Alcon Inc Q2 FY2022 Earnings Call

Greetings and welcome to the Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode, and a question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Dan Cravens, Vice President and Global Head of Investor Relations. Please, go ahead, sir.

Welcome to Alcon’s second quarter 2022 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 these documents in the Investor Relations section on our website at 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 from those in our forward-looking statements are included in Alcon’s Form 20-F 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 measures should be considered along with but not as alternatives to the operating performance measures as prescribed by IFRS. Please see a reconciliation between our non-IFRS measures with directly comparable measures presented in accordance with IFRS in our public filings. For discussion purposes only, our comments on growth are expressed in constant currency. With that, I will now turn the call over to our CEO, David Endicott.

Thanks, Dan. Welcome to Alcon’s second quarter 2022 earnings call. I’ll begin by giving a brief update on our second quarter results, overall market dynamics, and recent performance. After my comments, Tim will discuss our second quarter performance and our outlook for the remainder of the year. Then I’ll wrap up with some closing remarks and we’ll open the call for Q&A. I’m pleased to report that we had another strong quarter, despite broad macroeconomic headwinds with sales growth of 10%, core operating margin of 18.4%, and core diluted earnings per share of $0.63. These results were driven by our innovative product portfolio, strong commercial execution, and continued improvements in international markets as they recover from COVID-19. Overall, our Surgical franchise continues to lead the market with our portfolio of advanced technology, intraocular lenses, our substantial installed base of equipment, and our growing consumables base. Now, implantables, we remain the market leader in PCIOLs due to the strong customer reception for Vivity and PanOptix. Alcon is taking share in key international markets and exited the quarter with approximately 55% of the global PCIOL market, up 5 percentage points from when we launched Vivity in the first quarter of 2020. In the U.S., we’ve maintained our leading PCIOL market share of over 80%, despite competitive products that entered the market last year. In equipment, we continue to lead the market on the strength of our innovative cataract suite. Interest in Active Sentry remains strong. If you recall, Active Sentry is the most advanced phaco hand piece, where the system’s fluidics are controlled through sensors near the eye. This unique feature reduces surge and improves safety. Innovations like Active Sentry, as well as our leading Centurion technology are driving favorable account conversions as we upgrade legacy phaco equipment to Centurion in our international markets. We’re also seeing momentum for our Legion phaco machine in international markets among surgeons who are looking for premium performance on a portable machine and at a lower cost per use. Additionally, we saw another strong quarter in our consumables business, which grew high single digits versus last year, in line with the recovery in procedural volumes. Earlier in the quarter, we participated in the American Society of Cataract and Refractive Surgery conference where we showcased a robust scientific program. Data was presented that highlights the sharp crisp vision and glistening-free clarity of Clareon, our most advanced IOL material. Clareon has been implanted in more than 1 million eyes and is now available on most of our IOL and PCIOL platforms across key geographies. In addition, surgeons at the meeting presented a real-world study highlighting that our Argos biometer delivers significant time savings in cataract evaluation. This is becoming an increasingly critical element for surgeons looking to improve practice efficiency, especially given current levels of staff turnover. Innovation and data presented at the event demonstrate that our products and services continue to support surgeons in delivering increased efficiencies and improved patient outcomes. Now, moving to Vision Care, our new and recent product launches including our Precision1 family lenses, Total30, and Dailies Total1 for astigmatism continue to drive momentum. We’re particularly excited about having two SiHy toric lenses in the market, Precision1 for astigmatism, which is aimed at the mainstream market, and Dailies Total1 for astigmatism for the premium segment. Dailies Total1 for astigmatism has been eagerly anticipated by eye care professionals for years and the reception has been very strong. This is the first and only daily disposable toric lens to feature water gradient surface material. With this lens’ exceptional comfort, eye care professionals are well-positioned to fit and keep more astigmatic patients in contact lenses. This is contributing to our growing share of the daily toric market, which is the fastest-growing market segment. Additionally, we continue to see positive uptake of Total30, our newest reusable lens. This water gradient lens is nearly as soft as the cornea itself and is almost 100% water at the surface, creating a lens that is exceptionally comfortable, yet durable for 30 days of wear. We’ve now rolled out Total30 in both Europe and the U.S. and we’re preparing to launch Total30 for astigmatism early next year. With new entries in daily, reusable, and specialty lenses, we’re excited about the progress we’re making in new and switch fits, which is a strong leading indicator of long-term share growth. And finally, turning to ocular health. We continue to see strong retail, consumer, and physician interest in our portfolio of eye drops. Sales of our popular Systane family of artificial tears grew in the high single digits, driven by the recent launches of our multi-dose preservative-free formulations in the United States and international markets. Simbrinza also continues to contribute nicely to our portfolio of eye drops. Recall that we’ve invested in a new sales force dedicated to supporting our portfolio of eye drops in the United States. Now, let me provide an update on our end markets. In Surgical, global cataract procedures were up high single digits in the second quarter versus the prior year. This excludes the impact of the market recovery in India which was significantly impacted by COVID-19 last year. Against this backdrop, we saw significant growth in our implantables business, driven by the strength of our advanced technology lenses through commercial execution and international market recovery. In Vision Care, the market growth was very dynamic and varied by region. United States grew mid-single-digits, in line with historical averages, while Europe and Japan, which were impacted more significantly by COVID-19 in the second quarter of last year, grew double digits. To summarize, despite the macro and supply chain challenges we’ve faced, I’m very pleased with the strong underlying performance of our business in the second quarter. We grew revenue 10% while continuing to invest in the business. Our robust innovation pipeline is delivering solid results as evidenced by the successful launches of our new ATIOLs roles and SiHy contact lenses. We continue to drive operating leverage. And our second quarter 2022 core operating margin expanded by 170 basis points on a constant currency basis over the prior year. Given the current economic environment, we will continue to take measures to offset some of the headwinds as we are well-positioned to succeed in the future. With that, let me pass it to Tim who will take you through our financial results and provide an outlook for the rest of the year.

