The Cooper Companies Inc. (NYSE:COO)
F1Q2012 Earnings Conference Call
March 8, 2012 5:00 PM ET
Kim Duncan – Director of Investor Relations
Bob Weiss – President and Chief Executive Officer
Greg Matz – Vice President and Chief Financial Officer
Larry Keusch – Morgan Keegan
Jeff Johnson – Robert W. Baird
Steve Willoughby – Cleveland Research
Chris Cooley – Stephens
Matthew O’Brien – William Blair
Larry Biegelsen – Wells Fargo
Kim Gailun – JP Morgan
Joanne Wuensch – BMO Capital Market
Amit Bhalla – Citi
Good day ladies and gentlemen and welcome to the first quarter 2012 The Cooper Companies Incorporated earnings conference call. My name is Regina and I will be your conference operator for today. At this time all participants on the phone line are in a listen-only mode. Later, we will be conducting a question-and-answer session. (Operator Instructions) Today’s event is being recorded for replay purposes.
I would now like to turn the conference over to your host for today Ms. Kim Duncan, Senior Director of Investor Relations. Please go ahead ma’am.
Good afternoon and welcome to The Cooper Companies' first quarter 2012 earnings conference call. I'm Kim Duncan, Senior Director of Investor Relations, and joining me on today's call are Bob Weiss, President and Chief Executive Officer; Greg Matz, 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 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 conditions and integration of any acquisitions.
Forward-looking statements 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 on the quarter, followed by Greg who will then discuss first quarter 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 yourselves to one question. Should you have any additional questions, please call our Investor line at 925-460-3663 or email firstname.lastname@example.org. 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. Good afternoon, good evening everyone. After a successful 2011 we started 2012 out strong. Our Biofinity and Proclear momentum continued for the first quarter of 2012 we put up solid top line growth plus 11% also in constant currency. We delivered $326 million in revenue, our gross profit margin achieved 65% with the strong top line, solid margins, lower interest expense non-GAAP earnings per share was up 32% to $1.12, 35% on a GAAP basis.
The soft contact lens market rebounded in calendar year fourth quarter to 5% growth to provision at 7%. Key takeaways from today’s call we again put up great results with strong revenue growth, good margins, favorable impact from lowering interest expense with solid bottom line. Biofinity global rollout continues with Biofinity Sphere in Japan and Biofinity Multifocal in the United States and Europe. This work horse sealed 40% constant currency growth in our silicone hydrogel family Biofinity and Avaira.
During the quarter, given the strength of our balance sheet and free cash flow $200 million on an annualized basis we announced the share repurchase program of up to $150 million. We in fact executed on part of the plan buying 666,000 shares for $46 million in a transaction that was $0.01 accretive for the quarter and will be $0.05 accretive for the fiscal year. While we continue to put up solid results and free cash flow we continue to invest. Our sales force expansion, marketing and R&D expenses are up in the 17% to 18% range.
For competitive reasons, we won’t give the exact numbers, but our sales force expansion is 22% in the past 15 months and overall 36% in the past two and a quarter year. During the same two and a quarter year period our G&A headcount is up only 11% so we are leveraging what we need to leverage. There were no callouts GAAP numbers equal non-GAAP numbers for the quarter.
Nothing major with the FDA on Avaira Toric, we have ongoing dialogue with them and still hoping to relaunch our Avaira Toric beyond April of this year. We made the decision to launch a single use single silicon hydrogel this year and will be began manufacturing shortly. For competitive reasons I won’t provide any more at this time.
Our silicon hydrogel family is driving our growth. During the first quarter the family achieved $87 million in revenues that equates to 40% constant currency increase versus the prior year. Silicon hydrogel is now 32% of our CDI revenues. We continue to feel positive about future of our silicon hydrogel sales driven by multiple factors this includes success of Biofinity Multifocal launch and $150 million silicon hydrogel multifocal market and the launch of Biofinity Sphere in Japan’s $400 million silicon hydrogel market.
While we are early in both the successes are obvious. We continue to manufacture the Avaira Toric product and are hoping for the April relaunch as I indicated. Once this happens we will be lot more aggressive with our Avaira family in the two week space, which is dominated by J&J. But back to Biofinity the shear strength of this family of monthly silicon hydrogel Spheres, Torics and Multifocal remains a source of pride. Biofinity has a long way to go before fully exploiting here on a global basis that’s in terms of years. It is and remains prior calling card of our expanding CooperVision sales force.
Geographically, foreign exchange movements have netted out during the most recent quarter while CooperVision revenue, for CooperVision Inc revenue growth was 10% actual and 10% constant currency. Regionally we had solid results in constant currency with Americas up 11%, Europe up 7%, Asia Pac up 13% and overall once again constant currency 10%.
