The Cooper Companies' (COO) CEO Robert Weiss on Q3 2014 Results - Earnings Call Transcript

Sep. 5.14 | About: The Cooper (COO)

The Cooper Companies, Inc. (NYSE:COO)

Q3 2014 Results Earnings Conference Call

September 04, 2014, 05:00 PM ET

Executives

Kim Duncan - Senior Director, IR

Robert S. Weiss - President and CEO

Greg W. Matz - VP, CFO and Chief Risk Officer

Analysts

Jeff Johnson - Robert W. Baird

Lawrence Keusch - Raymond James

Christopher Pasquale - JPMorgan

Larry Biegelsen - Wells Fargo

Joanne Wuensch - BMO Capital Markets

Matthew Mishan - KeyBanc Capital Markets

Steve Willoughby - Cleveland Research

Matthew O'Brien - William Blair

Jonathan D. Block - Stifel Nicolaus & Co.

Operator

Good day, ladies and gentlemen and welcome to The Cooper Companies’ Third Quarter Earnings Results Conference Call. My name is Philip and I will be your operator for today. At this time all participants are in listen-only mode. Later we will be conducting a question-and-answer session. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Kim Duncan. Please proceed.

Kim Duncan

Good afternoon, and welcome to The Cooper Companies’ third quarter 2014 earnings conference call. I am Kim Duncan, Senior Director of Investor Relations. And joining me on today’s call are Bob Weiss, Chief Executive Officer; Greg Matz, Chief Financial Officer; and Al White, Chief Strategy Officer.

Before we get started I would like to remind you that this conference call contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, including all revenue and earnings per share guidance and other statements regarding anticipated results of operations, market or regulatory conditions and integration of any acquisitions or their failure to achieve anticipated benefits. Forward-looking statements depend on assumptions, data or methods that maybe incorrect or imprecise and are subject to risks and uncertainties. Events that could cause our actual results or future actions of the company to differ materially from those described in the forward-looking statements are set forth under the caption Forward-Looking Statements in today’s earnings release and are described in our SEC filings, including the business section of Cooper’s Annual Report on Form 10-K. These are publicly available and on request from the company’s Investor Relations department.

Now before I turn the call over to Bob, let me comment on the agenda for the call. Bob will begin by providing highlights on the quarter, followed by Greg, who will then discuss the third quarter financial results. We will keep the formal presentation to roughly 30 minutes then open up the call for questions. We expect the call to last approximately one hour. We request that anyone asking questions please limit yourself to one question. Should you have any additional questions please call our Investor line at 925-460-3663 or email ir@cooperco.com. As a reminder this call is being webcast and a copy of the earnings release is available through the Investor Relations section of The Cooper Companies’ website.

And with that I’ll turn the call over to Bob for his opening remarks.

Robert S. Weiss

Thank you, Kim and welcome everyone. We had a very busy third quarter so we have a lot to discuss. As I am sure everyone is aware we announced the acquisition of Sauflon in our fiscal third quarter and we closed the deal on August 6th early in our fiscal fourth quarter. Since then we’ve had incredibly -- we’ve been incredibly focused on integrating the business and making it part of CooperVision. I am very happy to say we are making great progress and the integration is running smoothly and on time. Additionally I am very happy to say that we have learned a number of things post closing that makes me more positive on this deal, especially with respect to the manufacturing side. I will discuss this and the Sauflon business in more detail later.

Let me now start by providing some highlights on our fiscal third quarter. On a consolidated basis we grew revenues 5% to $432.5 million. Revenues were also up 5% in constant currency and excluding our Aime divestiture from last October. We posted GAAP earnings per share of $1.80 and non-GAAP earnings per share of a $1.90. Free cash flow was $54 million brining our 12 month trailing free cash flow to $206 million.

Before getting into too many details let me comment on CooperVision and CooperSurgical at a high level. CooperVision grew 6% year-over-year to $350 million. We continued making progress in a number of different areas and we saw strength in all our key areas including silicone hydrogel family of lenses which grew 21%. We also continued taking market share, growing roughly 1.6 times the global market in calendar second quarter. Within CooperSurgical we grew 1% year-over-year to $83 million. This met our expectations as we are implementing some minor restructuring and reducing our focus on low margin capital equipment sales within the IVF section.

Now let me provide some additional color on the Sauflon acquisition. As you know we closed the acquisition on August 6th. We immediately began integrating the business and again I am happy to say things are going very well. We believe we will be able to get the vast majority of the integration done by the end of 2015 with a significant portion done in the next six months. We have a number of personnel decisions we are in the process of making along with a number of the decisions around product offerings, back office combinations and manufacturing decisions. Regarding details I visited Sauflon’s primary manufacturing facility in Budapest last month and I can tell you it’s an extremely impressive facility. The cost and speed to get new lines operational combined with their flexibility is really impressive. As a matter of fact it’s better than we anticipated and I think is going to offer us manufacturing improvements in the outer years as we integrate our platforms.

Now before I get into the details of last quarter I want to touch on the soft contact lens market in calendar Q2 and our related performance. First off I am happy to say we once again took market share growing roughly 1.6 times the global market. The global market grew 3% for the quarter and we continued to take market share growing 5%. Although the 3% market growth is low remember there was large amount of pull forward in Q1 as Japan raised their sales tax effective March 31st and this resulted in a significant channel sale which resulted in a global growth of 8% in the first quarter.

To net everything out we believe the best way to look at the market is on a trailing 12 month basis where the market grew 6% and we grew 10%. At this point I believe the global market will continue to grow around 6% and you should see us continuing to take share especially with the addition of Sauflon’s daily Silicone hydrogel family of lenses.