Thank you, David. We’re pleased to report second quarter sales of $2.2 billion, up 10% versus prior year. This double-digit growth was driven by demand for our innovative products and international market recovery. Similar to the first quarter, our overall second quarter sales growth included approximately 1 percentage point of contribution from recently acquired products, Simbrinza and Hydrus. Our second quarter U.S. dollar sales growth included approximately 5 percentage points of pressure from foreign currency. For the first half of 2022, total company sales of $4.4 billion grew 14%. In the quarter, we continued to build upon our positive momentum, despite the persistent macroeconomic headwinds. These headwinds included a historically strong U.S. dollar, supply chain tightness, and inflationary pressures. This was pervasive across both our franchises and included pressures on availability of supply, rising prices on electronic components and commodities including plastics and resins, as well as increased costs for labor and transportation. Fortunately, our team was able to offset much of the impact through productivity and cost reduction initiatives, strategic price increases from earlier in the year, and contract negotiations with suppliers. In our Surgical franchise, revenue was up 13% year-over-year to $1.3 billion in the second quarter. Surgical revenue in the first half of 2022 was up 17%. Implantable sales were $444 million in the quarter, up 21% year-over-year, primarily due to market recovery, the strength of Vivity, and sales of Hydrus, which was not part of our portfolio last year. Implantable sales in the first half of the year were up 29%. For consumables, our second quarter sales were up 9% to $644 million, with cataract growing low-double-digits and vit-ret growing high single digits. For the first half of the year, consumable sales are up 13%. In equipment and other, our sales were up 10% year-over-year to $208 million in the second quarter, primarily due to strong reception of our suite of cataract equipment. In our international regions, we continue to upgrade customers from older generations of phaco equipment to Centurion. Additionally, demand for Legion has been strong. We also see solid interest in our Active Sentry hand piece, our Revalia microscope, and our Argos biometer. Sales growth was partially offset by declines in refractive equipment due to a difficult year-over-year comparison. Equipment sales for the first half of the year were up 8%. Turning now to Vision Care, second quarter sales were up 7% year-over-year to $904 million. During the quarter, we saw robust international demand driven by market recovery and product launches. Vision Care sales were $1.8 billion for the first half of 2022, up 10%. Contact lens sales were $547 million in the quarter, up 9% versus last year. We continue to see strong demand for our Precision1 and Total brand families as the recent launches of Dailies Total1 for astigmatism and Total30 continue to gain traction and take share. This growth was partially offset by declines in other reusable and non-SiHy daily lenses. Contact lens sales for the first half of the year were up 11%. In ocular health, our second quarter sales were $357 million, up 4% year-over-year. This is primarily driven by our sustained family of products, as well as sales of Simbrinza, which was not part of our portfolio for most of the second quarter last year. This growth was partially offset by supply chain challenges, primarily in contact lens care, which impacted growth by approximately 3 percentage points. Ocular health sales were up 9% for the first half of the year. Now, moving down the income statement. Second quarter core gross margin was 63.3%, down 20 basis points on a constant currency basis, primarily due to inflationary pressures. Core operating margin was 18.4% in the quarter, up 170 basis points on a constant currency basis. The improvement was primarily driven by operating leverage from higher sales, partially offset by increased inflationary pressures. As expected, we saw a planned increase in marketing and sales expense in the quarter. Second quarter interest expense was $31 million, broadly