The Cooper Companies (NYSE:COO)
December 8, 2011 5:00 p.m. ET
Bob Weiss - President and CEO
Gene Midlock - Senior VP and CFO
Al White - VP of Investor Relations, Treasurer, and Chief Strategic Officer
Larry Keusch - Morgan Keegan
Jeff Johnson - Robert W. Baird
Chris Cooley - Stephens Incorporated
Matthew O'Brien - William Blair
Larry Biegelsen - Wells Fargo
Joanne Wuensch - BMO Capital Markets
Anthony Patron - Jefferies
Kim Gailun - JPMorgan
Steve Willoughby - Cleveland Research
Adam - Citigroup
Good day ladies and gentlemen, and welcome to the fourth quarter and full year 2011 The Cooper Companies Incorporated earnings conference call. [Operator instructions.] I would now like to turn the conference over to your host for today, Ms. Kim Duncan, director of investor relations. Please go ahead Ms. Duncan.
Good afternoon, and welcome to the Cooper Companies fourth quarter and full year 2011 earnings conference call. I’m Kim Duncan, director of investor relations, and joining me on today’s call are Bob Weiss, president and chief executive officer; Gene Midlock, senior vice president and chief financial officer; and Al White, VP, investor relations, treasurer, and chief strategic officer.
Before we get started, I’d like to remind you that this conference call continues 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 conditions, and integration of any acquisitions.
Forward looking statements necessarily depend on assumptions, data, or methods that may be incorrect or imprecise and are subject to risks and uncertainties. Events that could cause our actual results and future actions of the company to differ materially from those described in 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 of the quarter, followed by Gene, who will then discuss the fourth quarter and full year 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 e-mail IR@coopercos.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.
Thank you Kim, and good afternoon, good evening to everyone. Another great quarter here at Cooper. Aside from the Avaira recall, the momentum continues. For the fourth fiscal quarter, we put up stellar top line growth, up 15%, 12% in constant currency. We delivered $361 million in revenue. Excluding the Avaira recall impact, our gross margin was 63%. Strong top line, solid margins, lower interest expense lifted our non-GAAP earnings per share 34% to $1.46.
GAAP earnings per share was $1.15, hurdling the recall’s $1 million charge that we took in the fourth quarter and a settlement of a patent claim for $10 million in aggregate. Then we had an outstanding cash flow quarter generating over $78 million of free cash flow and reducing our debt-to-cap to 16%.
The key takeaways for today’s call: We again put up great results, with strong revenue growth, good margins, favorable impact from lowering interest expense and a great bottom line. The impact of our launches of Biofinity Multifocal globally and Biofinity into Japan helped continue our silicone hydrogel momentum, which fueled our double digit results.
Our $78 million of free cash flow allowed us to continue to deleverage, with debt-to-cap now only 16%. Today our debt, at $380 million, is down 58% versus the $900 million it was in January of 2009. We’ve done this while continuing to invest in sales force expansion, R&D, and acquisitions.
Without giving away too much competitive information, our sales force expansion was about 25% this past year. Our sales force expansion reflects our strategy to get more feet on the street and cover a greater amount of geographic coverage worldwide. We have the products, we have the capacity. Why not test our geographic strength?
Our silicone hydrogel family is driving growth. During the fourth quarter the family achieved $103 million in revenues. That’s 39% constant currency increase versus the prior year’s fourth quarter. Silicone hydrogel are now 34% of CooperVision’s revenue.
We continue to feel positive about the future of our silicone hydrogel sales, driven by multiple factors including the recent success of our Biofinity Multifocal launch in the $150 million silicone hydrogel multifocal market and the launch of Biofinity sphere in Japan in the $400 million silicon hydrogel market.
To update you on the progress with respect to our Avaira recall, let me touch on several points. We believe the situation has been fully addressed, and no further expansion of the recall will be required. We are working closely with the FDA and other global regulatory agencies to complete the recall as quickly as possible.
We have completed contacting our customers for the Avaira Toric recall and are in the final stages of product recovery. Initial notifications have been sent to our customers for the Avaira Sphere recall and follow up activities are ongoing. We are continuing to ship Avaira Sphere and we are optimistic that we’ll be able to relaunch Toric in the April timeframe.
Let me also highlight a few recent developments with the FDA. The FDA has completed inspections of two of our three manufacturing facilities, that being Puerto Rico and New York, and no observations were received, that is no Form 483. We expect the FDA to inspect our UK facilities as well, although we are not aware of the timing at this point.
The FDA has also inspected our US distribution center located in West Henrietta, New York. We received a 483 with five observations and subsequently, on December 7, we received a warning letter from the FDA. The observations are related to labeling and packaging and are not product-specific.