For the quarter our strength continued to -- you've seen in Europe where we grew 9% against the market at 3%. This is the market where we sell all our products including MyDay and are doing very well. The Americas on the other hand is a market where our performance lagged, the market grew 7% which surprised me and makes me believe there is something going on with channel sale. Our new set data shows CooperVision running roughly 200 basis points above existing market share in the U.S. which clearly indicates we are growing share on a [fit] [ph] basis. We did see some inventory contraction so perhaps others saw some inventory expansion. Regardless I believe you will see CooperVision return to gaining share in the near future as we incorporate Sauflon and bring MyDay into the United States.

Now turning CooperVision details for the past quarter. On the sell side we had revenues of $350 million, up 6%. Excluding currency and the impact of the divestiture of Aime sales were up 6%. Our silicon hydrogel family continues to drive our topline with revenues of $174 million, up 21%. The silicon hydrogel family is now very deep with our monthly Biofinity product leading the way posting upper teens growth this past quarter. Our two-week family of products, the Avaira line also posted strong growth in the quarter up slightly over 20%. It's important to note that we're still under indexed against the market in the non-daily silicone space.

This portion of the market is now approximately 71% silicon’s and we are at 66%. So we're expecting to continue growing our non-daily silicon franchise for several years. Regarding silicon daily, our one-day product MyDay had a solid quarter. We're continuing to improve production on our lines and we remain on schedule to bring additional manufacturing lines into production in calendar Q2 and Q3 of 2015. We remain very positive about this product.

Obviously we are spending a lot of time evaluating the market with the addition of Sauflon’s daily silicon hydrogel product family and we continue to believe there’s a great opportunity to split the market with a premium daily silicon hydrogel lines and a mass market lens. We also believe we have a premier portfolio in this space to become the market leader in comings years. As a reminder with the Sauflon acquisition we now are the only company offering daily silicon hydrogel product portfolio which includes sphere, Toric and a multi-focal. The marketplace is clearly hungry for this portfolio and we're here to deliver it. Our Toric business remains strong, growing 11% and now accounts for 32% of CooperVision total revenues, multi-focals grew 16% and now represent 11% of our total revenue. We continue to lead the global market in these specialized categories and we're taking market share.

CooperSurgical our women's healthcare franchise turned in a solid performance meeting our expectations. Revenue growth was only 1% but we're pleased with the strength in margins. On a GAAP basis we increased our margins from 64% -- excuse me, on a non-GAAP basis we increased our margins from 64% to 66%. Our fertility business continued to grow with our reduced focus on low margin capital equipment sales, growth was only 3%. We're continuing to work to find the optimal model of sales growth and margin improvement and we're confident we're on the right track. Based on this revenues will likely continue to be lower than we've historically seen in our IVF business over the next year but gross margin should remain strong. IVF now accounts for 34% of CooperSurgical’s franchise.

Within our office and surgical business we posted growth of 1%. We're continuing to experience the challenges a lot of medical device companies are with the change in U.S. healthcare landscape. Having said that we believe we're maintaining if not takings share in our overall product portfolio. We also believe we have some products in development that should help grow in 2015 and 2016.

A few comments about strategy. We continue with our successful strategy which I frequently articulated in the past. We believe it's a solid strategy and it has delivered results. This includes investing in our businesses to ensure we continue to take market share. This includes direct investments such as our new manufacturing facility in Costa Rica which we anticipate producing products in late 2015 and our investments in emerging markets such as China.

This also includes strategic acquisitions such as Sauflon. We also keenly focused on improving our operating margins which we now are targeting being 26% plus in the 2018 time period excluding amortization. Contact lens industry is $7.4 billion globally and our unique manufacturing platforms and wide product offerings mean we offer the most comprehensive portfolio in the industry. Just to crystallize this point CooperVision aggressively promotes silicone hydrogel and non-silicone lenses. We also emphasize branded and private label products and note private label does not mean lower operating margins. We also actively promote and specialize in custom lenses. We support all modalities that eye care professionals prescribe; one-day, two-week and monthly.

And we support all types of lenses here spheres, Torics and multi focus. With the market leading position in the hybrid specialty lens categories Torics and multifocal it is acknowledged by eye care professionals that we are pretty good at specialty contact lenses. In my opinion we continue to be the most focused company in the industry. In today's market we have a solid product portfolio to leverage all modalities, multiple materials, all lens types and we retain our expertise to emphasize customizing lenses for the 10% to 20% of those lens wearers that require other than standard sizes in our designs.

While we already have pretty respectable gross margin and operating margins we have considerable upside yet to be fully developed upsize include elimination of our silicone hydrogel royalty with the expiration of patents, reduction of labor cost through opening new facilities such as Costa Rica. Improving molding cycle times, synergies from Sauflon and also leverage from our one day strategy. CooperSurgical is putting up solid results and is leveraging its infrastructure. The franchise was built with a solid understanding of the value of the critical mass in the women's healthcare market targeting the OB/GYNs.

We follow the profession wherever they go, bi it in the office, the surgery center, hospital or the IDF center. Although the call points are different the leverage is considerable. CooperSurgical maintained solid margins, gross margins in the mid-60s and operating margins in the low 20s both of which have upside.

And due to the minimum capital expenditure requirements CooperSurgical is a significant contributor to our free cash flow. We are dedicated to our surgical strategy and we will continue to leverage the surgical structure and products. Additionally the market for both women's healthcare and soft contact lenses are much less developed outside United States. And we generate considerable amount of cash offshore due in part to our local manufacturing outside the United States. As such we will continue to aggressively invest in global expansion opportunities. With over 95% of the people on the planet outside the United States we continue to find opportunities to invest in other countries for decades to come thereby sustaining our low effective tax rate definitely. And finally we'll have a share -- we have a share repurchase plan which has roughly $212 million of remaining availability and we'll use that program when believe it makes sense.