Our growth drivers were in the Americas trading up to silicon hydrogel including the success of Biofinity Multifocal, as well as solid performance in the 1 Day category by Proclear 1 Day Sphere. In Europe, essential the same thing trading up to silicon hydrogel including Biofinity Multifocal as well as Proclear 1 Day Sphere. And in Asia Pac success reflects the growth of silicon hydrogel primarily or particularly the Biofinity Sphere in Japan as we as the Proclear 1 Day Sphere throughout the region.
The soft contact lens market was up 5% while CooperVision was up 7% during the most recent quarter. This brings the full calendar year in at 4% for the market while Cooper on the strength of silicon hydrogel and Proclear 1 Day grew 7%, 1.5 times to the market.
For the calendar year the market growth was in silicon hydrogel 1 Day or in silicon hydrogel 1 Day or single use lenses as well as specialty lenses, Torics and Multifocal. Remember in more established regions of the world the market is a trade up market. We trade you up to silicon hydrogel, which is roughly 20% to 40% trade up and trading you up into 1 Days, which at the manufacturer level is roughly 4 to 6 times the amount of average revenue per wear at the manufacturer level.
Worldwide Torics and Multifocal lenses continue to grow solidly. These are much less penetrated typically outside of the U.S. geographically each region had a respectable year with the Americas and Asia delivering 4% growth while Europe rounded up to 5%.
CooperSurgical our women’s healthcare franchise had another greater quarter with $57 million in revenue it was up 15%, 9% excluding acquisitions. Drivers continue to be surgical procedures, hospital and same day surgery where revenue was up 24% and now accounts for 40% of CooperSurgical.
Devices used by the gynecologist during laparoscopic procedures such as closure systems retractors; injectors, uterine manipulator and related trade are driving the growth in this area. Importantly, these are high margin items and CooperSurgical’s overall gross margin percent during the quarter was a very impressive 67%, while its operating income hit 27%. To say we are pleased and proud of our CooperSurgical franchise would be an understatement. We will continue to look for the ways to leverage franchise both in the United States as well through geographic expansion.
Importantly CooperSurgical is an integral part of our global tax structure it allows us the luxury of continuing to report and pay at a low effective tax rate. Without it we disrupt our global tax balance, which to us in keeping with our objective to maximize total shareholder returns or PSR is strategic. Simply put any money that goes to the government is not available for reinvestment or to pay dividends.
We generated, we are generally sticking to our guidance range except for the increase in earnings per share guidance. As Greg will get into further, we delivered strong results in Q1 with a favorable tax settlement outcome offsetting some negative cost associated with the Avaira recall. These costs impacted sales and operating expenses. Strong bottom line results in Q1 and the accretive effect of our stock buyback are contributing to the overall improvement in our earnings per share guidance.
Our guidance to soon stable foreign exchange rates, the ongoing investment in sales force, R&D and geographic expansion. We also anticipate some drag on our gross and operating margins as we accelerate investments in China and other developing countries and launch single use silicon hydrogel and re-launch Avaira Toric later in the fiscal year.
On strategy we are continuing with our successful strategy. We believe it is solid and it has delivered results. CooperSurgical is putting up outstanding results and its leveraging its infrastructure. This franchise was built on a solid understanding of the value of critical mass and in women’s healthcare market targeting the OB/GYN. We follow the profession wherever they go office, surgery center, hospital or IVS Centers. Although the call points are different for each the leverage is considerable.
CooperSurgical’s Q1 ’12 gross margin was 67%, our operating margin 27% and due to minimal CapEx CooperSurgical is a significant contributor to free cash flow. We are dedicated to this strategy and we will continue talking acquisitions to leverage the CooperSurgical infrastructure.
At CooperVision the strategy is more complex and it’s much more global in nature. And the $6.9 billion soft contact lens industry because of the uniqueness of our manufacturing platforms and product portfolio, we are the only participant that promotes both silicon hydrogel and non-silicon hydrogel that is the Proclear family. We emphasize branded and non-branded products. But private label does not mean lower gross margin or low price.
Actively we promote both special, actively we promote and specialize in custom lenses it’s a high gross profit of course. We support all modalities that the eye care profession prescribes 1 Day, two week and monthly lenses and we support all types of lenses Spheres, Torics and Multifocals. We are close to 30% in high growth specialty lens categories Torics and Multifocals. It is acknowledged by the eye care professional that we are pretty good at specialty contact lenses.
Few would challenge why the success of Biofinity Toric for astigmatism. Put a great design together with a great material and great things can happen. We've seen early successes for the same reason with Biofinity Multifocal, which hit the market in the middle of last year.