We are working closely with the FDA to solve the observations. Our focus remains on doing the best for our customers and we remain 100% focused on delivering high-quality products to the marketplace.
Now let me move on and discuss how we did geographically. Foreign exchange still played a positive role, although at a much-reduced rate, in the third quarter. For CooperVision, currency impacted revenue versus prior year by 4%, down from 9% in the third quarter. In constant currency, we had a solid growth rate in each region. The Americas was up 10% constant currency, Europe 4%, Asia 29%, and overall I understand we had 11% constant currency growth.
In constant currency regional drivers were in the Americas, trading up to silicon hydrogel and one-days; in Europe, growth in silicon hydrogel and one-days; and in Asia-Pacific, growth related to the IME acquisition completed in the first fiscal quarter of the year, together with primarily Proclear one-day and also the Biofinity rollout now in Japan.
The soft contact lens market weakened slightly in the third quarter. That’s the third calendar quarter. But it is likely to finish the current year in the 4-6% range we predicted. The third calendar quarter growth was 3% constant currency. Trailing 12-month, a more important gauge, was 4%.
The market was up 3% and CooperVision was up 5% in the third quarter. Clearly CooperVision is growing, at almost 2X the market in the third quarter. That was sponsored by our silicon hydrogel, up 37% in constant currency versus market growth for silicon hydrogel of 9%.
We continue to gain share in our trading up. Market growth in one-days is up 8% constant currency; Torics, up 7%; Multifocals up 6%; silicon hydrogel materials ended up being up 9% and are now 43% of the total market. Recall the market remains a trade-up market. Trade-ups for silicon hydrogel are roughly 20-40% and for one-days the trade-up is roughly 5 times revenue.
Worldwide, Torics, or specialty lenses, are also supporting solid gains, up 7% partially due to the fact that lenses are much less penetrated outside the United States. The strong performance in Asia-Pacific reflects some rebound in Japan with strength in Torics and one-days. Japan’s growth had been more modest in the past two years.
CooperSurgical, our women’s healthcare franchise, had another great quarter. With $57 million in revenue, it was up 14%, 8% in organic growth. Drivers continue to be surgical procedures, hospital, and same-day surgery, where revenue is up 24% and now accounts for 36% of CooperSurgical revenue.
Fertility also turned in double-digit revenue growth of 10%. CooperSurgical continues to impress with a solid gross margin at 65% and operating margins at 26%. With its $220 million now of run rate revenue; multiple sales force call points; strong centralized campus in Trumbull, Connecticut; and strong franchise with the OBGYN professional, this business is very leverageable.
In the quarter we acquired a business in Colorado called Summit Doppler. Summit, a supplier to us, has revenues of about $8 million annualized. It makes both obstetrical and vascular ultrasound Doppler systems. In addition to a strong portfolio, Summit brings a strong electrical engineering expertise that can be used to upgrade several of our older products such as the MedaSonics brand of Dopplers. We paid $16 million, and expect the deal to be meaningful to earnings in year one and accretive thereafter.
A little bit about guidance. We are providing 2012 guidance for the first time. For the soft contact lens market, we believe the market will grow in the 4-6% range in spite of its relative weakness in the past calendar quarter.
For CooperVision, we expect to continue to gain share, and are projecting growth of 6% in the midpoint of our guidance range. Momentum should continue, sponsored by the geographic expansion of our silicon hydrogel family, particularly with our recent successes in Biofinity in Japan and Biofinity Multifocal as well as our Proclear one-day.
We expect to deliver an earnings per share growth that should have us achieving an earnings per share number approaching $5 next year. We will do this while continuing our program of investing in geographic expansion, particularly in China.
Now continuing with our successful strategy, we believe it is solid and it has delivered results. CooperSurgical is putting up outstanding results and is leveraging operating ratios. This franchise was built with a solid understanding of the value of critical mass in the women’s healthcare market targeting the OBGYNs. We follow the professionals wherever they go: Office, surgery center, hospital, or IVF centers.
Although the call point is different for each, the leverage is considerable. CooperSurgical’s fourth quarter gross profit was 65% and as I mentioned operating margins 26%. And due to minimal capex requirements for surgical to generate a significant free cash flow, we are dedicated to this strategy and will continue to do tuck-in acquisitions and leverage the CooperSurgical structure.
CooperVision’s strategy is more complex and is much more global in nature. In the $6.8 billion soft contact lens industry, because of the uniqueness of our manufacturing platforms and product portfolio, we are the only participant that follows a complex strategy, which means we are the only company that promotes silicon hydrogel as well as non silicon hydrogel. That is, the Proclear family.