Now to touch a little on guidance, I'll let Greg provide the detail but I want to comment on a few things. As you can imagine we have a significant number of moving parts as we work to integrate Sauflon. Every acquisition requires a number of decisions to maximize revenues while realizing synergies. As such the CooperVision team needs time to evaluate and implement their plans, including decisions on personnel, facilities to get products and so forth.

Having said that I do want to provide some color on the numbers. For fiscal fourth quarter we are providing guidance on consolidated sales of $477 million to $490 million and this includes $395 million to $405 million for CooperVision and $82 million to $85 million for CooperSurgical. Regarding CooperVision I am not going to breakout Sauflon number as we have over lapping products, specialty specifically daily hydrogels and we need to determine the best products to focus on. This may result in eliminating certain CooperVision or Sauflon products. We are working to make these decisions as quickly as possible and we will communicate those details once available.

Regarding earnings we anticipate non-GAAP earnings of $2 to $2.10. Note this range excludes all amortization. Also note this guidance reflects updated currency rates which have moved against us recently with the Euro dropping to the low 130’s actually today down to the sub-130 level and the Yen to roughly 105.

Regarding fiscal 2015 due to the Sauflon acquisition I have decided to change our historical practice of waiting till December to provide any details. Obviously it’s too early to provide any granularity. Let me say I believe we will see consolidated pro forma revenue growth in the upper single digit range on a constant currency basis which should mean $2 billion to $2.060 billion in revenue in 2015. We believe this should result in a non-GAAP earnings per share in the range of $8.20 to $8.60. As you can imagine there are a lot of moving parts with the Sauflon integration so, we will wait to provide more details on the December call.

In the meantime we have a Analyst Day next week in New York City on September 11th and we will provide additional color on the integration details at that time. Speaking of our Analyst Day the format will be similar to our last one which the majority of the presentations will be from our operational management. Al and I will only make a few brief comments which will provide plenty of time for our Chief Operating Officer, Dan McBride and his team to discuss CooperVision and CooperSurgical. This will include Dennis Murphy presenting on CooperVision’s commercial operations and Fernando Torre presenting on the manufacturing and distribution parts of the business. Al will now present details on CooperSurgical and Greg will cover our financials. This should be very informative a very informative morning. So I hope you can all join us.

In summary before I turn it over to Greg. Let me say how happy I am with our businesses. Operationally we continue to outperform the market, growing 1.6 times the market last quarter and on a trailing 12 months basis. Our family of CooperVision products led by our silicone hydrogel families and our fertility line within women’s healthcare are all very promising, each offering growth opportunities throughout the world. We also closed the acquisition of Sauflon and I truly believe our new market leading product offering in the daily silicon space is going to provide strong growth for many, many years to come. We believe our optimism is with good reason because of our solid profit margins and free cash flow generation we have been able to continue investing in our business including maintaining our commitment to capital expenditures to support the one-day expansion strategy. Today’s one-day market is over $3 billion and growing much faster than the rest of soft contact lens market.

Not everyone will play. We have the products, the manufacturing platforms in the financial strength to move the needle. We remain keenly focused on delivering improving results, mindful of our desire to invest and leverage prudently, thereby delivering optimized long-term total shareholder return. With that as always, a reminder that at Cooper our number one asset is our employees. To them I express my appreciation for their dedication to creating value, delivering results. And now I'll turn it over to Greg to cover our financial results.

Greg W. Matz

Thanks, Bob, and good afternoon everyone. Bob shared with you a pretty thorough review of the market and our revenue picture. Now let me start with gross margins. In Q3 consolidated GAAP and non-GAAP gross margins were 64.9% and 65% respectively compared with 65.1% for GAAP and non-GAAP in the prior year. Gross margins came in at expectation. When looking at FX we had a slight negative impact due to pound-based inventory flushing through the system as we have discussed in the last couple of earnings calls, which was partially offset by favorable currency impact on revenue over the prior year.

We saw similar offset due to mix as favorable Biofinity products were largely offset by other products including MyDay, MyDay specifically. We still expect this product to exit the year in the high single-digit gross margin range. CooperVision on a GAAP and non-GAAP basis reported a gross margin of 64.8% versus 65.4 for GAAP and non-GAAP in Q3 last year. As I just mentioned this reduction of gross margin was mainly due to a slight negative currency impact related to pound based inventory flushing through the system and product mix. CooperSurgical had a GAAP and non-GAAP gross margin of 65.3% and 65.8% respectively which compares to Q3 '13 of 64.1%.

We saw positive impact from reducing our low margin capital equipment sales within IVF and with growth from certain higher margin products in the base business. It's worth remembering that our fertility business has lower margins than the rest of our business. But we are seeing improvement there as we focus on selling higher margin products. The difference between GAAP and non-GAAP relates to approximately 427K of severance cost.

Now looking at operating expenses, SG&A in the quarter on a GAAP basis, SG&A expenses increased by approximately 6% from Q3 last year to $161.2 million and were 37% of revenue similar to the prior year. On a non-GAAP basis SG&A increased approximately 3% to $156.5 million. Difference between GAAP and non-GAAP was about $4.7 million in acquisition-related costs which were included in our GAAP numbers. SG&A on a non-GAAP basis increased 1% sequentially.

Now looking at R&D, in Q3 R&D increased quite approximately 8% year-over-year to $16.1 million or up $1.2 million. R&D was 3.7% of revenue, up from 3.6% of revenue in Q3 '13 and down from 4% sequentially. And looking at depreciation and amortization in Q3 depreciation was $25.7 million, up $2.3 million or 10% year-over-year. Amortization was $6.8 million, down approximately $900K or 12% year-over-year for a total of $32.5 million.

