Alcon Inc. (ALC) Q2 2019 Earnings Report, Transcript and Summary

Good day and welcome to Alcon’s Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Karen King, Senior Vice President of Investor Relations and Communications. Please go ahead.

Welcome to Alcon’s second quarter 2019 conference call. Today, we are discussing our mid-year results from our headquarters in beautiful Geneva, Switzerland. We issued a press release and interim financial results yesterday and posted a supplemental slide presentation a few hours ago to our website to enhance today’s call. You can find all three documents in the Investor Relations section of our website at www.investor.alcon.com. We have also posted our third quarter earnings date and several upcoming investor relations activities on our corporate calendar, which you can find under Events and then Presentations. Joining me on today’s call are David Endicott, our Chief Executive Officer; and Tim Stonesifer, our Chief Financial Officer. Our quarterly press release, slide presentation and discussion will include forward-looking statements. We do not intend to and expressly disclaim any obligation to update any forward-looking statements as a result of new information or future events or developments except as required by law. Our actual results may vary materially from those expressed or implied in our forward-looking statements. Accordingly, you should not place undue reliance on any forward-looking statements. Important factors that could cause our actual results to differ materially from those in our forward-looking statements are included in Alcon’s earning press release and Form 20-F registration statement on file with the Securities and Exchange Commission and available on the SEC website at www.sec.gov. Included in the press release are selected non-IFRS measures. Company management uses these measures as aids in monitoring the company’s ongoing financial performance from quarter-to-quarter and from year-to-year on a regular basis and for benchmarking purposes. Non-IFRS financial measures used by the company may be calculated differently from and therefore may not be comparable to similarly titled measures used by other companies. These non-IFRS financial measures should be considered along with but not as alternatives to be operating performance measures as prescribed per IFRS. Please review the financial tables provided in the press release and our filings that reconcile such non-IFRS measures to directly comparable financial measures presented in accordance with IFRS. In just a few moments, David and Tim will be discussing net sales results for the quarter and year-to-date. In our press release, we provide a table that shows both reported net sales and constant currency growth, so you can see the impact of foreign currency fluctuations. For discussion purposes, our comments on net sales growth during our opening remarks will be expressed in constant currency. And with that, I’ll now turn the call over to David.