in line with last year. The second quarter core tax rate was 11.1%, compared to 19.2% last year. The lower rate was primarily due to the timing of a favorable geographic mix of pre-tax income, a benefit on inventory build in certain markets as a result of new product launches, as well as a benefit associated with an agreement for deductibility of a statutory expense in Switzerland related to the fiscal year 2022. The core effective tax rate was 13.7% for the first six months of the year. Core diluted earnings per share in the second quarter of 2022 were $0.63, up from $0.56 last year. Before I discuss our outlook for the remainder of 2022, I’ll touch on a couple of cash flow and other related items. Free cash flow for the first half of 2022 was $233 million, compared to $320 million last year. This variance was primarily driven by lower cash flow from operations in 2022 due to the annual bonus payment, which was higher than in 2021, and the timing of tax payments. Capital expenditures were $237 million for the first half of 2022, which were primarily related to our contact lens manufacturing production lines. Transformation costs were $9 million in the quarter, and $193 million life to date. During the second quarter, we completed a public offering of €500 million of senior notes, which are due in 2028. The proceeds from the offering were primarily used to repay existing debt. I’m also pleased to report that in the second quarter, we paid $100 million in cash dividends to our shareholders. Now, moving to our full year 2022 guidance. As is mentioned, we continue to see certain macro headwinds, including foreign exchange pressure from an appreciating U.S. dollar, inflation, and supply chain tightness, the global impacts of the war on Ukraine, and the ongoing effects from COVID-19. Our current 2022 outlook assumes that the 2022 global markets grow at slightly above historical rates, inflation stays at current levels through the remainder of the year, supply chain does not materially deteriorate, and the U.S. dollar holds steady at mid-July foreign exchange rates. Based on our current assumptions, we are updating our net sales guidance for full year 2022 to $8.6 billion to $8.8 billion versus our previous guide of $8.7 billion to $8.9 billion. However, given the strong performance of the business, we are maintaining our year-over-year constant currency sales growth of 9% to 11%. Foreign exchange is now expected to have a negative impact of approximately 5 percentage points versus the prior year as compared to the negative 3 percentage-point impact we estimated in May. Moving to core operating margin, despite the headwinds I’ve described, we are maintaining our full-year outlook of 18% to 19%. This guidance now reflects approximately 160 basis points of FX pressure versus last year, as compared to the 110 basis points in our May outlook. It also includes approximately 90 basis points of net inflationary pressure, consistent with what we provided in May. Interest and other financial expense is now expected to be between $210 million to $220 million, up $10 million versus the guidance we provided in May. The increased expense is driven by higher interest rates and hedging costs due to market volatility. We’re maintaining our core effective tax rate of 17% to 19% for the year, despite the favorable rates in the first half. The increase in the second half will be driven by a less favorable geographic mix, along with less of an inventory build for new product launches. We’re also discussing an advanced pricing agreement with the U.S. and Swiss tax authorities. Our guidance incorporates the impact of the new agreement and assumes the negotiations we finalize in 2022. Finally, we now expect full year 2022 core diluted EPS of $2.20 to $2.30 per share, down from the $2.35 to $2.45 per share we provided in May. This updated guidance reflects an increase of approximately $0.15 of FX headwind versus our last call, and approximately $0.37 versus the prior year. However, we are maintaining our constant currency core diluted EPS growth outlook of 19% to 24%, due to the strong momentum we’re seeing in the business. With that, I’ll turn it back to David.