We emphasize branded as well as non-branded products, but private label does not translate to lower priced products. We actively promote and specialize in custom lenses, with a high gross profit margin of course. We support all modalities to the eye care professional. That is, one-day, two-week, as well as monthly lenses. And we support all types of lenses: Spheres, Torics, multifocals, and with close to 30% share in the specialty categories of Torics and multifocal, it is acknowledged that we’re pretty good at specialty lenses.
Few would challenge the success of Biofinity Toric for astigmatism. Put a great design together with a great material and great things can happen. We have seen early successes for the same reason with Biofinity Multifocal, which hit the market in the last fiscal quarter.
On the capacity front, with the exception of Avaira Toric, things are ahead of plan to deliver considerably more product where we’ve been supply-constrained. The Biofinity family, Proclear one-day, one-day Torics, are all ramping up nicely. So we are no longer supply-constrained in these areas.
On price, we, like the soft contact lens industry, have a trade-up strategy. Our new wearers and existing wearers are targeted for silicon hydrogel, the Proclear family, and one-day and single-use lenses. Each creates more revenue per wearer. The one-day modality, for example, results in three to five times more revenue per wearer.
While this strategy sacrifices the gross profit margin percent, it generally creates two to four times more profit per wearer. Of course, this strategy competes head on with the lens care space since we are shifting wearers’ resources from lens care to contact lenses.
In my opinion, we also are the one company that is the most focused currently in the industry, lacking many of the distractions that some of our competitors are going through. Now, I might add, that with Biofinity, Avaira, and Proclear, we have a lot to talk about with the eye care professionals around the globe.
Just a brief comment about some management changes. As previously announced, Gene Midlock, who has helped me take Cooper to the next level the past several years, will be turning over the reins at Cooper as CFO. Gene is not leaving Cooper, just taking more time to smell the roses or play more golf, if you will. He will continue to head up our global tax strategy and the tax department.
At Cooper we have invested a lot of energy in grooming our bench strength. I’m happy to announce that Greg Matz, who is currently our VP of Finance, and up until recently VP and CFO of vision, will be taking over for Gene. With an extensive knowledge of CooperVision, which is 85% of Cooper’s operations and our very active successor planning program here at Cooper, Greg is already very much up to speed for this new role.
I want to personally thank Gene for his hard work and dedication in getting us to where we are and welcome Greg to his new role, where he, I’m sure, will help continue to momentum. Al White, I might add, will continue his role as VP of investor relations, treasurer, as well as the company’s chief strategy officer, reporting directly to me.
In summary, before I turn it over to Gene for his swan song on solid results, fourth quarter ’11 continued our string of pleasant surprises. We again delivered on the top line gross profit percent, operating income margin, EPS, free cash flow, deleveraging and many value-enhancing projects like capacity expansion, geographic expansion, and tuck-in acquisitions.
Our silicon hydrogel family of products are doing well, up 39% in constant currency, exceeding $100 million this last quarter. We are pleased with our progress and our rollout of Biofinity into the $150 million silicon hydrogel multifocal market, 50% of the entire multifocal market, as well as our expansion in the $400 million Japanese silicon hydrogel market.
Our CooperSurgical tuck-in strategy has continued to execute well and exceed expectations. Few would question CooperSurgical’s ability to achieve synergy following these tuck-ins. In the middle of the so-called great recession, we again delivered impressive numbers with non-GAAP earnings per share of $1.46 in the fourth quarter, up 34%; free cash flow over $78 million, bringing our fiscal year free cash flow to over $232 million, and allowing us to delever to 60% debt-to-cap compared to 27% at the beginning of the fiscal year.
As always, I remind you, our people are our number-one asset. They delivered again. One of the key goals is to keep our employees healthy and productive, and here we have a very robust bonus program globally. Once again, we owe our employees a big thank you for all their great accomplishments as well as their loyalty to Cooper.
With that, I’ll turn it over to Gene, who will elaborate on our impressive results.
Thank you Bob. Good afternoon everyone. Thanks for joining us again. I’ll briefly highlight some of the financial results and profit and loss, as well as touch on some balance sheet items before we get to the Q&A.
I think revenue again is pretty well laid out in the press release as well as Bob’s comments, so I’ll start with gross margin. In Q4, GAAP gross margin was 62%, compared with 60% in Q4 last year. Non-GAAP gross margin was 63% versus 61% in Q4 last year.
For the full year, GAAP gross margin was 60% versus 58% in 2010, non-GAAP gross margin was 62% versus 60% last year. CooperVision reported a GAAP gross margin of 61% versus 59% in Q4 last year. On a non-GAAP basis gross margin was 63% versus 60% last year.
The increase was attributable mainly to manufacturing efficiency gains and favorable product mix with silicon hydrogel sales now representing 34% of revenue, up 41% from last year. Also, remember last year’s fourth quarter had a charge of $3.5 million for the closure of our Norfolk facility which we transferred the manufacturing to our existing plants in Puerto Rico and the UK.