Welcome to our second quarter 2019 performance update. We’re almost five months post-spin and settling nicely into our independence and we’re pleased with our first half performance in the organization that’s making great progress against the strategy we laid out at our Capital Markets Day. We focused the organization on three big priorities, which we have communicated to all our associates. The first priority is to stand up the new Alcon. This includes things like standing up new functions, implementing SAP, separating IT systems and ensuring supply, while maintaining our focus on the customer, advancing the pipeline and otherwise operating as business as usual. Feel good about the progress on all these activities, which will remain the focus over the next 18 to 24 months. The second priority is to grow revenue. We are a products company at our core and at our Capital Markets Day last year, we identified and discussed four key growth drivers, which are contributing significantly to our strong first half sales performance. As a reminder, these are advanced technology intra-ocular lenses or AT-IOLs for cataract surgery, DAILIES TOTAL1 contact lenses, SYSTANE Complete eye drops for dry eye, and surgical products to treat retinal conditions. We are leveraging our deep expertise in eye care to expand our product pipeline and incubate future platforms for growth. We’re already seeing the impact of iterative innovation, like our smaller gauge consumable instrumentation. And we’ll shortly see the impact of new products with the upcoming launch of our newest contact lens PRECISION1 in the U.S. The third priority is transforming our culture. Now that we’re independent, we can move full steam ahead on creating a culture that lets us move quickly and take full advantage of market opportunities. So what does that mean? We’re placing two asks on every associate regardless of where they sit in the organization. First is to increase ownership and accountability and the second is to operate with greater speed and simplicity. So as we continue our transition from a large company environment to a smaller focused medical device company our 20,000 associates are helping us to spot areas, where we can be more efficient and really ensure our people in investments are focused toward our core growth drivers. This ensures our associates always have a customer first mentality. So speaking of customers, I recently spent several weeks on the road in the U.S. with a number of surgical and Vision Care customers receiving valuable insights and feedbacks on our business. What I’m hearing is that our customers excited about the new Alcon and where we’re headed, there’s a lot of enthusiasm for our innovative pipeline and specifically some of our newest products like PRECISION1 and PANOPTIX. Our customers have high expectations of Alcon as an independent company, which is a big part of what’s driving the organization to succeed. Before I turn it over to Tim to go through the detailed financials, I wanted to touch on sales performance, current market trends, and then also a little bit on innovation. I’m pleased to report we delivered strong top line results with both our surgical and Vision Care businesses performing well. Overall, sales were up 5%, that’s for both the quarter and the first half of the year. In the quarter, our surgical business was up 5% and our Vision Care business up 6% with all product categories posting mid single digit growth. On a year-to-date basis, surgical was up 6% and Vision Care up 3%, which puts us on track to deliver the full year guidance of 3% to 5% constant currency growth. We recently received the latest round of surgical and Vision Care market data. Now for surgical cataract procedure growth has remained consistent with historical trends up approximately 4% in the second quarter. For Vision Care, contact lens market growth for the second quarter increased by approximately 4% on a value basis with toric and multifocal growth outpacing sphere. We also saw stable market performance in reusable lenses, which were up almost 2% during the second quarter, driven by the U.S. and Japan. Now we’re very excited to be bringing PRECISION1 our new SiHy contact lens to the fast growing daily disposable market. We’re doing a little bit better than expected and ramping up our new manufacturing lines, which is facilitating a slightly earlier launch than we originally anticipated. Our sales force is trained and we will enter the market in a highly organized fashion starting with select customers and then steadily expanding our distribution into early 2020. Our investments are paying off and we’re making good use of our capital. We expect these new lines to provide better throughput and a lower cost per lens at optimal capacity all on a more flexible platform. We’re also being very deliberate in how we position our existing and forthcoming contact lens brands. Last February, we completed a comprehensive study of about 8,000 patients and 1,200 eye care professionals, which looked at the lifestyle, functional and emotional needs of contact lens wearers. We found that customer needs can be broken down into three distinct segments, smart value, lasting performance and ultimate comfort. Now with PRECISION1, we are offering a robust daily contact lens portfolio with products that targeted each one of those segments. So start with a smart value segment. We offer DAILIES AQUA COMFORT PLUS or DACP for the younger, more value conscious patient, where price is a primary buying decision. On the other end of the spectrum is the ultimate comfort segment, where customers are looking for a premium lens experience. This segment is where DAILIES TOTAL1 plays as our unique water gradient technology provides superior comfort. The final segment is lasting performance, which is where PRECISION1 fits in. This is a large underserved group of customers, who are looking for lasting performance at the end of the day. These customers live an active lifestyle and rely on their context to perform from early in the morning to late at night and are willing to pay a little more for this feature. We also ran multiple clinical trials with PRECISION1 versus competitive lenses. PRECISION1 performed extremely well in these trials and we are anticipating a favorable response from professionals in the United States. Now moving on to PANOPTIX. We submitted our dossier to the FDA in the first quarter of 2019 and are expecting regulatory approval this year. PANOPTIX is a trifocal IOL that provides uninterrupted vision at near, intermediate and distance and will likely be the first trifocal in the U.S. market. With the increasing demands of near reading due to the use of mobile devices and electronic tools, people are now spending more time using products at arms length. The near focal point of PANOPTIX is set at a distance, which is compatible with this lifestyle change, which is one of the significant advantages of PANOPTIX versus traditional bifocals or other trifocal technologies. Our continuous IOL innovation enables us to help surgeons significantly improve cataract patient outcomes. By default patients accept they need to wear spectacles after monofocal cataract surgery, however, advances in IOL allow for a greater degree of spectacle independence, which is important to the increasingly active aging population. Research finds that patients using PANOPTIX experienced spectacle independence 80% to 85% of the time post-surgery compared with 7% to 12% of patients, who undergo monofocal surgery. PANOPTIX has driven strong market share gains in international markets, where the product has been available for a few years and strong word of mouth has made PANOPTIX one of our most anticipated U.S. launches. With that, let me turn it over to Tim, who will review our financial results.