On the capacity front, with the exception of Avaira Toric, we are ahead of plan to deliver considerably more products, where we have previously been supply constrained. The Biofinity family, Proclear 1 Day, our 1 Day Torics are all ramping up nicely. On pricing, we like the rest of the soft contact lens industry have a trade of strategy. Our new wears and existing wears are targeted for silicone hydrogel and Proclear family and the 1 Day or single use lenses each creates more revenue per patient.
The 1 Day modality, for example, results in four to six times more revenue per wearer. While this strategy sacrifices the gross margin percent. It generally creates three to five 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 only. Competing for lens care dollars is more of a problem for some of our competitors.
In my opinion we needed to be the most focused company in the industry lacking many of the distractions that all of our competitors are now going through. I might add with Biofinity, Avaira and Proclear, we have a lot to talk about with our eye care professionals around the globe.
As we look down the road the next several years we expect to continue improving operating margins and delivering above average TSRs. We expect to continue to deliver double digit earnings per share growth while investing in geographic expansion, sales force expansion and new product development. In today’s market, we have a solid product portfolio to leverage in all modalities multiple materials, all lens types and we retain our expertise to emphasize custom lens for the 10% to 20% of lens wearers, who require other than standard lenses and a more unique sizes and designs.
We have a lot of work to do before we come close to having exploited our number one contact lens family Biofinity. This is particularly true when it comes to geographic expansion and fully developing its family of Torics and Multifocals around the world. The same applies to Avaira where Avaira Sphere thanks for your waiting the re-launch of Avaira Toric. The combination will put us in much better position to exploit the U.S. two week space owned by J&J and to also exploit our private label strategy more aggressively with this family.
While we are already pretty respectable when it comes to gross margins and operating income margins from a cost perspective, we have considerable upside yet to be fully developed. Upsides include the elimination of silicon hydrogel royalty in September 2012 I’m sorry 2014 in the U.S. and March 2016 in the rest of the world. The reduction of our manufacturing costs by getting alcohol and our silicon hydrogel production, improving molding cycle times, increasing capacity utilization and improving yields in general.
Given the considerable amount of free cash flow we generate we will continue to look for tuck in acquisitions in geographic expansion opportunities. In our two businesses that exceed our hurdle rates. Given the fact that the markets for women’s healthcare and soft contact lenses are so much less developed outside U.S. and we generate a considerable amount of cash outside the U.S. due in part to our level manufacturing outside the U.S. We will continue to aggressive invest in global expansion opportunities. With over 95% of the people on the planet outside of the United States we believe we will find opportunities to invest, there for decades to come thereby retaining our lower effective tax rate and definitely. And as was the case in the past quarter where the stock was suppressed we even demonstrated we are willing to buy in some of our own stock at times.
In summary, before I turn it over to Greg the first quarter 2012 got us off on the right foot. We are having another in a string successful fiscal years in 2012. We again deliver the solid top line gross profit percent, operating income percent, earnings per share, free cash flow and even a stock buyback to enhance total shareholder returns. Our silicon hydrogel family even in the middle of a recall continues to perform delivering 40% constant currency growth above already respectable prior year comparisons.
While we accomplished a lot we have a long way to go before we fully exploit our silicon hydrogel family and our excellent 1 Day Proclear 1 Day. Japan’s silicon hydrogel market breaks geographical expansion a large rapidly growing silicon hydrogel multifocal market, a royalty expiration starting in 2014 a very leverage able CooperSurgical with ongoing tuck in opportunities and many, many more global opportunity signaled we have many opportunities to grow our opening business and maximize TSR. Whether the soft contact lens market accelerate 6% to 8% range or pumps along at 4% to 5% we clearly see the opportunity.
Finally, I remind you our people are our number one asset. They have continued to deliver as a quality of life company. We remain focused on keeping our employees and their family healthy and productive. To them once again I say thank you for all that they’ve done and continue to do with that I will turn it over to Greg.
Okay, thanks Bob and good afternoon everyone. Bob has given you a pretty thorough view of our revenue picture so let me start with gross margin. But before I go there I want to provide some color on the Avaira recall expenses in Q1. By the end of Q4 we had accrued for about $20million of recall cost.
In Q1 we had an additional $2.9 million and what we consider operational cost directly related to the recall, which were split about roughly equally between revenue for things like customer concessions and operating expenses for things like reviewing all Avaira Sphere fitting sets. To ensure that there were no lenses impacted by the recall in the fitting set.
At this point we believe the majority of the costs are behind us but we expect we could have some small charges paid over time and so we have Avaira Toric back in the market. Now looking at gross margins, in Q1, the consolidated GAAP and non-GAAP gross margins for 64.5% compared with 60.2% and 60.9% respectively for Q1 last year.
CooperSurgical had a GAAP and non-GAAP gross profit margin of 67%, which compares to Q1 ’11 64%, this improvement was mainly due to manufacturing efficiencies and favorable product mix especially in our surgical space. Products like closure systems and uterine manipulators to name a couple have done well and they also have better than average gross margins.