Moving to operating margins. For Q3 consolidated GAAP operating income and margin were $96.6 million and 22.3% of revenue versus $93.6 million and 22.7% of revenue for GAAP in Q3 last year. Non-GAAP operating income and margin were $101.7 million and 23.5% of revenue versus $93.6 million and 22.7% of revenue for the prior year. This represents a 3% increase in operating income over the prior year GAAP numbers and a 9% increase for non-GAAP. Difference between GAAP and non-GAAP is due to approximately $5.1 million worth of acquisition and severance cost. In Q3 CooperVision had GAAP operating income and margin of $88.4 million and 25.3% of revenue versus the prior year Q3 of $88 million and 26.6% of revenue for GAAP and non-GAAP. In Q3 '14 on a non-GAAP basis operating income and margin were $93.4 million and 26.7% of revenue. The difference here between GAAP and non-GAAP is due to approximately $5 million of acquisition cost for Sauflon.

CSI, CoooperSurgical had GAAP operating income and margin of $18.4 million and 22.3% of revenue versus the prior year Q3 of $16.4 million and 20.2% of revenue for GAAP and non-GAAP. Q3 '14 non-GAAP operating income and margin were $19.2 million and 23.2% of revenue. This difference between GAAP and non-GAAP is related to approximately $800K of acquisition and severance cost.

Moving on to interest expense, interest expense was $1.5 million for the quarter down 34% year-over-year. Looking at the effective tax rate in Q3, the GAAP and non-GAAP effective tax rate was 6.1% versus Q3, ‘13 GAAP effective tax rate of 2.3% and non-GAAP effective tax rate of 5%. As a reminder the effective tax rate was abnormally low in last year's third quarter due to a drop in the UK statutory rate from 23% to 20% which was enacted during that quarter. As we've mentioned before the effective tax rate continues to be below the U.S. statutory rate as a majority of our income is earned in foreign jurisdictions with lower tax rates.

Looking at earnings per share, our Q3 earnings per share on a GAAP and non-GAAP basis was $1.80 and $1.90 respectively versus $1.79 and $1.74 on a GAAP and non-GAAP basis in Q3 ‘13 respectively. GAAP EPS includes the impact of acquisition and severance related charges of approximately $5.1 million or $0.10 per share.

Ahead of recasting our non-GAAP reporting to include Sauflon which will do in Q4, we are today updating our non-GAAP reporting to exclude amortization. We believe this change reflects how our industry is treating amortization and believe this will aid in transparency and the ability to compare results across companies. Regarding the financial impact of amortization, if you exclude it from non-GAAP results this year the impact on non-GAAP EPS would be as follows: For Q1 ‘14, with $7.5 million of amortization reported the earnings per share impact would be $0.12. In Q2 14 with $7.5 million of amortization our interest here is also $0.12. In Q3 with $6.8 million in amortization, we saw a $0.10 impact on EPS and for Q4 excluding Sauflon we expect $6.8 million of amortization and an impact of $0.10 on EPS.

For comparability, fiscal 2013 amortization impact on earnings per share was in Q1, $0.11, Q2, $0.11, Q3, $0.12 and Q4 was also $0.12. For fiscal 2014 excluding Sauflon the full year amortization would be approximately $22 million with an estimated EPS impact of $0.32. It's important to note there is a tax impact on the amortization depending upon where geographically the intangibles reside. We have intangibles relating to deals in several countries including the U.S. and UK, so the tax effect on amortization expense I just quoted is higher than our average effective tax rate.

Moving on to share repurchases. There were no share repurchases in Q3. Looking at foreign exchange and the net impact year-over-year for Q3 was slightly favorable by $0.02 at the current FX rates we will see a headwind on our fiscal Q4 guidance. For Q4 we are expecting a negative year-over-year impact of $0.17 which is $0.06 more than we guided to on our last earnings call. This EPS deterioration for Q4 is generally related to the weakening of the Euro and European currencies which track the Euro like the Kroner as well as the Yen.

Note, at the current FX rates, we now expect a $0.31 negative FX impact on earnings per share in 2014. For today's guidance we used the rate of 1.31 for the Euro, 1.05 for the Yen and 1.65 for the Pound. And if any one of you who have been following it during the day you realize it has gone a little weaker from this morning.

Balance sheet and liquidity, in Q3 we had cash provided by operations of $107.9 million, capital expenditures of $55.8 million and excluding acquisition related cost of $1.7 million resulting in $53.8 million of free cash flow. Total debt increased within the quarter by $12.5 million to $347.9 million. Subsequent to quarter end on August 6th we announced the company entered into a $700 million three year senior unsecured term loan which matures August 4th 2017. The facility was used to contribute to the funding of the Sauflon acquisition as well as to provide future working capital and be available for other general corporate purposes. This loan combine with previous facilities gives a combined debt capacity of over $2 billion.

Inventories increased approximately $7.6 million to $353.4 million from last quarter. For the quarter we are seeing months on hand at seven months down from months on hand of 7.1 months last year and down from 7.2 months on hand last quarter. DSO is at 53 days up from 51 days in the prior quarter and same as last year. Touching on a couple of topics, important topics first off we closed the Sauflon acquisition for $1.2 billion on August 6th using offshore cash and debt facilities. We will be including their results in our Q4 reporting. With this acquisition we now expect to see interest expense of roughly $3 million in Q4. It's a little early to forecast the interest expense in fiscal 2015 but at current rates it's likely to be in the range of $18 million.