CooperSurgical had a GAAP and non-GAAP gross profit margin of 65%, which is the same as it had last year in Q4. Again, this is due to manufacturing efficiencies and favorable product mix.
SG&A in Q4 on a GAAP basis, expenses increased by 18% from Q4 last year to $129.7 million, and were 36% of revenue versus 35% in Q4 last year. This is generally attributable to increased sales and marketing expenses, commissions, new hires, etc. associated with higher revenue and new product launches in addition to increased legal costs.
Non-GAAP SG&A was up 19% in Q4 of 2011 and was 36% of revenue, up from 35%. For the full year, GAAP SG&A increased by 16% to $503.1 million and increased to 38% of revenue from 37% last year. Non-GAAP SG&A increased by 17% and increased to 38% of revenue, up from 37% last year.
Turning to R&D expenses, in Q4 R&D increased by 12% from Q4 last year to $11.7 million and were 3% of revenue, the same as last year. This increase is attributable to additional staffing and costs associated with increased clinical trials for a variety of products. For the full year, R&D was up 24% and again was 3% of revenue.
As a result of the above, operating margin on a GAAP basis for Q4 was 18% of revenue, a decrease from 20% in Q4 last year. For the full year, operating margin was 17% of revenue, up from 16% in FY10. On a non-GAAP basis, operating margin was 23% of revenue, up from 21% in Q4 last year, and for the fiscal year operating margin was 20% versus 18% last year.
Interest expense was $2.9 million and was 64% lower than Q4 last year. This reflects the maintenance of a strong fund to debt EBITDA ratio, reduced borrowings, and lower interest rates. For the full year, interest expense was $17.3 million, a 53% decrease from FY10.
The effective tax rate on a GAAP basis in Q4 was 10% versus 10.5% last year. On a non-GAAP basis, the Q4 effective tax rate was 9% versus 14% last year. The tax rate decrease from Q4 last year was largely because of a shift of income to lower tax jurisdictions. As we’ve mentioned many times, we now have minimal manufacturing in the US, and most of it is now done in jurisdictions with lower tax rates, as well as decreased tax rate in certain non-US jurisdictions like UK, which is continued to lower its tax rate, now to 26%.
For the full year, GAAP effective tax rate was 9% and non-GAAP tax rate was 10%, and that’s consistent with our previously provided estimates. Guidance for 2012, which we’ll get into a little later, will be in the 10-12% range.
In Q4, depreciation was $20.7 million, including $800,000 of accelerated depreciation and amortization of $5.6 million, for a total of $26.3 million of noncash charges. For the full-year, depreciation was $77.5 million, amortization was $20.6 million, for a total of $98.1 million. In the fourth quarter we had a $1.6 million charge for stock option compensation.
Earnings per share were laid out pretty well in the press release. For Q4 we had $1.15 on a GAAP basis and $1.46 on a non-GAAP basis. As you’ll note, in the earnings release the main difference is attributable to the limited voluntary Sphere recall of $6.2 million, which is about $0.10, and the settlement of patent litigation of $10 million, which was approximately $0.21.
So you can model correctly for next year, the non-GAAP charges were $1.1 million of revenue, $4.9 million to cost of goods sold, opex of $10.2 million. For the full year, GAAP EPS was $3.63 and non-GAAP EPS was $4.50.
Turning to the balance sheet, As Bob indicated, we had $78.5 million of free cash flow for the quarter and $232.6 million for the full year. Total debt was reduced by $64.8 million to $380.4 million in the quarter, and debt as a percentage of capitalization is 16.4%, down from 19.1% in Q3.
At quarter end, the ratio of funded debt to EBITDA was 1.03, a decrease from 1.26 in Q3. Inventories increased slightly by $10.2 million from the last quarter, with 5.5 months on hand, up from 4.9 months on hand in Q3. And note, Q3 was artificially low because of the Avaira Toric recall.
Accounts receivable were also closely monitored, with DSOs at 55 days, same as last quarter, down from 57 days last year.
At this point, I’d like to turn it back over for the question and answer period.
[Operator instructions.] And your first question today comes from the line of Larry Keusch with Morgan Keegan.
Larry Keusch - Morgan Keegan
I just wanted to start off, perhaps you can help us understand a little bit about what you guys are assuming for the 2012 guidance. I’m sure that’s higher than a lot of people anticipated and I think people are just going to want to understand the assumptions that you guys are baking in there in terms of operating margins. It sounds like Avaira Toric you’re assuming will be back in the mix. Any color on that would be really helpful.