CooperVision reported a GAAP gross margin of 64% versus 59.5% in Q1 last year. On a non-GAAP basis gross margin was again 64% versus 60% in Q1 last year. As you can see we had a strong gross margin quarter. The increase was attributable to many different components like the completion of our Norfolk closure effective last year, which contributed over one percentage point or roughly about 120 basis points to 130 basis points to our gross margin. In addition, we had favorable product mix with silicon hydrogel sales now representing 32% of revenue up 39% from last year, up 40% on a constant currency basis.
We also had lower idle costs and favorable manufacturing variances carrying forward into Q1 from last year reflective of our inventory terms. All this being said and looking at the reminder of the year, we believe that our gross margins will be lower than Q1 due to several factors starting with the increased (Inaudible) cost related to modification of some of our production processes related to the recall. In addition, the anticipated relaunch of Avaira Toric startup cost with the new Biofinity line in Puerto Rico coming up in early Q3 and the introduction of a single use silicon lens will also impact gross margins.
We see these latter events as possible for our business in the long-term and as typical it will be drag on margins for manufacturing efficiency type variances in the earlier period. Two, further build on the single use silicon lens our experience is that new material or derivatives of material always plays a steep cost curve as we start production. High volume lines or products that utilize high volume lines are the most susceptible. Our first single use silicon hydrogel is no exception and we expect to be in a situation of higher cost in the short-term as we ramp up production. For these reasons we are staying with our previous gross margin guidance of 62.5% to 63% range for the year.
Now looking at operating expenses, SG&A in Q1 on a GAAP basis SG&A expenses increased by 16% from Q1 last year to $131.7 million and were 40% of revenue versus 39% in Q1 last year. This is generally attributable to the added investment we’ve been discussing over the last year, which has resulted in increased sales and marketing expenses for commissions, new hires associated with generating higher revenue and expenses for new product launches.
We have seen increased selling investment both CooperVision as well as CooperSurgical. Last year we highlighted that we would be investing that investment really did not ramp up until the March April timeframe, which when you look year-over-year leads to some higher expense growth rate. So with our growth rate and SG&A and R&D we will see a run rate impact on spending.
On the R&D front, we have talked about investing in our business and R&D is one of those areas where we continue to make investment. In Q1 on a GAAP basis R&D increased by 17% year-over-year to $11.4 million and it was 3.5% of revenue, up slightly from 3.3% in Q1 ’11. This increase is mainly attributable to adding staffing in both businesses.
Moving to operating margins, just a reminder we adjusted Q1 2011 for the $6.1 million gain on settlement for pre existing relationship related to the IME acquisition we originally recorded it in Q1 ’11 and reverse in Q3 ’11. If your models are based on non-GAAP there should be no change but if you are using GAAP be aware of the change from last year’s Q1 financial statements. And if you need more information on that you can refer to Form 10-K and Note 14 of our financial statements for 2011.
On a GAAP and a non-GAAP basis for Q1 consolidated operating income and margin were $61.7 million or 19% of revenue versus $48.7 million or 17% of revenue in Q1 ’11 on a GAAP basis and then in Q1 ’11 on a non-GAAP basis operating income was $50.8 million or 17% of revenue. This represents 27% and a 21% increase in operating income over Q1 ’11 GAAP and non-GAAP respectively.
Couple of points for your models if you are looking below operating income you will see another income we had roughly 700k of income approximately 200k related to an FX gain compared to a 700k loss last year. And the reminders related to a gain on sale for an investment, which we picked up this part with the IME acquisition last year.
Interest expense that was $3.7 million was $3.3 million or 47% lower than Q1 last year. This reflects reduced borrowings and lower interest rates resulting from refinancing and the redemption of the senior debt beginning in Q2 ’11. Included in Q1 was additional interest expense associated with repurchasing shares and some non-recurring operational discrete items we expect interest expense in the $12 million to $14 million range for the year.
Move on to effective tax rate on a GAAP and non-GAAP basis in Q1 the effective tax rate was 7% versus Q1 ’11 GAAP of 4.4%, non-GAAP of 6.7%. As we’ve discussed in the past the effective tax rate continues to be below the U.S. statutory rate as majority of our income is earned in foreign jurisdictions with lower tax rates. This also continues the trend of income earned in foreign jurisdictions increasing as a percent of the total as compared to income earned in the U.S. In addition, we are seeing some foreign jurisdictions dropping their rates.
The Q1 effective tax rate was lower than our 10% to 12% annual guidance mainly due to a settlement with the IRS, which resulted in the release of certain reserves and the cash ban of approximately $50,000. It would not be appropriate to gain any specific details to settlement that we now believe that an effective tax rate in the lower part of our full year guidance, which was 10% to 12%.