Thanks David. We were pleased to report a healthy 5% top line growth in both the second quarter and year-to-date. As David mentioned, this includes strong performance by all of our key growth drivers. So let me provide more details for each franchise, starting with surgical. Surgical sales were up 5% in the second quarter, driven by strong performance in all three of our surgical categories implantables, consumables and equipment. Implantable sales of $300 million, increased by 4%, primarily due to strong double-digit gains in PANOPTIX and other AT-IOLs. We also saw a solid performance in monofocals, driven by innovation in new materials with the launch of CLAREON and the continued shift to preloaded injectors. Consumable sales of $588 million increased by 5% in the second quarter. Similar to last year, we saw strong demand for both our dedicated consumables, as well as our custom packs due to customer conversions of equipment and innovation and smaller gauge instrumentation. Sales from the equipment and other subcategory were $163 million, an increase of 7% versus the second quarter of last year, primarily resulting from strong growth in cataract equipment and service revenue during the quarter. Turning to Vision Care. Contact lens sales were $493 million, up 6% versus the second quarter of 2018. Although our Vision Care business benefited from a favorable year-over-year comparison, our leading DAILIES product, DAILIES TOTAL1 continues to post double digit growth rates globally. Sales in our more established lens business improved in the quarter because of several innovative initiatives. We launched AIROPTIX HYDRAGLYDE toric for patients with astigmatism around the globe and extended the parameters of DAILIES AQUA COMFORT PLUS toric lenses to serve a greater percentage of lens wearers. We also reorganized our U.S. Vision Care sales force to improve coverage and support for our customers. We continue to address our portfolio gaps in toric, which we believe will enable us to gain market share over time. We are making targeted investments that will strengthen our core, elevate commercial execution and address untapped customer needs. Shifting now to ocular health. Second quarter sales were $319 million, up 5% compared to last year, primarily due to continued double digit growth in SYSTANE Complete. We also saw sequential improvement in our contact lens care portfolio, which was slightly down but more in line with the reusable contact lens market, which we believe is starting to stabilize. Now moving down the income statement. Core gross margin was 64.6% up 40 basis points versus last year, primarily due to lower production costs and favorable manufacturing volume. Core operating margin was 16.6% in the second quarter, down 60 basis points versus prior year but up 30 basis points, excluding the negative impact from foreign currency. Revenue growth and gross margin expansion offset the incremental R&D and G&A investments. We also increased advertising and promotional spend for DT1 and SYSTANE Complete sequentially to support our regional launch campaign. Second quarter interest expense was $35 million up $29 million compared to last year, primarily due to borrowings related to the spin-off. As planned, given the short-term nature of our debt structure, we’re planning on refinancing a portion of our debt in the latter part of the year. As we finalize the structure, we expect our overall average maturity and interest expense to increase. Interest expense also includes interest associated with the new lease accounting standard and accretion of contingent consideration liabilities related to previous acquisitions. And as you think about the longer-term models, keep in mind that 2019 only has three quarters of interest expense due to the spin, where 2020 we’ll have a full year of interest expense. Core effective tax rate was 13.5% in the quarter compared to 14.1% last year. The lower tax rate was primarily due to the mix of pretax income from geographical tax jurisdictions and an incremental catch up of R&D tax credits. The passage of Swiss tax reform on June 30, resulted in a non-cash charge of $301 million from the re-measurement of net deferred tax assets in our reporter results this quarter. In 2020, we expect Swiss tax reform to increase our core effective tax rate by about 3 percentage points, assuming today’s mix of profits. Core earnings per share was $0.47 in the second quarter. The pressure both on a sequential and a year-over-year basis was primarily due to increased interest expense related to the new capital structure. Before I move to guidance, I wanted to touch on a couple of cash flow related items. Free cash flow for the first six months was in line with expectations of $95 million compared to $376 million last year. The decrease versus last year was primarily due to spin readiness, separation and legal costs. On a year-to-date basis, capital expenditures were $206 million driven by expansion of our Vision Care contact lens manufacturing platform. As we’ve indicated in the past, we will continue to incur separation and capitalize expenses over the next couple of years as we prioritize standing up the organization and investing in our business. Now, turning to our full year projections. Our first half performance gives us confidence that we are on track to meet our full year 2019 guidance. As such, we’re reaffirming all our previous guidance ranges that we provided on our first quarter trading update. We expect net sales growth of 3% to 5% on a constant currency basis with a negative 2% impact from foreign currency. We expect core operating margin to be in the range of 17% to 18%. We expect core effective tax rate to be in the range of 17% to 19% but are currently running towards the lower end of the range. So to summarize, we’ve made good progress in the last six months towards our strategic priorities. Although there is more work to be done, I’m confident in our ability to execute on our commitments. With that, I’ll turn over the call to David for some final comments.

Thanks, Tim. We’ve got a good start to the first half of the year and we are on plan executing our strategy. We’re continuing our processes of standing up and then transforming Alcon into a simpler, more agile company. We’re investing in key products that maximize the potential for revenue growth and we continue to accelerate the innovation of new technologies that will drive our long-term growth. In the end, our business is about creating the products patients need and with our independence we’re making disciplined capital allocation decisions to advance science, to address significant unmet needs in eye care, allowing more patients to live our mission to see brilliantly. And with that operator, we’re ready for questions.

Thank you. [Operator Instructions] Our first question today will come from Veronika Dubajova of Goldman Sachs. Please go ahead.

Good afternoon and thank you for taking my questions. I’d like to start with a bigger picture question looking at the guidance. David, Tim if I look, you are tracking at the top end of the revenue guidance, but the low end of the margin for the year. Just would love to get your thoughts as you look at the remainder of the year, what are the pulls and pushes that you see. And Tim in particular, if you can help us think about FX because I think that was one of the negative surprises looking at the profitability in the second quarter that would be very helpful. And I have a quick follow-up after that.

Sure. Veronika, thanks for the question. Let me start with the top line. I think we’ve obviously had a solid first half kind of as expected. I think we see the markets growing as we expected them to. And as I think I’ve indicated in the past, we think the surgical business is probably growing just a little bit faster than the market and Vision Care just a little bit behind it. That’s pretty much what you see through the middle part of the year. So, we’re pleased with where we are. Right now we’re at the upper end of our guidance. But again, the fact of the matter is the markets have to stay steady, strong through the rest of the year. And we’ll see how that takes shape. So assuming that does, obviously we’re very comfortable with where we are.