Thanks, Tim. To wrap up, our underlying business continues to perform well, despite the headwinds that we continue to face. We’re launching new products and gaining share in both franchises. We continue to invest in the business, and we’re creating operating leverage and expanding margins. As we look to the future, our focus remains the same. We’ll continue to fuel our innovative engine while prudently managing our resources. All the while, we remain committed to creating long-term value for our shareholders. Finally, I want to thank all our associates for their hard work and delivering great results in an increasingly challenging environment. With that, let’s open the line for Q&A.

Our first question comes from Zach Weiner with Jeffries.

I just wanted to touch on the PCIOL market. First, expectations for market growth, which you kind of touched on, but then also PCIOL has been more premium procedure. How do you think that market will evolve as we head towards a potential economic downturn in the near future? Thanks.

First of all, we had a good quarter on PCIOLs. We’re very pleased with our share performance, United States, I think was up over 80 again. So, we’re under some new competitor launch in the United States now for almost a year. And I think we’ve really held up quite well, I think maybe better than many expected. So, that’s been terrific. I think outside the U.S., we’ve done a really nice job of growing share. So, I think, maybe in the script we quoted 55. That’s correct. We’re excited about that. That has been a combination of continuous progress made on PanOptix, but the addition of Vivity into the mix. And so, really importantly, we’ve gained 5 share points in the last 18 months or so, on the back of Vivity. So, what was really important to us was to show that that was additive to the share position, as opposed to potentially cannibalizing. So, we’re really very pleased with that performance so far. I think going forward, we expect that there is going to be continued growth in PCIOLs, I think year-over-year penetration continued to grow. It was slightly down from first quarter. I don’t know that I read much into that; principally was down in the U.S. And I think the thing we will have to see over time is how much this, what the effect of recession on this would be. We’ve modeled recession in the past on IOLs, and it hasn’t really been a very big effect because, of course, cataracts don’t go away and the cataract volumes continue in there. Back when we did it in ‘08, ‘09, which we’ve looked at, I think the kind of question in our minds was what was the PCL percentage, and it was quite low. So, it’s hard to take much from that. But it did stay pretty solid. So, I think from our perspective, it’s a little bit of wait and see. But I’ll remind people that the headroom in this space is quite big, right. So, we think people can afford ATIOLs, probably in that 35% to 40% of the market can afford it. We’re really sitting somewhere in the low-teens. So, I think there’s plenty of patients out there who can come get it, PCIOLs. We’re obviously spending a lot of time on it as well. So, we’ve increased our sales force effort. We’ve matched our coverage of ORs with now representatives responsible for trying to grow this business, clinical based sales force. And also, we’ve begun to use programming now that reaches patients directly on a digital basis. So, engaging in very specific information that will help move this along. So, we’re very positive on the outlook directionally, certainly on a share basis. But we’re very aware of the penetration needs going forward and continue to work on those.

Our next question comes from Chris Cooley with Stephens.

Good morning and thank you for taking the questions. And congrats on a great quarter in a tough environment. Maybe just one for me on the growth that you talked about in the MIGS market, recent acquisition there, obviously of Ivantis, would be interested in just learning a little bit more about your expectations for broad market growth, both here in the U.S. and abroad after we’ve seen a number of reimbursement changes in the space. And then, similarly, maybe any additional color you can provide just regarding receptivity to the various devices by channel when we think about the comprehensive ophthalmologist versus the glaucoma specialist? Thank you.

Yes. Thanks, Chris. I mean, the glaucoma business has been exciting for us. We’re glad to see the progress we’re making. We’ve integrated the Ivantis team. We’re actively training new surgeons. And we’ve got really great data on Hydrus now in the hands of the reps. So, we’re excited to talk a lot about two-thirds of patients remaining medication-free and a 50% reduction in the relative risk of a second surgery. So, we think MIGS is a growing space. And we see it growing high single digits and continuing to grow high single digits. The step-based part of the MIGS market I would say has been obviously year-on-year affected by the reimbursements. So, I think it’s growing currently in line with our expectations. And I think it has stabilized as well, I think as we kind of come into the middle part of this year. So pretty much as expected in the market for it. There are a couple of new products, I think, coming out. We’ve seen several new entries with at least approvals, I should say. And we think that’s a good thing, because I think what it’s showing is there’s increasing attention into these channels for glaucoma interventions. So, for the glaucoma surgeon, I think that’s very positive. It gives them a lot of choices, gives them choices in the mild to moderate where I think the vast majority of the market is and where we play. We’ll also give them some newer choices on the more severe end of the spectrum, which I think is where some of the newer players will play. And also, obviously, for the more comprehensive ophthalmologists, it gives them some choices on how to treat and refer or choose to do surgery. They’re called. But I think we believe there’s going to be a very specific group of surgeons who are going to follow these patients, are pretty good cataract surgeons. They’re not the super high-volume cataract surgeons who frankly are going to refer these patients, but I think we’re going to have a nice sweet spot in the middle of both glaucoma folks, and I’ll just call them busy surgeons that will do a good bit of this stuff. So very, very positive outlook, at least at this point, and I think kind of on par for where we had expected to be.

Our next question comes from Daniel Buchta with ZKB.