Integration activities are proceeding on schedule but we've not had a financial close with Sauflon yet. So we are working through a number of financial and operational detail and we'll continue to share information with you as we gain better insight into those details. Couple of points to note on this. We are in the process of doing our financial and tax evaluation work including completing pro forma financial statements. This will be completed in stages and we'll have quarterly pro forma financial statements completed by our Q4 earnings call and we'll distribute those as soon as possible. I appreciate that this is a key item for your fiscal 2015 model so we are working diligently to get this work completed.

Regarding taxes we believe the Q4 non-GAAP effective tax rate will be approximately 11.5% which is higher than our run rate but reflects the impact of excluding amortization as well as the addition of the Sauflon acquisition. And we are very much in the early stages and this number will change depending upon various integration decision but this is the best number we have at the moment. Regarding Sauflon's tax structure we are actively working on integrating their business into our global tax structure. This is in the early stages and depended on a number of items including the valuation work. But we hope to get this finished prior to calendar year-end and more to follow on this.

Looking at guidance, Bob gave you a little bit of guidance. So as Bob mentioned we are guiding to fiscal Q4 '14 revenues of $477 million to $490 million with CooperVision at $395 million to $405 million and CSI at $82 million. Bob covered the details around revenue but let me provide some more detail on EPS. It is difficult to provide too much granularity on a GAAP EPS basis as this number could change significantly based on Sauflon integration related decisions and the final valuation model. But on a non-GAAP basis we are anticipating Q4 '14 gross margins of roughly 64%, operating margins roughly 24.5% which combined with the interest and the tax rate I mentioned earlier $3 million and 11.5% respectively results in a non-GAAP range for the quarter of $2 to $2.10 and this excludes amortization.

Regarding fiscal 2014 annual guidance all this results in revenues of $1.725 billion to $1.74 billion with CooperVision at $1.4 billion to $1.412 billion and CooperSurgical at $325 million to $328 million. Non-GAAP EPS guidance excluding amortization is $7.34 to $7.44. As I mentioned earlier because of the large number of integration activities and the wide range of potential cost it does make sense provide to GAAP EPS at this time.

Looking at the preliminary guidance for 2015 Bob mentioned revenue at $2 billion to $2.06 billion and non-GAAP EPS in the range of $8.20 to $8.60. Taking into consideration that there are lot of moving parts and the things will change let me give you some of the assumptions we've used for our non-GAAP EPS at this point. Gross margins in the 63% to 64%; operating margin 23% to 24% range; ETR 9% to 11%, share count just under $50 million. Again a lot of work has to be done and these are some preliminary ranges. But because we know you are trying to set up your models we'll do what we can, we'll try to provide some more insight during our Q4 earnings call ion December.

With that let me turn it back to Kim for the question-and-answer session.

Kim Duncan

Operator, we are ready to take some questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Jeff Johnson with Baird. Please proceed.

Jeff Johnson - Robert W. Baird

Thank you. Good evening guys. Can you hear me okay?

Robert S. Weiss

We can you hear you fine Jeff.

Jeff Johnson - Robert W. Baird

Okay, great. Hey, Bob so I want to start first on the fiscal ‘15 guidance if I can, on the $8.20, $8.60 range, pretty big range obviously you've got a lot of moving parts. So I think we all kind of get that. I wonder if you can just maybe take us through risks and opportunities. There is any bias to that guidance to the upper and lower end and what would happen to take it to the low end, what would have maybe have to happen to get it to the higher end? Thank you.

Robert S. Weiss

Okay, Jeff you were little muffled but I think I got the gist of it. The $8.20 to $8.60 guidance let's call that middle of the road. It's broader than we normally would like. Obviously we're going out a lot further than we normally would, but a lot of moving parts that Greg alluded to. Obviously some of the moving parts have to do with each of the key assumptions. One is on product rationalization I alluded to the fact that we’re going to be making some decisions on product rationalization which could certainly impact top line, what happens and how we use the plants.

In some cases a factor might enter into -- you have MyDay, and you have Clariti, both in the one day space, how we position that and whether or not we put more emphasis on go to market or basically on which do we go to market with. So those decisions are being debated extensively as we speak, various meetings going on throughout the world and they certainly could have implications do you go faster or slower or do you build and roll out more fitting sets of one, product one compared to product two.

The finalization of the rationalization of the split between the mass market and the premium market and the related pricing that goes into that, particularly as we enter the U.S. all of those things are up in the air. Suffice to say one of the other things up in the air is foreign exchange, which is moving as we speak in unfortunately the wrong direction. We've given guidance coming into today with the euro, which is a very key catalyst for our business, if you will, top line and bottom line at 1.31, I think it was -- we're already down to sub 1.30. So clearly things like that would weigh us towards the bottom end of the range if that were to keep up.

The timing of our transition into the global tax arrangements of Sauflon and is it all of the products or only some of the products would weigh on our effective tax rate. So I guess I would say suffice it to say there is softness from the top to the bottom in terms of some of the assumptions therein why we have 63 to 64 or 1% spread on gross margin for example.

Jeff Johnson - Robert W. Baird

Understood, and then just as a follow-up, you mentioned in your prepared comments some better than expected things you are seeing on the manufacturing side on Sauflon. Any specifics you can provide and I know you can't just make MyDay on the Sauflon lines, I know it's not as simple as that but maybe give us some idea that how you could apply some of that manufacturing to some of your technology over time.