Obviously we came out real strong at the end of the fourth quarter, indicative of the fact that our franchise products, [unintelligible], exceeding $100 million in revenue for silicon hydrogel lenses in total for the quarter. And keep in mind that the monthly - as I’ve always said, when you look at gross margins, monthly is our area for high gross margins and high profits - so we’ve had a lot of our growth, which if you also reflect on the fact that foreign exchange weakened, therefore the amount of money we delivered in constant currency was a very robust quarter, very solid gross margins because of product mix.
We’re continuing to expect that Biofinity will continue to ramp up nicely. We have the capacity. So I guess I would credit, number one, why do we sound more bullish? Number one, this is the first time we have given guidance. Two, I’ve indicated we expected to grow earnings per share at double digit, in that range. The only area we’re taking a little money off the table, quite frankly, is we are investing, and will continue to invest, in sales force expansion, and we will continue, as we had indicated, we are going to go more aggressively into China in terms of making an investment there.
So the underlying assumption in our guidance is for investment in China, to a degree, and strong continuation of Biofinity, which has stellar operating profits, contributions, with it.
Your next question comes from the line of Jeff Johnson with Robert W. Baird.
Jeff Johnson - Robert W. Baird
Gene, just want to say good luck and congratulations on three good successful years here as CFO.
Jeff Johnson - Robert W. Baird
And Bob, question for you, just on the FDA front. Let me ask it in a three-part question, I guess, so it all fits as one question. But on the labeling and packaging warning letter, where’s the risk with this? It doesn’t sound like it’s product specific, but what could you imagine maybe spending on this? Is there risk, if it doesn’t get mitigated or resolved soon, that there could be any kind of products off the market, anything like that, number one?
Number two, with Puerto Rico having been successfully inspected, can you compare and contrast maybe the upcoming or the expected inspection of the UK what would be similar or different there, and is there a read through from Puerto Rico passing on how we should think about the UK?
And then just lastly, talking about Avaira Toric coming back in April. With the facility inspection done and successful, does that mean that you’re probably going to need a modified 510K? Is there something there that’s keeping it off the market until April?
Well, that is one long question. [laughter] I guess I don’t want to get too far into all of the details and tactics other than to say we obviously we were pleased with the outcome of no 483s in our two plants that have undergone that. And I’m not going to say we were pleased with the outcome in our distribution center, but if I said there’s good news, the good news is the distribution center, which doesn’t have all the technical nuances, clearly, that managing our plants do.
So, as I think we indicated, and I indicated in my comments, we think we’ve really had our arms around where we need to get to, both as to, if you will, addressing the FDA, where we’re working with them. It’s not like we’re battling them. We’re moving forward. There is a tie-in with obviously our expectation to get Avaira Toric back out onto the market. Yes, it does take a special, or some type of filing, 510K, and we expect at this point in time, that we’ll be able to get back on the market by mid-fiscal year.
So that is built into our assumptions, and keep in mind the plant in Puerto Rico makes both the Avaira Toric and all the high-volume Spheres, so the fact that we’ve been cleared on that side, that plant, and I don’t want to overstate what no comments means, relative to the regulatory process, but we factored where we think we are in the process into our guidance numbers and our expectation going forward.
I think beyond that I really don’t want to get into a lot of nuances dealing with the recall, emphasizing that Avaira Toric was less than 1% of our revenue. It doesn’t warrant as much time and airtime as it’s been getting. And recognizing that even Avaira Sphere, which continues on the market, we swapped out, that represented less than 1% of our overall revenue. That was the issue of the partial recall.
On the distribution side, I would just say, distribution side is packaging. If you can’t get that fixed, it’s kind of shame on you, so we’re not thinking we can’t be responsive at this juncture.
Your next question is from the line of Chris Cooley with Stephens.
Chris Cooley - Stephens Incorporated
Let me maybe just ask, as we think about the quarter and you look at the impressive gross margin expansion you had there, how much of that would you attribute to just what I was assuming was running those plants pretty much at capacity as you were building replacement stock, both in terms of Avaira Toric and also the Avaira Sphere. And are those inventories still at some level at risk? Just as we think about the recall process. That’s, I guess a two-part, one question. How about that?
Our plants are certainly running at much better capacity in 2011 than 2010. So we’re starting to see the benefits of the shutdown of Norfolk fully vetted through the quarter. Of course we started seeing that last quarter. We’re seeing the benefits of favorable mix. We think we’ve adequately reserved for those inventory lots that were part of the recall, if you will.
And the fact that we are continuing to make Avaira and ship Avaira, we’re just putting more demand on those units to beat back our inventory, if you will, that is taken out of the pipeline when we had a reserve in aggregate most of the 20 million third quarter and fourth quarter, the Toric and the Sphere. Most of everything we’re talking about is either inventory sitting in our plant or in the pipeline. So we wrote down a lot of inventory and that inventory also needs to be replaced. And when you think about idleness or absorption, then I don’t see that as a major drain going forward.
