and commercialization for this asset, resulting in a one-time non-cash impairment of $178 million. Lastly, on the legal provision, we refrain from commenting on ongoing legal cases. Each quarter, we assess the legal landscape and the balance sheet to ensure we provide adequate provisions, and we believe we are sufficiently covered in Q3.

I'm sorry. What was that?

He was asking about what it would look like regarding the legal matters. We review these every quarter. We assess our risks and make a suitable provision. That's what we've done.

Okay, thanks very much, thank you.

Our next question comes from the line of Cecilia Furlong with Morgan Stanley. Please proceed with your question.

Thank you for taking the question. Two questions, and I'll ask them both upfront. But just in terms of new fits, I'm curious if you talk a bit more about what you saw in OUS markets during the quarter as well as your outlook going forward from a recovery standpoint. And then also, just between TOTAL30 and ramping DT1 toric, can you talk a bit more about just how you're thinking about balancing those two in your comments on ramping manufacturing lines into '22, and thank you.

New fits are currently performing well for us, especially in the U.S., where we're seeing significant progress, particularly with the DAILIES and the new P30 brand, although we don’t have much data on it yet. The PRECISION1 has been successful, and the DT1 continues to perform well for us. Outside the U.S., the pace is slower. We've noticed a decline in the number of new fits coming into the office, particularly in Japan, which is our second largest market. Europe is gradually improving. It's important to have new patients visiting and existing patients seeking alternatives for their current lenses. As the market rebounds in those areas, we expect that our Vision Care international business will largely return to 2019 levels by the beginning of the year, which is positive for new fits of new products. However, we have been lagging in the U.S. due to the lack of new fits, but we're optimistic about the future. Encouragingly, when we provide these products to patients and optometrists, they're performing very well. Customers are pleased with our Precision1 for astigmatism and Precision1 sphere, and our DT1 has received great feedback in the U.S., as has the T30 in both Europe and the U.S. We are addressing these issues and are hopeful for a more typical market next year, allowing us to gain more share outside the U.S. Regarding manufacturing, we are in a good position. We experienced greater-than-expected demand for PRECISION1, particularly the astigmatism variant, which caught us off guard, resulting in some sporadic back orders in the U.S. and delayed rollouts. The positive aspect is the strong reception for this product. We now need to assess our expectations for these products and consider whether we require more line time or additional machines, so we're currently evaluating that. While I don't foresee any major changes, we may need to invest a bit more in manufacturing for next year.

Alright. Thank you for taking the questions.

And ladies and gentlemen, as we reached the top of the hour and we have time for one more question, which leads us to the line of Jeff Johnson from Baird. Please proceed with your question.

Thank you. Good morning, guys. Thanks for squeezing me in. David, just on that contact one point. I'd be interested to hear primarily your expectations, what you're seeing for trade-ups versus trade-downs from DT1 to trade downs, trade-ups from DHCP and some of the other older focus products, number 1. And number 2, let's say you grow a couple of points above market in the contact lens market over the next couple of years, do you think that will primarily be driven by net kind of trade-up benefits within your own portfolio, or do you expect that you'd also be taking unit or patient share on iShare however you want to think about it relative to competition?

Yes, a little bit of both, Jeff. Let’s start with the cannibalization question. We anticipated some cannibalization with P1 of DHCP in particular. However, DHCP has proven to be more stable than we expected. DT1 was likely more challenging than we thought as well, but generally, the overall value change was close to what we predicted. The mix may have differed slightly from our expectations, but we are making significant efforts to ensure that people fully understand these products and their offerings. One reason we accelerated the launch of DT1 Toric was due to the unexpected success of P1 Toric, which created some pressure on DT1, as we did not initially have a Toric version for the TOTAL1 product. This led to a bit of P1 affecting DT1. Now that we have the Toric available, it has stabilized our premium product line, along with both P1 and P1 Toric products. Our middle-market product lineup seems poised for success. Over time, there has been a consistent shift from reusables to dailies, which has been occurring for years. The Vision Care market is steady and strong, with this shift continuing to drive value growth even if overall growth in the market is around 1% to 2%. We anticipate gaining some competitive share, but we don’t need to take market share from everyone to achieve decent growth in the mid-single digits or higher. This is one of the advantages of our current strategy. Additionally, our share position in the reusable business is under-represented, and we believe we can easily gain share in that space with the new technology. This segment has a better margin profile compared to DAILIES, even though it has lower market growth. We can not only gain share but also improve margins and revenue, even if growth is slower. We have a solid mix moving forward, and we see that continuing. Also, when we discuss specialty lenses, particularly Torics, that’s where the market is currently thriving—growing rapidly within silicone hydrogel and adding a premium price for spheres. We are well-positioned for growth in the foreseeable future.

Understood. A quick follow-up. It's been a little quiet here recently. Maybe that's a good thing, but I haven't heard any updates recently on BBP in China. Any timing update there? Any kind of way to look at public versus private mix within your business? Just how to think about exposure. And if there is a timeline to think about when that exposure might have to be factored into models. Thanks.

Yes, I believe China has been on this path for a while now. The IOL has been implemented at a provincial level in most regions. In October, there was likely only one VBP tender, which was a joint tender for two provinces. In past IOL VBPs, some included AT-IOL, but generally, the price impacts were on our monofocal business, where we are somewhat underrepresented in the public sector. While we are fairly strong in China, it's primarily in the private AT-IOL market. I don't have specific data on the splits, but I can say that most of our revenue comes from the private sector AT-IOL business. We are monitoring some crossover impacts closely. Overall, I think we probably have less exposure than others in this market.

Thank you.

And we have reached the end of the question-and-answer session. And this also concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.