Depreciation and amortization, in Q1 depreciation was $20.2 million up 11% year-over-year and amortization was $5.6 million up 18% year-over-year for a total of $25.8 million. I know we have not generally talked about amortization expense but amortization expense increased to reflect the increase in amortization of intangibles on several deals we completed last year. For those interested in the stock comp number Q1 stock comp was $7.3 million.
Earnings per share as Bob mentioned in Q1 earnings per share was $1.12 on a GAAP basis and non-GAAP basis versus $0.83 and $0.85 respectively in Q1 ’11. Favorably impacting our current quarterly EPS is our share repurchases program and our settlement of the IRS tax case. As previously discussed in prior earnings call, the Internal Revenue Service issued a note of deficiency to the company on April 1, 2011.
It disserted that the company was subject to additional taxes for 2005 under the anti-deferral provisions of Subpart F of the Internal Revenue Code. In January, we solved the matter and agreed to a net efficiency of $50,000 as mentioned above. Due to the settlement of the tax case we will release certain reserves, which were largely offset by the additional and bearer recall cost I mentioned a few minutes ago.
On December 15, 2011 we announced that the company’s Board of Directors had authorized a share repurchase program of up to $150 million. As of the end of the quarter the company purchased approximately 663,000 shares of the company’s common stock for $46.1 million at an average purchase price of $69.60 per share. This had if you round up about a $0.01 impact in the quarter and we expect the impact of the year to be above $0.05.
Now looking at the balance sheet and liquidity in Q1 we had cash provided by operations of $41.6 million, capital expenditures of $20 million, insurance recovery of $1.6 million, which resulted in a $23.2 million of free cash flow. The two major items impacting free cash flow from our perspective was the one-time $10 million payment for the Rembrandt settlement we talked about at Q4 ’11 and an increase in inventory in the quarter of about $19 million.
Avaira Toric makes up about 40% of that inventory increase as we rebuild our stock in anticipation of a re-launch in the future. Insurance settlement relates to an October 28 incident in which a pipe broke in our fire suppression sprinkler system causing water and fire damaging in part of one of our manufacturing buildings in the UK. This incident did not have an impact on customers.
Total debt increase by $29.9 million to $410 million. Debt as a percentage of capitalization is now 17.5% up from 16.4% in Q4 and down from 26% in Q1 ’11 this leaves us with approximately $600 million of total credit available. AR continues to be closely monitored with DSO at 59 days down from 61 days last year.
With that let me turn it back to Kim for the Q&A session.
Operator, we are ready to open up the call for questions.
(Operator Instructions) and your first question today comes from the line of Larry Keusch with Morgan Keegan.
Larry Keusch – Morgan Keegan
Hi, good afternoon. Thanks for all the detail. Just if I’m looking at the numbers correctly growth in your single use lenses in the fourth quarter was about 8% and then the market grew 11%. Someone or if you could just talk a little bit again about your strategy there and what you can do to accelerate the growth there to have these market rates if not greater.
Yeah, Larry well we it’s that we are a little wider in the fourth quarter when you look at it from a first fiscal quarter basis we were up 10%, 14% all up 10% constant currency. So I think a lot of it is we continue to do well with our Proclear 1 Day, we are as I indicated credit coming out with the silicon hydrogel 1 Day not that I think that the it’s moved much beyond the little niche.
But I think that’s fact is just joining and being a participant with the crowd so to speak. I still think that Proclear 1 Day will be the driver of our global business and reasonably hold its tone out in the marketplace not only in Japan where it’s done well but also in the U.S. where, you see J&J is putting a lot their energy to develop that market. We are of course going to (Inaudible) of their work and as they expand that market right now. It doesn’t take too many wearers to move the needle quite a bit from a dollar point of view in that market and U.S. comes around 10% or 11% a couple of years to 17%, 18% now. So they are clearly helping that. Next question?
Your next question is from the line of Jeff Johnson with Robert W. Baird.
Jeff Johnson – Robert W. Baird
Thanks good evening guys. Bob, I just wanted to ask a question on the gross margin guidance at 62.5% the low end of your guidance for the year. It looks like you are implying kind of flat to maybe even down a little bit over the past three quarters of the year related to last year, which just I hear what you are saying on some of the expenses. But if you could flush that out or flush that out a little bit it just sounds a little bit hard to believe at this point. And then Greg just a very quick question on the reversal and the tax rate what your comments meant to me there was about a $2.5 million reversal in the tax rate in the quarter. Thanks.
I will comment first and I will let Greg amplify both gross margin and then his part on the taxes. You are right we came in with a very solid gross margin to provision was 64%, compared to a year ago 59.5% that shows better the value of Norfolk, which is ongoing of course, the value, one of the real catalyst of our gross margin is mix in fact that literally our growth is being sponsored by Biofinity we suppose is the high gross margin.