Robert S. Weiss

Yeah, I'll give you two insights. One is the ease of change; how easy it is for them to convert from making one product to another and the downtime, compared to much more expensive equipment that’s more rigid, but high volume they get a lot more versatility in their platform. It's kind of like our platform in Rochester which gives us the ability to make made to order product, make changes a lot more rapidly compared to our high volume gen two type line. So that's one thing. The other thing clearly is the ability to make a product without alcohol and so their product and their production is easier. We've never basically had a love affair with alcohol, I think as many of those on the phone call know now we have a platform that allows for that and importantly a material that allows for that. So those two things are -- will weigh heavily on where we might go with different products in the future.

Kim Duncan

Next question?

Operator

Our next question comes from the line of Larry Keusch from Raymond James. Please proceed.

Lawrence Keusch - Raymond James

Thanks, good afternoon. Bob I guess just going back to your prepared comments, certainly relative to our model the single use spheres were the one that had the biggest variance and if I -- and what I guess I am trying to really understand is you grew 15%, I believe if my numbers are right last quarter 2Q you grew 4%, this quarter and if I exclude MyDay it feels like this quarter the base business was actually down year-over-year. So could again run us through sort of what you believe actually happened in that product category?

Robert S. Weiss

Yeah, single use spheres, the biggest market in the world is Japan. And so Japan would be the most profoundly impacted by some of the activities with the VAT or the sales and use tax that occurred in Q1 versus Q2. So you do have to kind of normalize that, so one thing. The other thing is the second biggest market in the world now is the U.S. and it's clear we have a void where we are today. We have Proclear 1 Day doing a very credible job but it can't carry all the weight in the U.S. market. It does need a silicone hydrogel, a Clariti and a MyDay. So the absence of any of that activity yet into the U.S. numbers means that we are -- we have a temporary void that we all know will be filled up very shortly.

Lawrence Keusch - Raymond James

Okay, and then you mentioned what you felt like you saw some contraction in inventories and perhaps some expansion implied for other companies out there. Again can you provide some further comments on kind of geographically where that happened and at what product categories that may have happened as well?

Robert S. Weiss

Basically we had some further contraction in our distributor network here in the United States. And when we look at that contraction compared to when we look at iData which is survey data that we get, we know that we did not lose share in those spaces. We're gaining share modestly. And we still, as I indicated, have much greater new fit share than we do total fit share meaning directionally we're headed the right way.

Conversely when I look at the total market for the U.S. and some of the survey data we have we can see a pretty big expansion and I am capable of, if you will, assessing certain products of our competitors and I won’t get into the details on that, but know how some of them wind up on eye compared to how the total market moves.

So it's more speculative but I have a pretty strong hunch that there were some areas where there was pipeline expansion, some of it could have been new product-related. That leads to some expansion and we didn't have that going on in the U.S. So the U.S. would have been or the Americas is a big part of it.

Operator

All right, our next question comes from the line of Chris Pasquale from JPMorgan. Please proceed.

Christopher Pasquale - JPMorgan

Hey, thank you. I think I heard you say that the 4Q cash EPS guidance does not include the adjustment for the additional amortization created by the Sauflon acquisition, is that correct and is that the case also for the FY’15 EPS guidance and therefore should we be expecting that range to go up once you finalize the accounting for the deal itself?

Robert S. Weiss

We are basically excluding amortization of intangibles and so that will never enter our non-GAAP numbers, no matter what ultimately when those appraisals are done down the road leading to GAAP amortization, if you will, it will be -- it would go into GAAP and then be pulled out. It would be a better number wherever that number lands. Greg, I don't know if you want to add anything?

Greg W. Matz

Yeah, the only thing in Q4 until we move the IP and have similar tax structure that we currently have with Vision, you could have some tax effect and so without -- that's the only reason why we mentioned it, so we're fine. Our guidance range for 2015 is fine.

Christopher Pasquale - JPMorgan

Okay, so the guidance you have given for 4Q and then for presumably outlook for next year is as close to complete as you can get. There may be some moving parts but we shouldn't expect some other big adjustment as Sauflon is finalized.

Greg W. Matz

Right.

Christopher Pasquale - JPMorgan

Okay and then I just want to clarify the answer to Jeff's question, the comment about product rationalization, is it still an open question whether MyDay and Clariti will both be supported or is the debate more about positioning in different markets?

Robert S. Weiss

Both will be supported, the debate is about positioning and obviously one dilemma is do you try to introduce and I'll be a little kind on the words, two blockbuster products at once in the U.S. or does one get the lead and one not get the lead. So that, when you have limited supply you have to make some decisions on am I better off doing X and Y if I have, two products and then sequencing it. So that’s one thing that matters. The second thing on rationalization there are some overlapping products that are less glamorous, let’s say then Clariti, one-day or MyDay and it will come into, should we rationalize out some of those products.

Operator

All right, our next question comes from the line of Larry Biegelsen from Wells Fargo. Please proceed.

Larry Biegelsen - Wells Fargo

Good afternoon. Thanks for taking the question, guys. I just wanted to ask, Greg maybe could you tell us what the pro forma growth for CooperVision is implied in your Q4 guidance, and could you also talk about the capacity for Clariti, one-day. MyDay you said you could do $25 million in fiscal 2014, $75 million in fiscal 2015. For Clariti originally said they would do about $85 million in fiscal 2014, but you haven't given us much color on their capacity for fiscal 2015. Thanks.

Greg W. Matz

I'll jump in on the growth rate. So fourth quarter for total CooperVision because we're not breaking out CooperVision and Sauflon but for total CooperVision you are looking at 11% to 14% range in constant currency, excluding Aime.

Larry Biegelsen - Wells Fargo

Is that pro forma, Greg?

Greg W. Matz

Yes, it is.

Larry Biegelsen - Wells Fargo

Okay, and then the other questions?