Maybe the first question and then a follow-up question on that topic as well. First one on the core EBIT margin guidance, I mean, you’ve kept it stable at 18% to 19%. But now you have already 19.5% in the first half. I mean, at least the lower end of the margin guidance sounds pretty cautious. But in general, maybe you can provide a bit of a picture, what has changed or what could change now in the second half compared to the first half where you were able to get up the margin so much already. So why, at least the lower end is still possible or challenging?

Thanks, Daniel. That's a great observation. We do anticipate some challenges in the second half of the year. Starting with foreign exchange, as noted in our prepared remarks, we are experiencing increased FX pressure in the second half compared to the first. For instance, looking at mid-July, which we use for forecasting, the dollar has continued to strengthen, appreciating about 6% against the euro and 4% against the yen. This trend is likely to result in a pressure of approximately $60 million to $70 million in the second half compared to the first. Regarding our innovation efforts, our R&D expenditure in the first half was around 7.5%. We previously indicated our aim to have this at roughly 8% of revenue for the entire year. This means we expect to allocate around 8.5% in the second half, leading to an additional $40 million or $50 million in costs for innovation. Lastly, concerning gross margin, there are two main factors at play. Historically, we face seasonality issues; for example, since 2019, our gross margin has typically been under pressure in the second half compared to the first, often influenced by the allergy season that tends to be more favorable in the first half. Additionally, during the Q1 earnings call, we noted a one-time positive impact from the Korea IOL, which will not recur in the second half. These are the primary factors contributing to the pressure we expect in the latter part of the year.

And then, maybe the follow-up on what that means for your guidance basically next year and also for 2025. I mean, the last comment from your side was, you will be at low-20s core EBIT margin by the end of next year and then, mid-20s by the end of 2025. Given what you see in the FX environment and everything you just mentioned, are both guidance still valid, or how do you see that?

Yes. Well, the first thing I’d say is we’re pleased with the 18.4% in Q2. And actually if you take FX out of that that gets you pretty close to 20%. So, we’re pleased with the margin progression that we’re seeing in the business. And I would just add that we’re getting that improvement while we continue to invest in the business and R&D, while we have a very volatile supply chain and backorder environment, if you will, and inflation levels that we haven’t seen since, call it the ‘80s. So, we’re committed to our goal. We have an operational plan to achieve those goals. Now, having said that, if the dollar continues to strengthen, we’re going to have to evaluate the financial impact that has. And the one thing that we are committed to is we are committed to innovation and investing in innovation, we are committed to investing in programs that drive revenue growth, and we’re committed to doing the right thing for the long-term of the business.

Our next question comes from Larry Biegelsen with Wells Fargo.

Just a question for Tim and David, but in terms of the guidance, it indicates around 4% to 8% constant currency growth in the second half, which translates to about 5% organic growth when adjusting for acquisitions at the midpoint. What factors are contributing to this softer growth outlook for the second half? Is it due to a more conservative approach, or do you expect the market, which has been very strong in the first half, to cool down? Additionally, what does this suggest for growth in 2023? Any initial insights would be appreciated. I have one more follow-up. Thank you.

Yes. Larry, let me start with the market itself. We think the market for the remainder of the year is going to grow slightly faster than historical growth rates. But it really does start to come down, as we said at the last call, from what is wrapping around on the COVID numbers, so the kind of COVID problems last year to something that looks a lot more normal by the end of the year. And remember that our normal growth rates have always been kind of roughly, and depending on the market, they’re around 4%, 5%. We grow a little faster than that. That’s usually what we plan to do. But I think that’s very consistent with the guidance we’ve given. I think the short version of this year is that the international business is still doing quite well. Our U.S. business is kind of now wrapping around to a much more normal phase. And so, those will likely balance out as you get to the end of the year. And then, you’ll see a much more, I think, normal year-on-year trajectory next year. So, we’ll give further guidance and better color on ‘23, obviously, later in the year, but my expectation is that as we get through these difficult comparators, things will begin to normalize around what we have historically seen as a, kind of 4% or 5% growth rate for the markets and then us growing hopefully a little bit faster than that.

David, can you discuss pricing a bit, specifically where you've been able to increase prices and where you see more opportunities for that? Also, do you have any insights on what you expect net pricing to be for Alcon overall in 2022? Thank you for addressing this question.