So importantly as we get back into the two week market more robustly that doesn’t have the same theme if you will as Biofinity it’s not going to have the margin. But I think the startup cost associated with getting into the relaunching Avaira Toric as well as startup cost of answering the 1 Day silicon hydrogel market, which from the get go is not going to be much of a gross margin to talk about at all. And as I think Greg alluded enough to the fact that you do start off a very steep curve in terms of high cost and then you work it down over a period of literally years.
That’s the fact he did mention that we are now going to go through a startup phase or Biofinity in Puerto Rica so we have basically given the size of that product have decided to bite the bullet and go through a startup. It’s at a remote location compared to where all our other Biofinity is made, so there will be a cost on that. Those costs will be directly impacting the next three quarters. So I think what I will let Greg ask or clarify anything else and then respond on the tax side.
Well Bob, I think you’ve got the gross margin I think that makes sense on the tax side we don’t get to lie the detail I think you can really back into it based on the comments we mentioned earlier about Avaira and an offset between a likely offset between Avaira and the tax impact.
Operator, next question.
Your next question is from the line of Steve Willoughby with Cleveland Research.
Steve Willoughby – Cleveland Research
Hi thanks for taking the question. Bob I was wondering if you could give us a little bit more color regarding the FDA and the FDA going through your various facilities. And the letter you received last quarter, just kind of any other color you can provide us regarding your discussions with the FDA.
Probably can’t give you too much more than I said that we are going through a process with the FDA responding to your questions. No, well it’s tough to say there is not reply we are cooperating with them we are getting through their questions and at this juncture we still expect to re-launch Avaira Toric in April. But of course that is totally depended on whether or not the FDA has any further questions.
On the warning letter we are responding to the observations made by the FDA making good progress there. I think they are waiting on us to say we are complete with all the corrections, which is going to take several more months and at that point in time they will come back in and re-inspect. So that is down the road several more months. Relative to the FDA showing up in the UK plant you may recall they came into our plant in Puerto Rico there were no observations.
They came into our plant in Scottsville no observations and they have not been in our plant recently in or since the recall anyway in the UK. They have made no indication that they have eminent plans they will show up when they want to show up, it is to our expectation that they will show up eventually. So when it happens it happens. Beyond that we are marching forward with Avaira Sphere and anxiously waiting to get Avaira Toric back out on the market. Next question?
Your next question is from the line of Chris Cooley with Stephens.
Chris Cooley – Stephens
Thank you and good evening. Thanks for taking my questions. Hope you guys done a great job with CooperSurgical and consistently delivering good growth and margin expansion when you look at that franchise now is this, the new normal for profitability. And when do we start to see some, I guess some further development there on a little more global basis meaning how long could you provide that would be helpful? Thanks.
Yes Chris, we are very pleased with where we are with CooperSurgical. You know I think I would point out that if we aggressively go globally the margins that we are accustomed to seeing in the U.S. 67% gross margin, the 27% operating margin that we’ve now gotten to we will put some pressure on that that will be an investment. And I think obviously with the product portfolio we now have more like 600 products many of which have potential outside the U.S.
It is worth exploiting that we initiated activity last year I would say where we are in Europe is slow going mixed results, clearly not a wild factor at this juncture. But it is early in that cycle. I think one of the ways that we would against the ball with CooperSurgical with the acquisitions that are outside the U.S. and I would hope that over the several years we at least at that ball by having some of those to continue to leverage where we are with the franchise. Next question?
Your next question comes from the line of Matthew O’Brien.
Matthew O’Brien – William Blair
Good afternoon. Thanks for taking the question. Just one quick clarification if I might you talked about this $0.05 of accretion from the share repurchase in the quarter is that assuming that you don’t do any further repurchases or the other $100,000 million essentially is not used?
Yes Matt, you are right that assumes it’s where we are at this point.
Matthew O’Brien – William Blair
Okay and then my primary question I’m a little bit more concerned about it if. When you talked about, a little bit about Biofinity in seeing multiyear kind of rollout or opportunity that you see in front of you can you just provide a bit more color on why you think that’s the case, is it a function of you know you still haven’t even got to all of your customers with the product and that your sales force expansion is that the new market opportunity that you see there. I mean why is this a multiyear process in terms of delivering a lot of growth from that specific family of products?
Well number one I would say we are early even in the United States, which is our most mature market. Early by that I mean the total of the totality as a family we are when we came out with Biofinity Sphere it did good, when we brought out the Toric the Sphere did even better as a halo effect and when you come out with the Multifocal there is the compounding halo effect.