Your next question comes from the line of Matthew O'Brien with William Blair.
Matthew O'Brien - William Blair
I was hoping to just get a bit more color around the Avaira issues. I know it’s fairly early, since the Sphere expansion of the recall, but just any sense for anecdotal commentary around customers you may have lost because of these two recalls on top of each other? And then any sense for how many customers have actually just been switched over to Biofinity rather than back into a Sphere. And then how much time is this consuming of your sales force at this point?
Once again, I think we’re spending way too much time on 1% of our business. I will say, yes, there is strain on the sales force. There’s no doubt there’s some energy involved in switching out and explaining that. Most of that is right when the announcement happened. So we’ve taken a good chunk of that discussion. Your question about are we converting Avaira Toric to Biofinity Toric, the answer is very successfully so, yes. And that is a positive relative to certainly ARPs and gross margins, not a negative in that sense. That’s maybe the thin silver lining. And I don’t want to overstate the silver lining. But aside from that, we think we have our arms around where we’re going on the way forward.
Your next question is from the line of Larry Biegelsen with Wells Fargo.
Larry Biegelsen - Wells Fargo
Gene, could you give us a little more of the specifics around the P&L? I think Larry Keusch asked up front about the 2012 assumptions. Just some more specifics around the guidance assumptions? And Bob, why are you confident in 4-6% in 2012 for the contact lens market if the market slowed to 3%?
Specific on guidance. So revenue 4-8%, low to high obviously. Gross profit percentage, 62.5-63%. Opex 42-43. OI around 20-20.5. Interest expense 10-11. And effective tax rate, 10-12%.
And on assumptions on revenue, you’re correct. The market decelerated in one quarter to 3%. I think we’re all keenly aware that Europe is maybe taking its turn as far as softening. Could it be down to 3%, which was the worst year, 2009? I suppose, but do I believe it? I’m much more proponent of one quarter does not a trend make. And that’s why we put more weight on trailing 12 months than we do on the quarter. And the trailing 12 months is still 4.3%. And I’m not saying that’s stellar, but it’s in the middle of the great recession, as it’s called. I don’t think that’s all that bad.
I still remain optimistic that 4-6 going forward. I’m pleased with the life we’re seeing come out of Japan. I do think we’ll get more and more momentum in China and Asia. And I don’t think anyone really knows what Europe is going to be about, but the US has kind of held its own nicely. So I’m still a believer the 4-6% is a reasonable range and we’ve hit it pretty well the last four years. I don’t want to be too cavalier but it’s our best estimate.
Your next question is from the line of Joanne Wuensch with BMO Capital Markets.
Joanne Wuensch - BMO Capital Markets
Can you update us on how your view is changing, or may have changed, on acquisitions in women’s health? And as a secondary, could you tell us what else may be at risk in the UK given that the FDA has not gone through there yet?
Well, when it comes to our view on acquisitions in women’s health care, no change there. We’ve been successful, very successful, over the last 35 or so acquisitions we’ve done. Obviously we have the critical mass. We obviously have the balance sheet strength. And there’s no reason to think they can’t continue to handle one to two acquisitions a year. And they had two this past year that for all practical purposes and they’ve done a good chunk of what they plan to do already in those two acquisitions in terms of the integration process.
Relative to the third plant, I would say that the people that we have overseeing the manufacturing plants, and I’ll even add that we’ve kind of made a recent organizational change, unrelated to this in terms of overseeing not only manufacturing plants but also our distribution centers, at the senior level. I’m convinced they have their arms around it with a very solid quality assurance team as well as those running the plant.
So what I would say is an A+ relative to how they run the plant, I acknowledge the recall emanated out of there, we can debate that whole process and how that ever happened - and kind of like why are you in medical devices or healthcare at all? We know tough competitors of ours that are part of companies that have in excess of 40 recalls. So that’s just part of the nature of the beast of being in the healthcare arena.
I’m convinced that our people know what they’re doing when it comes to running plants, and good manufacturing processes. So I sleep well at night, generally.
Your next question is from the line of Anthony Patron with Jefferies.
Anthony Patron - Jefferies
Just one on the recall, going back to Avaira. If we look at prior conference calls that we’ve had and we’ve focused in on J&J’s recalls, the company had mentioned that that created opportunities for Cooper, and it seemed to come to fruition in the results. So how will the company go about stemming this the other way? Has there been any share losses? Not necessarily in this specific category, but in other categories. And last, on the 4-6%, what exactly is in there for the return of Avaira Toric by midyear?