Yes, we began implementing some price changes late last year and continued with them as much as possible early this year. We did not fully anticipate the level of inflation that occurred. Currently, the numbers are nearly at 9, which is higher than we had expected. While our pricing strategy was ambitious, it has resulted in more net inflation than we had hoped for. This can be challenging since a significant part of our business operates under fixed contracts for a certain duration. In particular, the surgical business deals with fixed government reimbursements or specific agreements with payers, making it difficult to adjust prices. In some cases, like for loose or one-off items, we have more flexibility, but overall it is tougher in the surgical sector. In Vision Care, we managed to implement reasonable price increases in the contact lens segment in the mid-single digits, expecting that most of this would be absorbed. So far, we're seeing low single digits translate through, which is encouraging. However, it’s important to assess this on a market-by-market basis and strategically. We're keeping a close watch on competitors and consumer pricing behavior as we aim to retain customers in Dailies and encourage their continued use. Therefore, we are cautious about how much we increase prices.

Our next question comes from Matthew Mishan with KeyBanc Capital.

A couple of follow-ups on some other topics. First, on the operating margin, do you expect trough quarter to be 3Q or 4Q?

I’m sorry. What did you say?

Last quarter.

Yes. We’re not providing quarterly guidance. I would just say to look at the normal seasonality for the business; if I review 2019 or possibly 2021, I would expect the quarters to behave similarly in 2022.

Okay. And then around ocular health, you said, you had some supply chain constraints in contact lens care. How long do you expect that to be impacting results?

It's difficult to determine. We experienced at least a 3% decrease in our growth rate, growing about 4% compared to the previous year in the second quarter. We could have seen growth closer to 7% if we had been able to fulfill all our orders. We didn’t experience much movement in contact lens care specifically, and some contract manufacturers were unable to supply us as well. This quarter has been challenging for that segment of the business. It is expected to improve, although the third quarter may still be somewhat unstable. At this point, while it's risky to make definitive statements since things can change, we believe the situation should stabilize by the fourth quarter. However, I would advise caution regarding that outlook, as we have assumed the supply chain will not deteriorate, despite the current volatility.

Our next question comes from Ryan Zimmerman with BTIG.

David, to start with cataracts for a moment, we have mentioned previously that there is a backlog of over $1 million, specifically $1.1 million. The cataract market has experienced double-digit growth over the past two quarters and has been performing well. However, the guidance and commentary indicate that it may slow down in the latter half of this year. I am interested in your thoughts on how long this situation might persist and how we can work through the backlog. If the cataract market does slow down in the second half of the year, will that prolong the backlog advantage as we move through 2022 and into 2023? I appreciate your insights on this.

Yes, I think it does, Ryan. Right now, we’re not seeing much benefit from the backlog. In the U.S., cataract procedures were probably growing around 4%, while overall growth was 9%, and international performance exceeded the market. It was a strong quarter for cataracts, but the slowdown in the U.S. was surprisingly low. They're struggling with staffing and training, and it seems that capacity is lacking, which we expected to be better. Many facilities are unable to operate at full capacity because keeping OR staff has been particularly challenging. I believe this situation will persist for a while. As things settle, these cataracts will return. I think we’ll see a steady recovery, with slightly better than historical rates for cataract surgery, both internationally and in the U.S., but for now, finding, training, and retaining OR staff remains difficult.

I appreciate that, David. And then, globally, you made a comment, and if I look back last quarter, I think you guys were at 60% share, PCIOL share globally last quarter went down to 55%. And I know it’s up since Vivity launch about 5%. But what do you attribute to that, that dip? Not to split hairs here, but curious kind of what drove that dynamic from 1Q to 2Q.

Yes. Ryan, we saw an increase quarter-over-quarter, so I'm not sure where the 60% figure comes from. I need to check if I mentioned 60%, but that's incorrect because we gained market share this quarter compared to the previous one. I'm a bit confused here. However, we view 55% as a very positive share. I believe we were in the low 50s last quarter, and we've improved by about a point and a half, largely driven by our international business in this time frame. Looking at our U.S. business, PCIOLs were in the low 80s, which had previously dropped below 80 but has now rebounded. As competitive trials ended, people had the opportunity to try different products and came back to Vivity and PanOptix. We are very comfortable with our progress in market share, especially in the PCIOLs.

Our next question comes from Cecilia Furlong with Morgan Stanley.

I wanted to start with Total30. If you could just speak to what you’re seeing from either new versus switch fit initially, as well as just how you’ve seen your overall share of the reusable market trend now versus when you initially launched the platform?

Total30 is performing very well, and we are excited about this product. It features a unique material, marking the introduction of one of the first new materials in a long time. The brilliance of this lens lies in its 30-day durability combined with a soft water gradient surface. This has always been the challenge in developing a reusable lens that can resist lipids and bacteria while remaining comfortable and soft. The positive reception in the market supports this. We also see some of the benefits we anticipated from Total1 extending to the reusable lens Total30. Our new and switch fittings are in excellent condition, and we are optimistic about our performance. If this serves as a forward indicator, we are in very good shape with Total30 and our Air Optix products, performing exceptionally well.