So they feed on each other as a family of products in front of practitioner he says I’m very comfortable with the material, you know how it works my Sphere they love it there and now I want to migrate. So Biofinity Multifocal of course we just launched it in mid last year and June of last year they have a long way to go. When I talk about, we are far from exploiting it around the world. I mean geographically, I mean when I talk about the brick expansion it is a good vehicle to get into some countries where perhaps we will be more challenged if we didn’t have a product like that, that is rapidly showing its presence in the silicon hydrogel space, which of course is the strong space.
All that takes work, you are right about expansion as a sales force putting in place more feet on the street it’s one of the limitations we have. And I guess I would just say world is a pretty big place it takes a while to get there. Japan for example $400 million market we have, I would say we have only just began, we’ve been in that market since June of last year also we are yet to introduce the Toric, which will probably be later this calendar year in that market and we are in further away from introducing the Multifocal in that market. So it takes time in some cases there is registration processes you have to go through also. Next question?
Your next question is from the line of Larry Biegelsen with Wells Fargo.
Larry Biegelsen – Wells Fargo
Hi, good afternoon everyone. Thanks for taking the question. Just a two part question in the guidance. First, CooperVision grew 9% ex-IMA ex-FX in the quarter. But the guidance is still I think 4% to 8% the market actually accelerated from 3% to 5%, so why not take the low end of the guidance today. But is it just conservatism early in the year is it something you are seeing. And then secondly on CooperSurgical the high end of the current guidance assumes basically that sales are flat sequentially. Is that a trend that you would expect for the reminder of the year? Thanks.
Thank you, Larry. I think they are valid questions we debated guidance quite frankly one of the things that causes a little pause was that foreign exchange started moving against this, it’s the last. It’s volatile it changes like about every day depending on which way grief blows on in given morning. So as we were setting here with paper and pencil it was one of those days where currencies were moving more stronger against this so we were a little cautious as we roll that into in fact into top line and bottom line.
On surgical I think we are probably a little conservative but having said that the franchise at 9% actually it’s 9% organically is they are good numbers they are not what we would deem as franchise would normally continue and sustain at 9%. So we are a little bit more cautious than assuming the first quarter’s strength of that organic growth.
Your next question is from the line of Kim Gailun with JP Morgan.
Kim Gailun – JP Morgan
Great. Hey, thanks guys. So a question on margins you talked a lot in the prepared comments about margin expansion in most of the highlights that you gave related to that expansion (Inaudible) at diverse margin line from what I heard. So I guess but I’m curious here you talk about is how you think about SG&A, SG&A numbers over the next few years. I guess the backdrop of you’ve added 22% to your sales force you are spending happily on free land worth of new product launches. So when do we start to bring some of that leverage through the SG&A line.
You will see some leverage first on the G&A distribution areas where we are as I indicated that only grew really 11% while everything else were growing substantially above that. We are investing heavily meaning we grew top line 11% we grew our line items for sales and marketing as well as R&D more like 17% to 18%.
We are investing now we continue to expect to invest over the next couple of years particularly tied in with geographic expansion, which plays into pushing operating cost if you will and the best areas by investing in the operating cost and investing in the structure. And an example to that would be we talked about China in the past then spend much time on China today. But China would be one we are still in check on going down our path of investing upwards to a drain of 40 basis points to 50 basis points on our operating margin this year. And that is still part of our expectation in a area like that.
Now when do you start getting the payback really the payback is going to happen post 2012 post 2013 and that has become somewhat a question of if we think we are getting our money’s worth by investing and expanding we might enter more countries. We haven’t really spend much time talking about aggressive investing in Brazil, aggressive investing or any investing in India, aggressive investing in countries such as Russia. So there are opportunities we saw there some of them are kind of not comfortable yet getting there.
But I would hope two years from now we are talking about some of those countries more aggressively. I’m not so hung up on we think a natural migration of our operating margin is going to be where we are to the mid 20s and we can get there with a little bit of operating expense leverage and the natural fall out of gross margin, because of royalty expiration and what we can do in cost of goods sold.
The first point is improve your operating margins weighting on cost of goods, continue to invest where it makes sense and seeing just how good the product is. The underlying assumption I’ve got three products in each modality 1 Day with Proclear family two week with Avaira and monthly with Biofinity and would be a shame to be short sighted not to have enough money to get the most out of this product so hopefully that help you. Next question?
Your next question is from the line of Joanne Wuensch with BMO Capital Market.
Joanne Wuensch – BMO Capital Market
Thank you very much for taking my question. Two part question of your silicon hydrogel revenue what percentage of it is in United States and what percentage of it is outside United States. And when the (Inaudible) royalty starts to roll off of that 8% gain, which we are talking about, which will help you get to those mid 20% operating margin. Are you going to let it all go through or can we expect some reinvestment?