You bring up a good point. I probably missed one of the earlier questions that was raised, on how the customers are dealing with it. I think there have been a number of those, including ourselves, that have gone out and sampled the attitude of our customers. We’ve done it. Others have done it.
And all I can say is I think we’ve done as professional a job as we can in dealing with our eye care professionals. Obviously they’re our bread and butter. We’ve taken care of them. A good many of them like the design of the products and have switched over from Avaira Toric to Biofinity.
So I would say there was a substantial amount of those that said, okay, I don’t have Avaira Toric available. I’ll switch over to Biofinity Toric as opposed to going the other way. Some did, in fact, go to Proclear, which is another good design. And yes, we did lose a small portion, and I emphasize a small portion, of where the Toric wearer went.
Relative to the Sphere, well, it never really came off the market. We swapped it out. We do have the capacity. So that was less problematic. There were no substantial time delays in getting them swapped. So as a result of that, and keeping the customers fully informed along the way, I think we’ve done a good job of preserving the franchise with minimal damage.
This product, [unintelligible] Avaira Toric, was less than 1% of our revenue and had just been launched. So it wasn’t like it had a substantial amount of wearer base out there that you then had a lot of challenges to deal with. So that minimized it.
How much is built into the 4-6% guidance? Of course that’s the market. We’re more like 6% midpoint for our guidance, 4-8%. And from the point of view of Avaira Toric, it was insignificant last year. It’s insignificant in any guidance in 2012. At the upper end of guidance, it’s in. At the lower end of guidance, it’s not in.
Your next question is from the line of Kim Gailun with JPMorgan.
Kim Gailun - JPMorgan
Just a quick question on the use of cash in 2012. You talked a little bit about the acquisition strategy in women’s health, but could you also touch on your plans in terms of debt paydown and maybe at what point a share buyback might make sense for Cooper? And the follow on to that one is just you’ve got your free cash flow guidance for next year, which implies a number that’s kind of flat to a bit down versus this year. So maybe talk a little bit about what the drivers of those assumptions are.
Use of cash. We will continue to be active in looking at acquisitions, both women’s healthcare as well as contact lenses, and particularly geographic expansion. In the absence of that, we will continue to pay down that and we still have $380 million of debt on our balance sheet. So we haven’t run out of debt to pay off.
Buybacks are a function of what other uses do you have of cash that you have on your radar. I would say we’re mindful of buybacks. We’re mindful that at times they’re popular and we would obviously keep our mind open as we look at our cash needs going forward.
In terms of free cash flow, the upper end of the range is $230 million, flat with this last year. Probably some things to factor in your thinking is the settlement, for example, of $10 million hits our P&L in 2011, but is a cash use in 2012. So we have a few things like that. But nothing major.
We are also assuming in 2012 that we’re spending more on capex than we did in 2011. In 2011, a little over $100 million. 2012 might be more in the $120-140 million range. So the underlying assumption is being more aggressive in the capital use area, and I think that probably covers it.
Your next question is from the line of Steve Willoughby with Cleveland Research.
Steve Willoughby - Cleveland Research
Just on internal growth this quarter, I was wondering if you could separate out how much was IME and then talk about the third quarter calendar internal growth for the company of 5% versus the third quarter fiscal that you guys reported of 11%.
The 11% includes about 3% for IME. [unintelligible] more like 8. The 5% for the calendar quarter is actually 5.4% and so when I mentioned that we grew almost 2 times to market - down to a decimal the market was 2.8, we were 5.4. We were about 1.9 times the market in the calendar quarter. We did finish strong. Biofinity, in October, which is off the calendar quarter, was a solid month for Biofinity, and the continued rollout of some of our products. So in that sense the delta between the 5.4% and the 8% for the fiscal quarter, which is the organic constant currency, CooperVision for the fiscal quarter is some to do with that, the [unintelligible].
Your next question is from the line of Amit Bhalla with Citi.
Adam - Citigroup
Hi, this is Adam in for Amit. I just want to go back to guidance really quick. So I believe on the last quarter’s earnings call that you had said you expected low double-digit earnings growth in 2012, and the midpoint of your guidance is right at 9%. I was wondering if you could talk about that. And maybe the comment that you had made on outgrowing the market growth of 4-6% on top line growth, even though the midpoint is at 6. So are you assuming very minimal beat on the market for next year?