And then I would just say on the margin front. Obviously we came into Q2 at 16.6%, but as we talked about on the last call Q2 we invested quite a bit of marketing and sales money to support new product launches, promos, et cetera. So Q2 will be the low point from a margin rate perspective, as you think about the entire year. And then as you think about kind of the second half versus the first half, take the average of 17.1%. We’ll continue to get margin expansion or gross margin expansion both from a volume and also from a mix perspective. So as we continue to grow AT-IOLs as an example, that becomes a bigger part of the overall portfolio that will drive a mix lift force. We’re going to continue to invest in the R&D, we’re going to continue to invest in marketing and sales and it won’t be at the level as what we did in 2Q. But as we’ve said all along, we’re going to continue to invest in growth and those are kind of the three levers, as you think about margin rate. And as we said, overall we feel very comfortable in landing in the 17% to 18% range. From a FX perspective, yes, we did see some FX pressure in Q2 as compared to Q2 of last year. That will be muted as you think about the second half of the year because the dollar really strengthened in the second half of last year. So that will be less of a pressure point for us in the second half of the year.

That’s very clear. And if I can just ask a quick follow-up. David, I think a couple of your competitors have called out some softness in the IOL market, just curious to get your thoughts on that. Any view on what’s going on and whether you expect a bit of an improvement in the second half of the year?

Look, the audit data that we’ve got – we just got it in looks pretty solid in the 4% growth range. We continue to gain share in both the quarter and on the moving annual. So we feel pretty good about the IOL market right now. We have the benefit of a good deal of mix. So our international business was definitely stronger than our U.S. business this particular quarter. But, generally speaking, we feel pretty good about where we are. There was a little bit of second quarter comp to concern yourself with. Our CyPass withdrawal from last year was peaking in the second quarter, and so you see a little bit of an impact there on the growth rate. But we don’t see anything unusual in what’s going on, and we feel good about the mix of international to U.S.

That’s very clear. Thank you both.

Our next question today will come from Jeff Johnson of Baird. Please go ahead.

Thank you. Good morning, guys. Maybe two questions for you: one strategic and one financial. But just following up on your margin comments there, Tim, maybe R&D was also up nicely year-over-year at 9% of revenue is a little bit higher than we were looking. Obviously, you guys have a full portfolio of pipeline products, but how should we be thinking about that line item especially? Is 9% kind of the number to think about going forward? Was there anything one-time in the quarter that popped that number up? Just how to think about that? Thanks.

Yes. There’s always some timing and some lumpiness to this, but again, we feel pretty good, as we’ve talked about before. You guys should expect sort of the 7% to 9% range over the course of time.

All right. That’s helpful. And then, David, on the strategic side, I’d love to take your pulse on the myopia control market using soft contact lenses. It seems like we’re starting to see more interest from docs in that area. Obviously, a couple of your competitors are investing in that area. Strategically, we’ve heard you may not personally believe as strongly in that market or at least aren’t yet willing to commit capital to that market. Just want to understand maybe if that’s true how you’re thinking about myopia control over the next few years. Thank you.

Well, thanks, Jeff. Let me just start by saying, look, we follow this market very closely. So we have a very high interest in what is an obvious epidemic with a prevalence that is quite substantial. So to the extent that we think there’s a technology in here that can really make a difference, I think we’re all in. I think the challenge is most of the technologies that we’re aware of and are following are many years old. So, if you look at much of the ortho-k, or the atropine derivatives, or the approach to soft contact lenses, again, I think those have been around a while. We haven’t seen one that we get excited about, but again, I hope that somebody innovates in this space in a way that it’s meaningful because I think we would be very quick to want to get in it to the extent we see some of that data come out and really be meaningful. Again, you know the size of this market. It’s a bunch of people out there, nearly 5 billion by 2050, that’ll be myopic. So, I think that’s where we are. We’ll follow it closely, and I think we maybe – we’ll certainly be interested if we see something exciting.

We’ll move onto the next question. Our next question will come from Larry Biegelsen of Wells Fargo. Please go ahead.

Hi. It’s Lei dialing in for Larry. And thanks for taking my question. David, if you can just talk a little bit about the top line outlook. The company is obviously growing well, already in the mid single-digit even without PANOPTIX and PRECISION1 in the U.S. How should we think about the top line growth momentum once you have both products in the U.S. market, especially as we look into next year? And then I have a follow-up.

