Mar 7, 2008
Executives
Albert White-Vice President of Investor Relations and Treasury Robert Weiss-Chief Executive Officer Eugene J. Midlock-Chief Financial Officer, Senior Vice President
Analysts
Joanne Wuensch -BMO Capital Markets-US Jared Holt-Bear Stearns Michael Weinstein-JP Morgan Larry Biegelsen -Wachovia Peter Bye-SG Cowen Jeff Johnson - Robert W. Baird
Operator
Good day ladies and gentlemen and welcome to the first quarter 2008 The Cooper Companies Inc. Earnings Conference Call.
(Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Al White.
Please proceed.
Albert White
Thank you. Good afternoon everyone and welcome to the Cooper Companies First Quarter 2008 Conference Call.
I’m Al White, Vice President of Investor Relations and Treasury and joining me on today’s call are: Bob White, Chief Executive Officer and Eugene Midloch, Chief Financial Officer. Before we get started I’d like to remind you that this conference call will contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 including revenue and earnings per share guidance and other statements regarding anticipated results of operations, market conditions and planned product launches.
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 available publicly and on request from the companies Investor Relations department. Now before I turn the call over the Bob, let me comment on the agenda for the call.
Bob will begin by providing some highlights on the quarter, then get into specific details including product launches, guidance and management changes. Following Bob’s remarks, Gene will comment on the first quarter financial results and provide some additional commentary on our guidance for 2008.
We will than open up the call for questions. Our intent is to keep the management presentation to roughly 30 minutes followed by 30 minutes of Q&A, so that the call will last one hour in total.
We request that anyone asking questions please limit yourself to only one question so that we may get to as many callers as possible in the allotted time. Should you have any additional questions following the call, please call Wendy Catie at 925-460-3663.
Once again, that’s 925-460-3663 and we’ll get back to you as soon as possible. As a reminder this call is being recorded and a copy of the press release is available on our website www.cooperco.com under investor relations.
With that, let me turn the call over to Bob for his opening remarks.
Robert Weiss
Al thank you and good afternoon everyone. Well, we finally have something I think we can feel real good about.
What I’ll say is a lot of great news. Before I get into the details I’d like to make a few just brief comments.
One is covering some good news on results, some good news on market share gains, great news on the launch of Avaira, our two week silicone hydrogel product. Great news on our manufacturing of Biofinity, some outstanding news about CapEx and free cash flow that I know many of you are waiting for and then just a brief comment on the market looking robust going forward.
On operating results we met or actually exceeded our internal targets and as a result of that we are highly confident going forward of hitting our revenue and our EPS goals and as you can see in our release, we actually increased our guidance both as to revenue and as to earnings per share. As far as market gains, if we look back over calendar year 2007, keeping in mind that the industry tracks by and large on a calendar year basis and a calendar basis, we actually exceeded the growth of the market.
And that was in spite of the fact that we really weren’t a participant in the silicone hydrogel market to any degree. So that’s really good news if we were able to gain market share even before we had a robust launch of Biofinity and now the Avaira product line.
As far as manufacturing some outstanding news on that; Biofinity had a record month in February of 3.8 million lenses. That reflects the fact that we had a planned shut down at the end of the calendar year, converted some of the lines to the new technology we learned from our line 5 as we called it, which was the R&D line.
And, once we basically validated all those lines we see that we’re getting a much better yield and I’ll talk to that a little bit more. CapEx, good news on the CapEx side is as we’re projecting the cash flow that we are this year, as we look down the road we’re expecting much less cash requirements going forward in that area.
When it comes to free cash flow, that would be a combination of lowering our CapEx requirements going forward as well improving operating margins going forward and lastly the market. The other good news is the market, as you may recall from past slow downs in the economy we are recession resistant.
Not recession proof, but clearly recession resistant. People need contact lenses no matter how good the economy is doing or not doing.
As a result of that we remain bullish about the future. We foresee 6 to 8% market growth.
And we certainly think that we, with the new product launches that we have going out, we’ll continue to be able to gain share and expect to grow 11/2 times or greater than the overall marketplace. Looking at some of the details for the quarter, revenues reached an all time high for the first quarter of 245 million up 12% and in cost and currency up 7%.
Cooper Vision was up 12%,Cooper Surgical 10%, our overall GAAP earnings per share was $0.15 up 25% or $0.03 from last year and adjusted earnings per share was $0.45 which excludes $14 million in charges. Looking at the details of Cooper Vision, we had revenue of $206 million up 12% and in cost and currency up 6%.