That would translate. If you took the mid, 4-6, that’s five. And you take our mid, 4-8, that’s six. So we’re basically saying we are going to continue to gain market share. We are not in guidance at all assuming we continue to grow at close to 2X the market. In trailing 12 months growth we were at 1.75 the market. So let’s say we’re assuming less robust market share gains, but continuing market share gains. As far as the bottom line is concerned, I said we would grow double digits. Obviously the earnings, and a lot of the assumptions at that point in time was more in and around 420, 425 as opposed to 450, so we’re basically taking a lot of that phenomenal strength in the fourth quarter into next year but the combination of that factor, you’re off of a much higher base, number one. And number two, I mentioned briefly that we’re investing in China. We plan on investing several millions of dollars. We’ll put some weight on opex that will grow next year as well as the bottom line. That is kind of one where there is an element of discretionary about that. The stronger we are on the top line the probably more aggressive we will invest along those lines and in fact that will weight down some of our - it could be - the good news is we grew faster on the top line. The bad news is our operating ratios are a little less because we invest more. It’s that type of thing where we’re going to pay attention to where we are, because we are mindful of our commitment toward the bottom line but we’re also pretty aggressive in our desire to continue to spend money on those things we think have good long term total shareholder return. So we think China does long term, we certainly think sales force expansion does long term. So I think that will probably give you enough color on why a little [unintelligible] the mid of our range a little less than 10%.
Your next question is a follow up question from the line of Larry Biegelsen.
Larry Biegelsen - Wells Fargo
[audio dropped out] I think that’s what it was in the past. And then just any feedback on Ciba’s DAILIES TOTAL1 launch in Europe?
It’s probably a little less than $10 million. More in the $4-6 million range as a starting in. But quite frankly, and quite honestly, we’re not going to start spending too much until we get some key positions in place, so some of it will be a function of our ability to hire and find the right people. So I’ll be a little - [unintelligible] from Missouri whether or not, even if we tried to spend $10 million, we could spend that much intelligently. So it’s not a fire drill. We’ll do it as we can and as it is prudent. So that’s there, and I think it’s more like $4-6 million than it is $10 million. And what’s built into guidance and the range we gave you, more at midpoint, ballpark around $5 million.
As far as the Ciba dailies, if you see it let me know. I haven’t seen it and quite frankly silicon hydrogel dailies, if we look at the US, I don’t quote HPR data, Health Products Research, too often. It gets into on eye. And if that’s any indication, the on eye experience of silicon hydrogel dailies in the US weakened in the third quarter versus the second quarter, that didn’t look like a growth story to me. And I will continue to be a skeptic on how fast silicon hydrogel dailies will make it. It will, ultimately, if we’re talking 10 years down the road, but I have a feeling most people are not asking questions, what it’s going to be like, in 2022. So more in the next several years. There will be a place for silicon hydrogel dailies, but it will be more nichy than it will be dominant.
Your next question is a follow up question from the line of Jeff Johnson.
Jeff Johnson - Robert W. Baird
Hey Bob, just a couple other questions on the daily comments you just made, and silicone. Can you tell us, or give us an update, on just kind of penetration rates on daily disposables in the US? Are you continuing to see those move up a little bit? And then from a guidance standpoint, on the revenue side, you come up against easier comps in the first half of the year relative to the second half. But you have some potential, building launches, and that could help more in the second half than the first. So how do we think about revenue dating throughout the year? Should we see it relatively level loaded from a growth standpoint? Or is the first half going to be faster than the second half? How do you think of that?
On revenue, I would say pretty much even over the year. And the reason I say that, because you’re going to have the first six months more to do with the recall related activities and ramping back up and getting back out into the market. So I would normally say you’re right, easier comps first six than the back six. Currency will play a little, particularly in the third quarter.
Next year will be a tougher comp because the dollar was pretty weak in the third quarter and everyone else’s currency was pretty strong in the third quarter. So that will play a little into it, but overall currency next year is pretty much a wash, maybe 1%, based on current rates. Now, we don’t get into, in our guidance we do not assume future rate changes. They’re set where we are today. We don’t get into the betting game.
As far as silicon hydrogel one-day in the US, I mentioned that the fits, both at HPR, health products research, did not increase during the quarter. They decreased. It was already a small part of the US market. So there’s no evidence right now that it, silicon hydrogel, is going anywhere in the US. When it comes to overall single-use lenses, they continue to do very well, both in the US. And that’s probably the one that’s really driving the global growth as much as anything now, is the US market has tremendous potential yet for trading up. And keep in mind the trading up, when it comes to single use, is still 3-5 times more revenue.
So as an industry we like it, particularly because we make a lot of money in that venue of trading up. We do take money away from lens care companies that obviously, if you go to the store and buy lens care products you know how much they charge for a bottle. I know how much they charge for a bottle. Anyway, I’m happy to take the money off the retail store and put it in the eye care professional’s pocket.
With that, I think we’ve probably concluded our hour, and I look forward to updating you again in March when we finish our first quarter. I wish everyone a happy new year, and hopefully you’ll enjoy our numbers. Thank you.
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