Sure, Lei. Thanks. Thanks for the question. Look, I think top line is, we’re pretty comfortable with our range right now. I think, we’re obviously doing well so far this year. My belief is that PRECISION1 and PANOPTIX over the long haul add a lot of value. I don’t think they’re going to have a material effect on this particular year, because again, we’ve kind of counted them into the plan and this is going along largely as expected. So we’ll get PRECISION1 out at September. That’s pretty much as we indicated, maybe a slight month advantage. But that’s not material in terms of its impact either really this year or next. It’s really about long-term trajectory. And I think to the extent that, you think about our Vision Care business as having more than one product here. I think that’s the way we’ve been thinking about it. So for us to sustain a kind of mid single-digit growth, as we’ve kind of indicated, I think we need consistent innovation. We need to fill out the toric line. We obviously know we have a gap there. That’s where we’re having the most difficult time in terms of share gain. And we will do that, but it will take us some time to do it. So I feel good about the kind of outlook that we’re giving, again, assuming the market stay solid and I believe they will, we should be fine. But that’s probably the way to think about it. On the Surgical side, the only other thing I’d add is that, we think that the long-term outlook on the surgical market is positive because you get this underlying 3%, 4% growth rate. It’s been closer to 4%, really maybe even a [little warmer] [ph] than that, some parts of the world. So I think that’s a big deal but there is downward pressure on price. So for us to succeed, we’ve got to do well with share, do well with the market unit volumes and then obviously we’ve got to either innovate or we’re going to be offset with price. So again, I think we feel comfortable with the guidance range that we’ve given.

Got it, thanks. And then my follow-up is just on PRECISION1, you talked about an organized launch and a fuller rollout in 2020. Can you give little more color on kind of your inventory capacity as we look into next year as well as timing for the rollout in Europe and Japan? Thanks.

Yes. Lei, I think the launch decision was made based on what we believe we needed to get the first groups of doctors trained. We have done this historically a number of times, and obviously, if you go back to when we launched DT1, one of the lessons we learned was be smart about how you handle consignments, inventories and these fit sets in particular. So we have – we needed a lot of fit sets to go out into inventory. But first, we will be available I think towards the end of the year in almost all distributors, beginning of next year, all distributors. And I think we’ll be kind of hitting pretty much all of who we want to have fit set that we’ll have one by the end of the first quarter. So that’s about as fast as our sales force can get to it. So we’re going to do some training or we do some education. We’ll rollout fit sets to people who are committed. But clearly we’re trying to be productive with the use of those samples, so that we’re not just putting them in places where they’re not productive. So we feel like that’s the right pace. It’s been our pace in the past. And again, it’s consistent with what we’ve said, which was kind of late this year, early next year rollout. But I think the way to think about it is we’re kind of full speed in the first quarter.

Our next question today will come from Chris Pasquale of Guggenheim. Please go ahead.

Thanks. A couple of questions on the Vision Care business. First, could you just talk a little bit more about the sales force reorganization in contact lenses, what you did there and is that process now complete?

Yes, Chris. The sales force, we just took a very good look at kind of what we thought was the best way to serve customers in this space. One of the things we had in the past was two different sales forces calling on the same optometry office. On the one hand that gave us some real depth of expertise in our specialty lenses. On the other hand, it gave us large territories – sorry, yes, large territories. And frankly, I think for our current mix and what we wanted to do next, we felt like we could use a fewer specialty folks and a greater degree of – I would just call it main reps, you’re going to call them the optometrist who could handle our sphere and toric lines. So my view was – and I think the U.S. team was really the originators of this. But we could get better service with smaller territories, keeps the reps on the road a little bit less and in the office a little bit more. So that was the basic idea. Again, I would say it was fairly smoothly executed. It was over in I think February or March, so we’re well past that, but I think you’re really starting to feel some effect from it, in our opinion, as we launched – we launched a couple of small things in the second quarter that really got some attraction I think because of this redeployment, which was our DAILIES AQUA COMFORT PLUS extended parameters in toric may seem like a small thing, but it was new to the reps and to a lot of the docs and gives us on the far ends of the spectrum some really good value for people. And I think also, we got out AIROPTIX HYDRAGLYDE, which, again, in the toric version is just coming out now, but those two, the HYDRAGLYDE has really made a difference, I think, for comfort in our reusable lines. So modest ideas that are having a reasonably positive impact on, I would just say, what’s a fairly mature line?

Thanks for that. And then, you mentioned that you think the reusable lens segment maybe stabilizing a bit. I’m curious what you think driving that and whether you think that speaks at all to a potential slowdown in the shift to DAILIES?

Well, I mean, I think – I looked at the data this morning, and I think that the truth is, Chris, the DAILIES market is still doing pretty well. It’s still running kind of on the annual rate, that 7% to 8%, and the reusable’s kind of in that flat to 2% range. So I don’t think there’s a ton of change here other than reusable used to be kind of in that minus 2% to flat range, so it’s kind of moved. The most recent quarter number was, I think, 2% and change in terms of growth. It maybe the law of large numbers, it’s just kind of modest. At some point, you’ve declined enough, and people stay in these lenses. There isn’t tons of movement once you’re in a lens, so again, I think it is a little bit of who’s left in that pile. I think there is still a lot of folks’ staying in, because they’re good lenses and they work well, but I think DAILIES continues to do pretty well. I would say that the units wearer look pretty solid this quarter as well. We’ve usually seen a relatively flat global wearer number, and I thought the wearer number looked pretty solid at a plus 2%. So who knows maybe it is – it could be a little bit of an international piece that is looks like where the first price point is fairly low. International tends to be a little bit higher reusable wear, so that may be the mix that’s causing it.