Well I will take the second one first you can expect some reinvestment we will take some of it to the bottom line but I would expect in the neighborhood of half of it will be reinvested. And keep in mind that happens over a period of time it doesn’t just, not a quiz though we will have some opportunity to plan that out. As far as silicon hydrogel’s the majority of our revenue actually the better half is outside the U.S. but it’s closer to 50-50 at this juncture. And therefore my opinion you know that 33% of revenue in the soft contact lens market is in the U.S. two-thirds it should be two to one. Well there are a lot of translators and a lot of leverage potential yet with silicon hydrogel outside the U.S. Next question?
Your final question today is from the line of Amit Bhalla with Citi.
Amit Bhalla – Citi
Hi quick question on Europe and just a clarification on guidance on Europe just the last quarter you talked about it’s a softening market. But it looks like it bounced back you just talk about the sustainability of what you are seeing in Europe. And just second on the guidance clarification so you took the midpoint up $0.13 did I hear it right $0.05 from the share repurchase and that will leave about $0.08 from the lower end of the tax rate or is there anything else that’s driving the earnings revision upward.
Europe first, Europe is I call it a daily event but as far as it’s been okay for the contact lens industry. It was a little softness you see in the fourth quarter compared to how it did last year for example the contact lens industry in the fourth calendar quarter was that 5% the overall market was stronger than that last year. Actually I guess it wasn’t held on 5 to 5 but it was not bad for us in the first quarter.
So it’s not as we are busting the woods prior two years where it was clearly strongest of the three regions but it’s holding its own. On guidance the best way to think of the $0.13 add is the accretion of, by the acting $0.05 related to the midpoint and the other $0.07 is non-detector or two offsetting items. The tax going one way and then there was some recall related to consensus going the other way those washed out.
Meaning we flushed through the P&L certain recall and that impacted the revenue line somewhat and operating cost somewhat. The pickup of the $0.07 really the strength of the first quarter, so we came out $0.07 stronger than the quarter we retained that in the guidance numbers you have going forward.
We didn’t keep the momentum of that $0.07 pickup in each quarter because we are investing and we talked about all the start up costs that will happen as we rollout, relaunch Avaira Toric and rollout SUS or single user silicon hydrogel, if you will and then have start up cost with the manufacturing of Biofinity in Puerto Rico. Any other questions?
You do have a follow-up question from the line of Jeff Johnson.
Jeff Johnson – Robert W. Baird
Thanks guys just two quick one here. So Bob, we danced around kind of gross margin and SG&A here. But it’s just operating margin are you still assuming there maybe 100 to a little north of 100 basis points for the year. And then did I hear you correctly if you are moving some Biofinity manufacturing to Puerto Rico some of that is even going to outside of the main Juana Diaz facility or we just knew why would you be doing that outside of that facility.
Let me come back on that one first the – we are not moving anything from UK where we make Biofinity to Puerto Rico we are expanding in Puerto Rico where they are starting up Biofinity production inside the plant. It’s in the same stall or some new location. Relative to gross margin and SG&A the expectation is we will be able to improve operating margin this year in that range of 50 basis points to 100 basis points, at the low end is the function of how impressive. We are with expansion in primarily China and at the high end assume that we get a little bit more out of leverage so it’s in the 50 basis points to 100 basis points improvement this year. Operator?
You do have a follow-up question from the line of Larry Biegelsen.
Larry Biegelsen – Wells Fargo
Hey, thanks for taking the follow-up question. Can you give us a little bit of comfort around some of the startup cost here? The new single daily use silicon hydrogel and Avaira Toric in the Biofinity line and I guess maybe on the single use of silicon hydrogel lens and have you made this lens. I guess I’m just trying to understand you know the risk here that there could be significant startup cost here versus modest startup cost the reminder of the year.
On the silicon hydrogel there are going to be cost it’s not going to be a high gross margin to get. And it’s I would say the technology we are using to make it is a somewhat a known commodity. So that will be somewhat controlled in that sense and we are not trying to go aggressively into the market in fact I should have been clear if I wasn’t that it is a limited launch we are talking about it’s not going to be a global launch.
I didn’t get into where and for to keep the competition guessing we are not going to say where, but the risk of startup cost being well beyond what we expect I think is steadily limited and controlled. Some of those other startup costs there is no doubt I think Greg when he gave his guidance on gross margin 62.5 I think to 63 kind of tells us we are what we expect will happen as we flush that into the P&L over the last three quarters if you will.
I’m sorry go ahead.
Sorry, we are at the top of the hour we would like to conclude.
Go ahead and make your closing remarks then.
Well with that I thank everyone for joining us in today’s call. Hopefully, you are pleased as we were with the results of the quarter and the progress we are making towards exploiting our family of products around the world, both gaining market share as well as successes in women’s healthcare. So with that we look forward to talking to you in June.
Ladies and gentlemen thank you so much for your participation in today’s program. This does conclude the presentation and you may now disconnect. Have a great day.
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