On the product front things were really exciting. First Avaira, which is a third generation two-week silicone hydrogel product; it’s the biggest news that we have certainly going that we now are launching.
We had said in the April, May time frame, we’ve actually brought that forward to April. The other good news is that this product is now in production, not only on what we call the fast track in the UK, but now on our Gen II platform in Puerto Rico.
While it’s only been in production for really 12 days, it would be premature to say that it’s totally debugged, but we are optimistic. Not only from the point of view we now understand the materials a lot better then, clearly when it was part of the Biofinity platform, but we understand the Gen II platform better.
So, we’re combining a more proven manufacturing know how materials with the equipment. So on that front, we’re very optimistic as we enter the two week silicone hydrogel space, which of course is the largest part of the US market.
We’re in essence, 2/3 of seers fit in that domain. Biofinity as I mentioned, we had record manufacturing.
But in addition, we reported $9.1 million in revenue in the quarter and that is basically almost as much as it was in the prior year and double what it was in the second quarter of ’07. Capacity, as I indicated, is approaching 4 million lenses a month and is continuing to grow.
With that we are optimistic that we could get our revenue to the 50 to $70 million range for the fiscal year and I’d like to point out, in the most recent month of January, we had basically over 4 million, $4.4 million in revenue in the month. So we’re approaching a revenue run rate in excess of $50 million.
Additionally, we’ve added one additional line since the end of February; it takes our line count from seven to eight with one more still to go. And the other thing, over the last two years we’ve frequently talked about our frustration on getting our yields up and our efficiency up, our utilization up.
I’m happy to report that we have now achieved 50% yield and 70% utilization and by no means is that where we’re stopping. We will continue to improve the process going forward, but we’ve reached that milestone.
On the Proclear 1-day front, we of course, are launching this product. We’ve launched it in the US and Europe, are very happy with the market receptivity to it.
Capacity continues to ramp up and we are now at a mode where we can roll out globally our availability of that product. And I might come back on Biofinity; there are no more allotments in our marketing organization or for Biofinity world wide.
So anyone that wants the spherical side has that coming their way. I guess in summary on the product front, we’re excited about all these new products that are available.
Our energized sales force, moral is obviously very good and they are clearly fully engaged with plenty to talk about. On the Cooper Surgical side, revenues were 39.5 million, up 10%.
Although organic growth was only 3%, we actually had orders of $42 million, so it was a very good quarter for orders and some of those orders will roll into the second quarter and going forward. We had operating margins of 175 and gross margins of 60%, so the margins continue to be good.
And as I indicated, while our CSI revenue was only 39.5 million, our orders were 42 million, which is good for the run rate of that business going forward. Let me talk a little bit about guidance.
Gene will get into more details during his presentation and I’ll just high light them a bit. But, revenue guidance was increased to 1 billion and 60 million, to 1.1 billion.
That’s taking the lower end up 20 million and the upper end up 10. Cooper Vision is what we moved up.
We moved Cooper Vision to 895 million to 930 million, an increase of 20 at the low end and 10 at the upper end. That reflects the fact that included in that revenue is now Avaira, was not in our prior quarterly guidance and we have ball park $10 in that number in the revised guidance.
Cooper Surgical has revenue of 165 to 170 million in its guidance, no change. On the earnings per share front, non-GAAP, we took up to $2.10 to $2.35 an increase of $0.10 at the lower end and $0.05 on the upper end.
And for GAAP guidance we’ve taken that up to $1.40 to $1.85, an increase of $0.10 on the lower end and $0.05 on the upper end. That reflects not only a strong first quarter and I might point out the non-GAAP guidance; we have now moved into consistency with all the analysts and that non-GAAP guidance does include our equity expense in the number.
As far as, I mentioned that Avaira is a $10 million in those numbers and you may recall when we talked about Avaira on the two-week silicone hydrogel product in December, we indicated some of the costs were already built into the guidance number. And as a result of that the 10 million of added sales from Avaira, while the product line itself will not generate profits this year, we are taking our guidance up $0.05 to reflect the fact that we already had some of those costs built into previous guidance.
I don’t, I think I’ll defer any other specifics on the guidance model to Gene in his presentation. CapEx, one of the heavy discussion items in the past has been, you guys are spending an awful lot of money on CapEx, and will it ever end.
And that’s translating into your free cash flow is non-existent. I’d like to talk briefly about that: number one, we’ve had six major projects that are going through the company in ’07 and ’08.