Thanks.

The next question will come from James Gordon of JPMorgan. Please go ahead.

Hello. Thanks for taking the questions. James Gordon from JPMorgan. One question was just on the surgical top line performance. So, there’s a four percentage point deceleration in IOL sales this quarter that affected the market procedure growth rate without benefit from more AT-IOL use or from a positive mix. Is that fair? Is there any slowdown in the shift over to AT? Any thoughts there would be useful. Second question with just the margins, so I know there were some comments about margins for the full year early on the call. In light of things like FX, is the upper end of the guidance range for core operating margin still potentially achievable this year, or is that more of a long shot now? And then, just a clarification, on the comments about the tax rate for 2020 and beyond, is the three percentage point increase on top of the guidance for this year, which is 17% to 19%, or is that just on top of the 15%, which is what you’re tracking at so far?

Thanks, James. Let me take the first one, and then Tim will take the second two on margin and tax. First, on the IOLs, be careful about IOLs and consumables. One of the reasons I made the point earlier around the CyPass impact was because if you think about the consumables as the 4% versus 8%, what you’re really seeing quarter-to-quarter is almost 2 points of CyPass impact, because CyPass was growing at this time last year quite substantially. So you have to kind of add that back. After that, you can quibble about whether it’s a couple of points is a big deal or a little deal. Our observation is that we are gaining share in the AT-IOL market and that the IOL market itself is not really slowed down much. So when we look at the data, it looks pretty good for us. I will say, the U.S. was a little bit softer than international, but we have a solid exposure to the international business, so that was very good for us.

As far as the margins go, again, I’m not going to get into the high end or the low end. I would just think through as you look at your models in the business, just think through the drivers. Again, we expect to get some gross margin expansion through volume and a little bit of mix. We do continue to expect to invest in R&D and marketing sales. Again, marketing sales will be to a lesser effect as to what we did in Q2, but we feel very good about the 17% to 18%. As far as the tax rate goes, that three points will be on top of wherever we end in 2019. Given assuming – and the assumption there is that we have the same mix of profits that we have today. So I would just think about it as three points on top of wherever you have us ending in 2019.

Thank you.

The next question will come from Bob Hopkins of Bank of America. Please go ahead.

Thank you and good morning. Lot of attention on the surgical division and on implantables, but I actually wanted to ask you a quick question about equipment and consumables, because equipment has been very consistently growing in the high single digits and consumables has been consistent in that 5% to 6% area really over the last five to six quarters. And I was just wondering if you could talk about sort of the sustainability of those growth rates for equipment and consumables as we look forward?

Bob, let me try and get at that. A couple of things to think about. Unit volumes for the market, I would just say, on a moving annual basis have been pretty solid for both of those buckets. So I like to think about triangulating the market data with Phaco Packs and OBDs as our Viscoelastic business because they’re kind of fairly decent proxies for how many procedures are actually going on, and both of them are trending roughly in that 4%, slightly hotter than that, kind of between the 4% and 5% range. So historically, it’s been maybe 3% to 4% I think, and we’re probably seeing it a little bit warmer than that. So could that slow down? Maybe. But it really looks like it’s coming from the international markets, so I suspect that’s just the natural way of things right now is probably a little bit warmer. And I think we see the same thing then on the cataract consumables and equipment side of things. The consumables is probably the one that I think is coming a little bit warmer because of mix. So we’ve been favorable as we’ve replaced equipment. We’re getting a little bit more expensive value out of our new cassettes, and remember that in our retina business, we’re generally trying to move people from larger gauge to smaller sized instruments, and that’s a really important value proposition for us. So there’s some ASP benefit to that on top of the constant unit value. Maybe the last thing to think about just would be careful about the equipment, assuming that that’s footprint, it’s not really – because there’s a couple of other drivers in there. One is our service element, which has been very solid for us, and also, we have our diagnostic drops in there, which again, has been very solid year-on-year growth. So the underlying hard equipment in our capital is solid growth. It’s pretty much at market, but I think it looks like it’s a little bit heavier than it actually is here if you’re trying to take that on as is that your footprint growing or is that just what’s all in there. So, I don’t know if that made sense, but that’s what’s happened.