Robert S. Weiss

As far as capacity for Clariti expansion, I guess two things, one is their total capacity is expanding rapidly, meaning Sauflon. And when I talk about versatility there are two plus on that. The versatility of whatever products you put on those lines, whether it’s Clariti single use or other products could influence your capacity considerably. If we were to take off the products off the lines that would directly influence the capacity. So when we look -- those decisions have yet to be determined, how much beyond their normal expansion of capacity that they were planning in their ramp up which was sustaining a company growing 20% a year if you will, and where we go with the product lines. So if we -- we can already make it on Cooper product line on Cooper equipment. We may elect to take even higher ARP products off of their lines and convert them to Clariti single-use if that makes sense.

Long and the short of it is expect good growth from one-day silicon hydrogel lenses next year and it should certainly be well north of run-rate of $110 million that we're kind of looking at this year in terms of our roll-out next year.

Operator

All right. Our next question comes from the line of Joanne Wuensch from BMO Capital Markets. Please proceed.

Joanne Wuensch - BMO Capital Markets

Thank you very much for taking the question and good afternoon. Can we talk about capital expenditures please? We estimate that you are probably going to spend a little over 200 million in 2014 can you comment if that’s sort of the right range and then how should we think about that next year as you ramp MyDay, integrate Sauflon and do the rationalization of products that you are thinking about?

Robert S. Weiss

Joanne, you are correct. We were targeted to spend well north of $200 million this year prior to picking up one quarter of Sauflon. So suffice it to say it's going to be well north of $200 million, if you will. The good news about Sauflon in terms of its impact on our capital requirements their capital is less expensive by a lot. And I mentioned the fact that they don't use alcohol. So among other things that makes it less expensive by a lot. So while we would normally in the context of all the activity we have going on with our plant expansions and you will be -- those of you attending the analyst meeting next week you will get a lot of insights in terms of what's going on in just how many locations, how robust that expansion has been.

There is no doubt that having Sauflon in the fold allows us to rethink certain capital projects going forward and migrate to some degree from a premium expensive equipment to less expensive equipment which is positive. Having said that I think in 2015 there will be some modest favorable impact of that, beyond 2015 a lot more favorable impact of that. So longer term the aggregate of having Sauflon included in our numbers I would [stress] that the total capital program doesn’t go up at all, post 2015. It could be consumed in the improved capital model if you will.

Joanne Wuensch - BMO Capital Markets

If I can follow-up please, on the tax rate, it sounds like you are doing a fair bit to manage that. Is that a project which lasts 12 months to 18 months or is that a multi-year project as you think about resuming that lowered tax rate? Thank you.

Greg W. Matz

No, Joanne it's a fairly quick project and we're hoping to have done what we need to do by the end of the calendar year. So we've done this before. It's fairly straight forward, just a lot of work that goes into doing it. Obviously there is tremendous amount of works and forms and calculations that need to be done.

Robert S. Weiss

And just to add a little bit color on that there are some pieces of that process that are business-related meaning what are your business decisions that could come into play, that may alter where we land and some of that may take a little longer. So that may be a piece of it, most of it we know exactly where we're going and how we want to get there.

Operator

Our next question comes from the line of Matthew Mishan from KeyBanc. Please proceed.

Matthew Mishan - KeyBanc Capital Markets

Yeah, great, thanks for taking my questions. I think the first thing I wanted to touch on is for the past couple of quarters, I think maybe two quarters ago you had [inaudible] distributor’s margin than the previous quarter, you had a price hike and sort of that pulled forth some demand and I think this quarter you saw some kind of inventory contraction. Where are you at with your largest distributors and distributor base and are we likely to see this kind of volatility continue?

Robert S. Weiss

I would say we are lower than I would have guessed as we end the third quarter. So I think they've rationalized their locations and that consolidation and that we're kind of near the floor.

Matthew Mishan - KeyBanc Capital Markets

Okay, and how much, if it’s possible could you quantify how much Sauflon did in the U.S. in the second quarter, the calendar year second quarter?

Robert S. Weiss

For a number of reasons we're not going to get into that initial rollout, so no, we're not.

Matthew Mishan - KeyBanc Capital Markets

And just last question trying to may be back into what Sauflon was in your fourth quarter guidance, I think you guided to about $210 million or so for that business for the full year, this year. Is there seasonality in the Sauflon business that would make the final quarter more or less robust and should we pretty much be thinking about that almost as a full quarter of Sauflon kind of minus seven days.

Robert S. Weiss

The way to think about it is -- it’s mainly a ramp up and roll out that they’re going through. So they have, they were on a trajectory and that was building. Having said that one of the key assumptions that would come into play would be that the initial rollout in the U.S. That initial rollout into the US which started last quarter for them is obviously one of the areas we need to think most about and that could mean going slow in certain parts of the U.S. as a result of that. It gets back into -- you have two products MyDay, Sauflon both entering the U.S. Really Sauflon Clariti is in front of MyDay getting here quicker. But you have an integrated operation in the U.S., that is what I'll call much more integrated than some parts of the world and much quicker, that comes into play and then product strategy we want to get it right from the get go and we don’t want to have to fix it further down the road. So that could all translate to less than what I would call a dynamic sales strategy in the U.S. in this next couple of months.

Operator

Our next question comes from the line of Steve Willoughby from Cleveland Research. Please proceed.

Steve Willoughby - Cleveland Research

Hey, guys. Thanks for taking my question. I guess you sort of answered my first question there, just regarding the guidance only going up by roughly $17 million on the high end despite you said Sauflon generating roughly $50 million a quarter. I guess following up on that for EPS for the year, I see that you've taken the high end up by $0.44. That basically accounts for the amortization that you no longer including. So I am just wondering where or when do you expect Sauflon to start to be accretive. As I know when you announced the deal you said it would be accretive, obviously there is some expectations by investors of how accretive it could be and it doesn’t look like that accretion is going to start showing up in the first quarter, I guess that my first question.