Of those six, Biofinity, was one which was a large capital spend. The Avaira product line we had upfront the equipment, another one three distribution centers that were combining 21 warehouses.
Yet a third, we put up two buildings, one in the UK that we expanded in ’07 and another one that’s going up in Puerto Rico with 70,000 added square feet in this year, it will be done by July. We had the expansion of the number of lines that are making the one day product line going from five up to ten and then we had the conversion onto the Gen II high volume platform that took place in the last year.
All told, all six projects are running around $400 million in costs. We are 2/3 through that process.
Biofinity is done and in fact Biofinity’s capacity can support more than a $200 million product line today; as you know, we only sold 9 million in ’07, we sold 9 million this quarter, so that gives you some indication of how much added capacity we have. Likewise on the distribution centers, we put three in place, two in Europe and one in the US; we now have the capacity to more than double our through put in those distribution centers.
Likewise on the conversion to Gen II, that is done. So that’s three of the six projects are totally done.
The ones that are ongoing is the building, we will be wrapping up the second building in the third quarter of this year, by July, and then going forward into ’09 and beyond, really there will be the continued expansion of only the Dk 100 project or Avaira as well as continued roll out of one day. Also working within this footprint if you will is a lot more things going on with efficiency that we know we can get out of it.
So net our capital requirements going forward will be substantially less than they have been the last two years, ’07 and ’08. We’re looking to drop our range in ’09 from about 125 million to 140 compared to 160 to 170 million this year and beyond ’09 we expect it to drop down more into the 100 to $125 million range in 2010 through 2012.
So we’re looking for the combination of much less capital requirements and improving margins to generate significant cash flow. We expect to start to be cash flow positive in the third quarter of this year going forward, so it’s not way down the road it‘s short term.
Let me just talk briefly about future product launches. We have a couple that we’re had yet to go, one of course is the two week Silicone/Hydrogel Silicone hydrogel toric.
As we’ve said in the past, we expect to be in production by the end of the fiscal year and we continue to expect to launch Silicone/Hydrogel Silicone hydrogel toric in the first half of the ’09 fiscal year. As far as Proclear 1-day, which is not being sold in Japan, we continue to expect to launch Proclear 1-day in Japan which is a very large one day market, 55% of that market is one day.
And Proclear has proved to be a very viable one day product through out the world. And as a result of that we are very optimistic about that launch in the first half of the next year’s fiscal year.
As far as, a couple comments on the marketplace; overall market for the quarter and by the way all my market numbers will be calendar year and in cost and currency, which is the way the data is put together by the company that tracks market share. Overall markets grew 9% in the fourth quarter in cost and currency and are up 5.8% for the calendar year.
We grew much faster than the market quarter at 12% for the calendar quarter and once again in cost and currency and overall we grew 6.3% for the calendar year; and once again, in spite of the fact that we were not selling a lot of Silicone/ Hydrogel. For the calendar year we had $14 million of Biofinity sales in the calendar year, by way of gauging that.
Single use lenses, single-use spheres continue to grow well, 15% for the quarter and now equals 35% of the global market. We continue to grow much faster in the market.
Our revenue for single-use spheres was up 40% in the fourth quarter and this still only leaves us with an 8% market share, so we have a long way to go. In essence we have twice as much market share in total as we yet have in the single use market and we’re very optimistic about the opportunity that presents.
There continues to be an expectation of strong growth in the one day market going forward. By the way, daily disposables now account for 17.5% of the overall business for Cooper, so we in theory should be able to double where we are.
In the fourth quarter, the US market for daily’s grew 19% and exited the year with 11% growth, so there is some indication that even the US market, which has not been a one- day market in the past, is starting to move that way. There are even some rumblings that, where at the most recent conference, that you know JJ is or Vista kind of is starting to make more noise in the one-day market in the US which will play well for migration and expansion of that market.
Silicone hydrogel torics, our Silicone/Hydrogel growth for the quarter was 27% and that brought the total calendar-year growth to 35%, although the rapid growth and the size of the Silicone/ Hydrogel market is mainly a US phenomena. The world market today is now 28% Silicone/Hydrogel and the total market worldwide is now 5.1 billion, so it’s basically, 28% of that is $5.1 million in calendar year 2007.
We had $6.7 million of revenue in the fourth calendar quarter and as I indicated, for the fiscal year we had 14 million in revenue for Biofinity. Silicone hydrogel torics, we don’t have a silicone hydrogel toric on the market yet, but overall our toric business was up 4$ worldwide, with 3% growth in the US and 6% growth in the rest of the world.