No, that’s great. That’s super helpful. And then, just one other follow-up. Since there’s so much focus on your two key product launches for the U.S. that’ll roll out over the course of 2020, PANOPTIX and PRECISION1, can you just give us a sense on both of those as to roughly how we should be thinking about the cadence of those launches like when do you think we’ll really see the impact of those launches in the growth rate of the business over the course of 2020? Just want to get a little better sense for how each of those products rolls out.

Well, I mean, they both roll out kind of similarly really because the same idea. There are large volumes of lenses that have to get put in play from an inventory perspective. And we basically do that as we have commitments from customers to use them so that we’re not wasting inventory. So, on the PRECISION1 circumstance, we’ll take the next 90 days through the end of the year. We’ve got appointments scheduled. We’ll begin to build inventories. We won’t release inventory to distributors until we know that we’ve satisfied all the independent ODs. We’ll then kind of somewhere late this year or early next release to distributors and it will be pretty much widely available sometime in the first quarter. I think that when it’s really kind of hitting, its full steam will be somewhere in that kind of early part of next year, as we’ve said. I think the same is pretty much true at PANOPTIX. It may come a little bit faster in terms of its impact on this year and next only because the IOL business just has to move a little faster. Each one is a discreet choice, whereas lenses, remember, people who are in lenses generally stay in lenses and you’re really – you’re fighting for a share of the new fit or a share of switch moments, which again is not as prevalent as necessarily or as frequent as you can move an IOL. So, I think the IOL reception will probably be a little bit faster than the PRECISION1 reception but I think both figure meaningfully and really, PRECISION1 over the long haul, we think the contact lens business benefits a great deal from having that product in play.

Perfect. Thanks very much.

Our next question will come from Matt Miksic of Credit Suisse. Please go ahead.

Thanks so much. So, I actually do have just one follow-up on the AT-IOL business and one on the financials, just clarity on some of the disclosures. So, on the AT-IOL business and the trends, at ASCRS, it seemed like there was a fair amount of anticipation and expectation awareness that PANOPTIX is coming to the U.S. As we get closer to that approval, do you get the sense that there is any kind of holding back or waiting among clinicians as they look at their procedures of their patients in anticipation of waiting for another month, or two, or three to treat a patient with PANOPTIX versus treating them with what’s available today that might be affecting any trends at all in your business surplus to market? And then I just had one follow-up on the disclosures.

Matt, good question. We hear that story a fair bit. I think there’s some truth to it. I think it’s a little bit of sales force urban legend. So to my way of thinking, most surgeons are not holding back doing cataract surgery, so they’re making a choice somewhere along the way. I do think there could be some of that. We certainly saw some of that I think when Symphony – when there was no Toric, but that’s a whole different deal because there were genuinely multifocal Toric patients who could not be served because there wasn’t an alternative on the market. So, I’d be a little bit surprised if that was the case this time but I really don’t know is the short answer.

Fair answer. That’s helpful. I understand. It’s a tough thing to pick out. But just given the trends across the market generally and the awareness that I saw, I wasn’t sure if that was something I have been hearing. But on the disclosures, it’s kind of just a book – sort of housekeeping question, but if you could remind us the contract manufacturing revenue that you report to other revenue, not to third parties, $40 million in the quarter. Understandably, very low margin and low contribution in terms of actual drop through, but can you remind us just how that’s accounted for in the overall reported results, non-GAAP reported?

That’s all the stuff that we did with Novartis, so that’s why you see it’s sort of in that other category and it’s not in our net sales reported number.

Okay. And not in the adjusted EPS number either, I’m assuming?

Correct. Correct.

Terrific. Thanks so much.

Our next question today will come from David Lewis of Morgan Stanley. Please go ahead.

Good morning. Just two for me this morning. David, just starting with you, I wanted to come back to one of the other questions on the call just in terms of the growth into the back half. So, obviously, your second half growth implies some deceleration just based on first half trends and you mentioned market as a potential wild card. Are you seeing anything from competitors on either the IOL side or the contact lens side into some of these launches or was that just more of a general comment?

David, it’s really more of a general comment. I don’t think there’s anything unusual going on with the competition. I think the market looks remarkably stable from where we see it at least the audited data shows that. I think – you can find it if you look for it. You can always find little elaborations here and there. I would think if your business is globally distributed as ours is, we feel like we’ve got the number roughly correct on the market. But again, if there was some kind of major dislocation in the back half of the year or something, you’d have to take that into account. On the other hand, we don’t anticipate that, so I would just say that my view is the market should stay solid. We should continue to either grow share or hold share. We’ve lost a little share and continue to do that. We’re just kind of barely stabilizing right now in vision care. I think PRECISION1 helps us, but it won’t help us probably enough this year to off put some pressure on the vision care business. So, I’m trying to piece it together for you the best I can. I know it sounds – because we’ve gotten to the top end of this range, it feels like it could go, but I’d be careful about what you assume because we’re wrapping around on pretty decent growth from last year starting in the back half.