And if I could follow-up, just the capital environment that you’re seeing today, if you could speak to, one, the regional dispersion of equipment demand that you’re seeing, as well as just your outlook for the balance of the year that you incorporate in your guidance, and really just the sustainability of the recent cataract capital demand you’ve seen in international markets? And thank you for taking the questions.

Yes, that's a great question. There is a noticeable difference between the U.S. and international markets. Most of our growth has come from international, as we had anticipated that the U.S. market, after a very positive year last year, would be either flat or slightly down in capital equipment. The international sector accounted for the entirety of our 10% growth. In the recent quarter, we experienced strong performance in recovering markets with new capital, and I expect this trend will remain stable for the rest of the year internationally. The U.S. is likely to follow a similar pattern since companies usually work with one-year capital budgets. If funds are available, they will be utilized, primarily coming from government sources abroad, while in the U.S., there is currently a lot of private investment, and many are holding back. None of this is unexpected for us, and it has actually been slightly stronger internationally than we believed, mainly due to the excellent performance of our cataract equipment. We had originally thought we would face more competition, but we’re actually performing better than forecasted in upgrading our own equipment. Currently, our Active Sentry hands piece is unmatched in its capability to maintain a soft stable chamber, and combined with our other equipment, it represents the best in the industry. We’re pleased with this progress. Additionally, we've seen great results from our Legion line, which is our value product with fantastic fluidics, and performs well as a portable option with a very low cost per use, particularly in India and Brazil among other regions. We're effectively maintaining and even increasing our share in the phaco market. Furthermore, our Argos biometer and Revalia microscope have also shown positive year-over-year growth. Overall, we are optimistic about our equipment performance this year, and we will address next year's outlook as we progress further into the year and assess the economic landscape.

Our next question comes from Jeff Johnson with Baird.

Maybe just a couple of follow-ups at this point, if I could. David, may be interested to hear on the new and switch fits with all the new products out there, just relative to your internal expectations. You have been surprised one way or the other on your share of new fit increasing or not increasing as fast you thought just either way there and same on switch fits. And then just net between P1 and DT1, are you still seeing trade-ups dominating trade-downs?

Yes, there are a few dynamics to address. The performance of switch fits on a share basis is better than we anticipated overall, both for daily and reusable products. However, we have seen a slight decline in the number of new and switch fits. This can be attributed to reduced foot traffic compared to pre-COVID years, which has hindered our ability to capture the desired volume. I believe this situation will stabilize over time. In the U.S., conditions have improved, and international markets are gradually recovering. These are positive trends we want to see progress. One factor is market dynamics, which are beyond our control, but I expect they will improve on their own. The other factor involves lens choices. We’re performing well in both reusable and daily segments. Specifically for daily products, P1 and DT1 are both performing exceptionally well. Initially, we anticipated that the introduction of the toric lens with DT1, along with the sphere and multifocal options, would contribute to the family’s growth. The Dailies Total1 line is user-friendly and suitable for a wide range of customers at a premium price point. This family of products encourages customer loyalty, positively influencing each individual modality. P1 is also thriving with its toric lens. The launch of the toric lens alongside the sphere has particularly boosted P1's growth, offering an attractive price for the mid-market and enhanced coverage without the rotation issues present in some competitors' products. This makes it an excellent offering. Overall, our share in the daily segment is strong and continues to grow.

And just one last point regarding the end market. It seems like the contact lens market might still be a bit sluggish, though I’m not sure if that applies globally or just in the U.S. If you could provide some insight on that, it would be helpful. He mentioned a mid-single digit growth in the Vision Care market in the U.S. Is that specifically related to contact lenses? We've been hearing that pricing is around 2% or 3%. It sounds like that's also what you're experiencing with pricing for contact lenses. Does this suggest that underlying growth in the contact lens market, excluding pricing, is currently weaker than historical trends?

Yes, I think you’re generally on the right track. We don’t have a precise understanding of the price EQ units, which we define as patient purchases in units. However, it does seem a bit softer than before, particularly in the second quarter, unlike the first quarter where we didn’t notice much change. We did see a slight difference in the second quarter in the U.S. It's important to note that we are comparing against a very strong quarter last year, where we saw an extraordinary growth of 80% in the U.S. compared to the previous year, while the overall market grew just over 50%, following the shutdown year in 2020. Therefore, interpreting the second quarter data for contact lenses is challenging. Globally, the market did grow about 7%, and we grew around 9%. This growth includes some pricing impacts; if you consider the 2% to 3% pricing applied to our 9% growth, it suggests healthy unit growth. Additionally, there's value trading up from reusables to dailies and a positive mix shift for toric lenses contributing to this. Therefore, unit volumes don't necessarily have to increase for us to achieve solid value growth. Overall, there's a lot to consider, but in short, I believe there may still be some recovery ahead, especially in international markets, and potentially a bit more in the U.S. as consumers return to offices to acquire new lenses and make switches.