During the fourth quarter the market grew 11% in the calendar year fourth quarter, so we continue to expand or grow our top line for torics even. A couple comments on management changes as everyone knows there has been some recent management changes.
Steve Neil, who resigned as Chief Financial Officer, as I’ve indicated, it certainly was a surprise. I wish him well in his future endeavors at the company he joined.
It was not at all an indication that there was a disagreement, an accounting issue, any disagreement on direction of the company or guidance that existed between he and myself. The speed at which Gene Midlock was promoted to Chief Financial Officer was really an indication of things that were in the works.
For those reading between the lines, Gene was promoted to VP of Finance in November of ’07. He in fact ran the year end audit from the point of view interface with the auditors and the books, closing of the books and as a result of that he was actually, it was expected he would step into the role of CFO in March of this year.
Things happened a little faster than planned and Steve was targeted to move into an operating role and of course that won’t happen. Recognizing that I then ended up with way too many direct reports, which put me in a mode where I was not adequately servicing the Cooper Vision organization and I was not adequately servicing our board as well as the investors and the analysts, I basically had indicated that I needed to fill in the position of Cooper Vision Inc.
president. I really haven’t dug deep into the organization over the last 12 months.
I was able to see the strength of our bench strength and I was very comfortable with, basically, going within the organization for promotion to the provisioning president. John Weber has my full support.
I know he will do an outstanding job and that certainly will make my job much easier from the point of view of focusing in on strategy and on the direction of the company as well as dealing with Wall Street. Both John and Gene have my full support and confidence and I believe that we now have a great team in place to carry the company to the next level.
To sum it up, we’ve worked very hard the last three years to get to this point where we now look forward to having a lot of fun. And I think we have the right team in place, I think we have the right products in place and it’s time to reap the benefits of all this hard work.
So with that I’ll turn it over to Gene to talk about some of the other financial attributes of the quarter.
Eugene Midlock
Thank you Bob, good afternoon everyone and thank you for joining us today. I’m delighted to be here as the CFO of Cooper.
I haven’t had an opportunity to meet many of you so perhaps just some background information. While I’m new as the CFO of Cooper I’ve been involved with the company since 1997 in various capacities, first as an auditor and an advisor, then as a consultant, then as the VP of Tax and most recently as the VP of Finance.
Bob and I have worked closely together over this time. We are completely aligned in the company’s strategy and financial outlook.
We believe that after our long and difficult integration trek, we are on the right track to deliver positive financial results into ’08 and beyond. Bob provided a fairly comprehensive over view of operational and strategic aspects of our first quarter.
I would like to cover, briefly, some of the financial highlights. In addition, there was some apparent confusion during the fourth quarters conference call regarding our full year guidance for 2008, so I would like to conclude my remarks by providing an update to the guidance in some detail.
Now let me begin my reviewing briefly some product sales and revenue information for the first quarter. This information has been posted to our website and it should be noted that it’s reflected in cost and currency, whereas in the press release, the information is provided in actual currency, so there are some differences.
Just the highlights, single-use spheres, which is mainly driven by our PC product Proclear, were up 29% in cost and currency. Our torics, which is really the work horse of Cooper and has historically been one of our strong products, is up 5% and comprises 43% of our lens revenue.
Multifocal’s outpaced the market and grew by 16% and Proclear materials have really continued to grow strong and comprised roughly 25% of our total revenue. On a regional basis for CVI, there was strong performance in each of our geographic areas.
Asia Pac was up 8% in cost and currency, Europe was up 6% and the America’s were up 5% with the US leading that at 7%. That is really a truly remarkable performance when you consider that we had done this without the Silicone/Hydrogel products until very lately and certainly put out a two-week product in the United States.
Let’s now turn to look at gross margin. In Q1 it was 58% versus 59% in’07, it was a slight decrease and that was slightly attributable to product mix.
The increase in single lenses with lower margins grew 41%, which is now 18% of CVI revenue and that was partially offset by our strong growth in Multifocal, Proclear and Biofinity, Proclear up 34% or 25% of our revenue. If you adjust the margins for the call outs or those costs that are not related to our core operating performance, the gross margin was 62%, same as it was last year.
CSI or Cooper Surgical’s gross margin was 60% in ’08, also unchanged from ’07 and we expect our gross margin for the year to be around 62%. Turning to operating margin, on a consolidated basis, it was 8% for ’08 compared to 7% for Q1 of ’07.