Robert S. Weiss

I wouldn't -- I would say the numbers that we've guided to for the fourth quarter don’t demonstrate any dilution from Sauflon and if anything there is some accretion starting in the fourth quarter, which then rolls into the period beyond, in other words we're not assuming it's a dilutive activity next year.

Steve Willoughby - Cleveland Research

Okay and then just two other quick question -- yeah.

Greg W. Matz

Just one thing you are seeing some of the FX impact, but again if you look at, just for the year we're looking at $0.31 but even the fourth quarter you are looking at $0.17 which is about $0.06 above the guidance we gave last time.

Steve Willoughby - Cleveland Research

Okay, got it. And then two other quick ones for you. Just so I’m clear, are you not going to be breaking out how much in revenue Sauflon does either in the fourth quarter or in 2015?

Robert S. Weiss

It’s going to be fully integrated with product rationalization. So the number in and of itself will be somewhat meaningless. We discontinued some of its products obviously, it’s going to minimize its growth in certain areas.

Steve Willoughby - Cleveland Research

Okay, and then just the final thing for you MyDay, can you comment about how much in revenue MyDay generated in the quarter and can MyDay still do $75 million in revenue next year?

Robert S. Weiss

I would put that MyDay decision in hand-in-hand with Clariti, meaning are decisions we can make that will slow up the on-eye or the revenue activity next year of either one of those products and the example would be where you turn a product more into fitting sets, you take more of your production into fitting sets than into revenue producers. So those decisions rather than to start quoting numbers if we were to take a whole bunch of lenses out of revenue we're better off looking at and it is a package of products which we will start putting color on probably in December. We're just not going to be there clearly next week. So the activity we're going through right now will shed light on that but not until then.

Just one more point on that. In December we will probably be talking to the total of how we're doing with silicon hydrogel in the one-day space more so than one or the other of those two products.

Operator

Our next question comes from the line of Matthew O'Brien from William Blair. Please proceed.

Matthew O'Brien - William Blair

Afternoon, I know we're running late here so I'll just keep it to one. Bob, I think you mentioned in your prepared comments that you now think you can get your operating margin up to about 26% in fiscal '18. I think that's 100 basis points higher than you've mentioned in the past. First of all is that right and secondly if that's true can you just give us a sense for the drivers of that improved optimism? Thank you.

Robert S. Weiss

You are correct, you heard that right, so 26% plus, but the driving factor of that change was the removal of amortization. So we really ex-the amortization it’s the 25, although we probably said 25 plus.

Matthew O'Brien - William Blair

Thank you.

Operator

Our next question comes from the line of Jon Block from Stifels. Please proceed.

Jonathan D. Block - Stifel Nicolaus & Co.

Thanks, guys. I'll try to ask two and half quickly. The first one, Bob relative to our expectations APAC was light, it was up 7% year-over-year, it was sort of mid to high teens ex-Aime in the first two quarters of the year. And I know we had some noise with VAT tax but I thought you said the channel was normalized. You got it more, you gave it back in April. So can you talk to that, was there still more inventory in the channel that you had thought or if not what led to that slowdown over in APAC?

Robert S. Weiss

Yeah, I think if we look at again on a fiscal quarter basis we were up 7% and we were up a lot more in the prior quarter. On a calendar basis where you don’t have that flush out period obviously it was pretty dramatic and there we had given, if I give the number in front of me, you had for the quarter a negative 3% for the industry, us coming with a positive one. And there I think if you look to the full fiscal year it's more meaningful which is 7% for the market plus that 14%. So we're still doing very good. I think the most meaningful gauge is the trailing 12 months when it comes to Asia Pac.

Jonathan D. Block - Stifel Nicolaus & Co.

Okay, and then just, next one, I mean there is a lot of moving parts, I guess if you isolate AMEA, where it’s say, it's the only market where you're sort of fighting the fight on equal footing with Si-Hy dailies, you grew 4x the market, last quarter you grew 3x the market this quarter. So can you just talk -- is that where the bullishness is coming from long-term just going forward with the addition of Sauflon you feel you are for the most part on equal footing and when that's the case we should start thinking of market share gains that are still some sort of multiple of the market if you would?

Robert S. Weiss

Yeah, I think when we look at Asia-Pac we say we're doing pretty good right now with Biofinity and the Proclear one-day material. When we look at Europe we're basically saying it was good even before we add Sauflon’s family or Clariti, it was already good. So it should say and continue very good. And you are right MyDay was an important catalyst as was Biofinity and even Avaira all products are doing -- are kind of humming in Europe, against the market that's doing fair.

When it comes to the Americas we know we have the void. It's a big void. The market is shifting rapidly from two week into one day and to a lesser extent into monthly. And filling in that void is really going with a dynamic growth of the one-day which is both MyDay and Clariti. So we think we have the right answer and therefore have every reason to think we feel good about gaining market share in all three geographic areas.

Operator

And ladies and gentlemen, this will conclude the question-and-answer portion of today’s conference. I would now like to turn the call back over to Bob Weiss for closing remarks.

Robert S. Weiss

Well, I want to thank everyone for joining us today. For those of you that are attending next week’s analyst meeting in New York we hope to see a lot of you there. We look forward to the presentation and as I indicated Al and I are going to speak less and you will again hear a lot more from the managers that make it happen. So we are excited about that. And for those of you not joining us in New York next week, we look forward to updating you in December when we report our year-end results. With that thank you operator.

Operator

You are quite welcome. Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. And you may all now disconnect. Have a wonderful day.

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