Okay. That’s very helpful. And then Tim, I just wondered if we could spend some time on the progression of margin expansion. I mean, we’ve had headwinds this year, obviously your currency and SAP this quarter adjusted margins were closer to 19%, but as we think about headwinds next year, the reinvestment you’re making first half this year, the SAP implementation, how should we think about some of those headwinds dissipating into 2020? And then, also, in terms of market expansion broadly across the long-term plan, how do you expect that to be? Do you expect it to be routable across the periods or do you think it’s going to be more tied to when you get the inflections in some of these key products, so it could be earlier in the plan? So, those two pieces of information would be great. Thanks so much.

Yes. Great questions. Again, listen, I don’t want to get into a lot about the 2020 progression because we got to get through 2019 first and then we’ll obviously, as we get closer to the year, talk more about – end of the year, more about 2020. And as we talk about it, if you look at the long-term plan, so what we talked about at Capital Markets Day, we would expect this margin expansion to be somewhat back-end loaded because, again, we’ve got to get through a lot of this spin stuff, the separation stuff. We are launching a bunch of – if you think about vision care, we don’t get full optimization, if you will, on the lines until a couple years out, so we would expect that margin expansion to be more back-end loaded.

Our next question today will come from Anthony Petrone of Jefferies. Please go ahead.

Thanks and maybe we’ll keep two on surgical. The first on surgical would be just kind of the reception out of the cataract surgery conference earlier this year for PANOPTIX. Just what are surgeons actually saying in terms of where this will fit into sort of their overall book? I mean, is there a certain patient type they’re looking at and will that product potentially kind of gain share or even cannibalize other lenses? And then, maybe the follow-up would be just on strategy. The company’s done a couple tuck-in acquisitions. What are the latest thoughts there? And in particular, is there any kind of views on glaucoma? Thanks.

Yes. Let me just start with the PANOPTIX piece. I think, look, PANOPTIX has been around the world in a lot of markets but Europe in particular, obviously, for a while. But it was late into Europe. So, I think the way to think about – the performance has been in a very positive light. I mean, in many markets, it’s now the number one trifocal. I think that comes from a place of preferred performance in the way in which it selects its near visual point, which is its moat. It is a significantly improved power at the midpoint, so it’s your functional distance of a handheld. That’s different than other devices. So, many of the other trifocals are have a stronger near-vision, like a near reading vision and they may have a little bit more power at a distance. We think we’ve got the distance right. We’ve got the division of light correct on this and we’re kind of excited about what it does that way. It has the highest light transmission to the near and distance piece of any of these, so I think that’s a big part of the differentiation between other trifocals. The benefit of being a trifocal in the U.S. will be we think we’re going to be first. Assuming that we are first, there’s quite a big advantage, I think, over the existing lenses with two focal points where it is difficult for physicians to predict patients or even for patients sometimes to predict what they prefer to do. So, if you’re using a ReSTOR lens or any of our competitors’ multifocals, you kind of have to pick either do you want 60 centimeters, do you want 30 centimeters, which is it that you prefer. And sometimes people don’t know, so you give the near reading, and then all of a sudden, they realize they’re on their computer all the time, and they’re having to wear glasses, they’re disappointed. This allows patients not to have to choose and the doctors not to have to guess a little bit about what it is, it gives them a nice advantage there. I think relative to existing products, this will perform very well. I think what we’ve said in the past is a fairly decent proxy for this is the Canadian launch. The Canadian launch for us has done very well. I think the surgeons there have similar choices to the U.S. and after I think 24 months or so, we’re well over a 50 share of the PC market. So, the present view is of correcting being a subset of AT-IOL, but important part of the market as we see it. Maybe the other piece on this one, you mentioned, was really just M&A and how we see M&A. I think right now, we have an interest. I think we would just reiterate that we have an interest in deals that are technology oriented where we think we can add value to the development process or where we can commercialize. We tend to look at things that a little bit more in the ready to develop phase as opposed to commercialization phase. We obviously would take some things into the commercialization phase if we could afford to buy them or that the markets would allow us to do that, but I think the glaucoma space is of particular interest, of course. I think that part of the market seems to be growing nicely. We were in it, obviously where we’ve been in it and are in it – with both Express and with CyPass previously. So, I think we have some very high interest. It sits right on top of an area that we already call on doctors with and so we will continue to look in that space for things that make a difference. Big picture though, we’re in that $50 million to $300 million deal range. We’ve done a lot of them. We’ll keep doing them. Our bet is that we can find technologies there that we could add some value to over time.

Thank you.

This is Tim. Just one clarification is on the third-party, it is a small number, but it is in our core EPS, so I apologize for that.

So, we are going to go ahead and wrap up the call at this point. We appreciate everybody being on today, and we look forward to talking to you soon. Thank you.

Ladies and gentlemen, the conference is now concluded, and we thank you for attending today’s presentation. At this time, you may now disconnect your lines.