Our next question comes from Julien Dormois with BNP Paribas.

I have two follow-up questions. The first is about ATIOLs and their overall penetration in the context of a softening microenvironment. You mentioned that this category now represents about 12.5% of global penetration and over 19% in the U.S. Have those numbers changed since last quarter, and how do you anticipate that evolving? The second question concerns margin development. Should we expect the macro headwinds you discussed to alter our perspective on the contributions of operating leverage versus gross margin to margin developments in the coming years? You previously mentioned an 80-20 ratio; is that still how we should view this?

Let me begin by discussing the penetration of ATIOLs. In the second quarter, global penetration increased by 30 basis points compared to the previous year, showing continued growth. However, it seems to have stabilized since the first quarter, which experienced significant growth, particularly in Korea. Thus, the first quarter's figures may be somewhat inflated. It's challenging to determine the current trend accurately, but we regard penetration as a critical factor in driving our business, given our market shares. We are focused on enhancing programs that assist consumers and surgeons in accessing ATIOLs. Regarding penetration during a recession, we believe there is considerable potential for continued growth. Last quarter, total penetration in the U.S. was approximately 19%, while globally it was around 12%, indicating that outside the U.S., penetration is likely in the high-single digits. This suggests significant growth opportunities, especially in international markets. If the U.S. enters a recession, we recognize the uncertainty surrounding the timeline and severity, but we are prepared to navigate potential scenarios. Historically, refractive products have seen the most impact, though they represent a small segment of our business. We anticipate sustained demand for eye care surgeries and visits will continue. While there might be some reduction in the shift from reusable contacts to daily ones, we have not encountered this situation at our current growth rate, making it difficult to predict. Nonetheless, we feel confident in our ability to manage any changes effectively.

Regarding margin progression, we see two main macro challenges. The first is foreign exchange, which impacts the entire profit and loss statement without significant differentiation. The second challenge is inflation. If inflation persists, it may exert additional pressure on gross margins. Given that our material purchases and labor costs significantly influence gross margins, I believe that looking at the long-term outlook for the business and margin progression, we can expect approximately 80% of margin improvement to result from operating leverage and 20% from margin expansion.

Our next question comes from David Adlington with JPMorgan.

I have two follow-up questions. You mentioned an outlook for improvement in ocular health. Can you elaborate on how much of the lost demand from the supply chain issues is pent-up and could return, versus how much might be permanently lost? Additionally, could you address any impact from the Chinese lockdown on the second quarter?

Yes, we experienced a challenging quarter in China. We estimate it was flat or down by about 2 percent, which is disappointing. This is a significant market for us that did not show growth during the quarter, impacting our surgical business primarily due to its reliance on surgical products. We are hopeful for a recovery next quarter. Regarding eye drops, our perspective has been that when we lose sales, they generally go to competitors. For those looking for contact lens solutions, reusable users may choose private label brands or alternatives, which likely means a permanent loss of those sales. I don't anticipate any recovery from that situation.

Our next question comes from Larry Biegelsen with Wells Fargo.

Tim, just one for you on the tax rate. The guidance seems to imply like 23% or so in the second half of the year. And I see the guidance for the full year. But I guess my question is, how do we think about the tax rate beyond 2022? And I heard you talk about some type of settlement between the U.S. and Switzerland. So, any color there would be helpful. Thanks for taking the follow-up.

Yes, you’re correct; the implied rate in the second half will be around 23%. This is primarily due to having less profit in inventory, which will lead to the release of some deferred tax assets, consequently increasing the tax rate. The timing of the advance pricing agreement is significant. We initially expected to finalize it in the first half, but it now appears we will close it in the second half, which is why the tax rate will rise for that period. However, for the entire year, this impact is relatively minor. We remain confident in the 17% to 19% range we previously discussed for the full year. I suggest referring to our comments on capital markets for your tax rates moving forward until we provide an update at the next capital markets day.

Ladies and gentlemen, we have reached the end of the question-and-answer session and this concludes our call for today. Thank you for your participation. You may disconnect your lines at this time.