This is comprised of CVIs of 11% versus 13% last year and CSI was 17% versus 5% of last year. But, last year there was a very large charge in Q1 in process research and development attributable to an acquisition; if you adjust for that, Cooper surgical was 17% in’07 as well, so year on year they were essentially at 17%.
We would anticipate an operating margin for the year somewhere in the 15.5 to 16.5% range on a non-GAAP basis. There has been some discussion in the past, some questions about our SG&A and the level that they have risen to and their largely comprised of two components, the selling expenses and the G&A expenses.
The selling expenses obviously will be higher as we launch new products in new markets, but we are closely monitoring those. If we turn to our G&A expenses, they increased by 2% over 2007, but if you look at them on a non-GAAP basis, they actually decreased by 6%; that’s because there was some one time litigation expenses included in those charges in ’08, so we actually had a decrease of 6% year on year and we’re going to continue to monitor those expenses and hopefully reduce them further.
Looking at R&D expense year on year, the financials project somewhat of a misleading result; it indicates that there was a decrease of 27%. For CVI there was actually an increase year over year of 14% and for Cooper Surgical, again if we adjust for that unusual last year Q1 IP&R deep charge, they increased 37%.
So, consolidated with that adjustment there was actually an increase of 18% and we would expect in the future R&D growth should exceed the growth in revenue and should equal approximately 3 to 4% of sales. Turning to the beloved subject of call outs, we will expect for the year to be in the range of about 35 million as we indicated.
We had 14 million in Q1 so there is approximately 21 million to be incurred for remainder of the year and most of those should be incurred in the early part, the first two to three quarters. Just as a reminder, we’re no longer calling out stock-based compensation.
Turning to the effective income tax rate, you’ll note that in Q1 for GAAP it was 27.5 % versus 21.2% last year. I wouldn’t run off and change your models as yet, because we project for the year the annual GAAP rate will be about 18.6 and the non-GAAP rate about 15.7.
You will note, as you monitor the quarters however, that the rate is going to fluctuate considerably more than it has in the past and this is because we adapted FIN 48 in Q1 at Cooper. And if you’ll look to the other companies who adapted last year, because of our fiscal year basis, you’ll note that because of the workings of FIN 48 and the clarity it has brought to tax and certainties in FAS 109 in accounting for income taxes that the effective rates were no longer predictable on the quarter basis, so ours too will fluctuate for the first three quarters, but should settle down for the year as I indicated.
I would like now to go through and refresh, at a high level, what we expect our EPS guidance to be for 2008, again clarify any of the misunderstandings that might have occurred last year. So if we start with the GAAP earnings, we’re predicting revenue, forecasting revenue of 1 billion 80 which is in the mid point of the guidance range.
Operating margin of 13% which again is the mid point, which would give us 140, interest expense and other expenses will be 46, so we’ll have pre tax income of 94, 19% tax rate, as I mentioned, is 18, leaves us net income of 76 million. There is 2 million of convertible interest that we need to adjust for under EITF 04-8, so that leads you to the net of 78 which is approximately $1.63 earnings per share which is in the mid point of the range of 140 to 185.
If you turn to the non-GAAP numbers, again revenue is 1 billion 80, operating margin, as we indicated was 15.5 to 16.5, so at 16% that would give us 173 million interest, others 46, so pre tax of 127, 16% rate is 20, leaves us the net income of 107, again adjusting for interest on our converts of 2 million leaves us with earnings of 109 and earnings per share of $2.28, which is again in the range that we quoted of 210 to 235. So with that I will conclude my remarks and turn the call back over to Al White.
Albert White
Okay, thanks Gene, thanks Bob and we’ll take a few calls. Just let me reiterate, preferably one call per analyst so we can get through the analysts and move through the questions in ½ hour.
We’ll start, operator if you could patch in Joanne from BMO.
Joanne Wuensch -BMO Capital Markets-US
Hi, can you hear me?
Eugene Midlock
Joanne?
Joanne Wuensch -BMO Capital Markets-US
Can you hear me?
Eugene Midlock
Yes, hi Joanne.
Joanne Wuensch -BMO Capital Markets-US
Hi, sorry about that. Could you walk us through some of the launch steps that you’re taking regarding Avaira in regards to how you are starting to prepare the industry that you’ve got this new product about to come out?
Robert Weiss
Yes, briefly Joanne and we are targeting for an April launch, so we’re a little over a, about a month away, we will be concentrating on a number of the chains that, if you will, have been left behind somewhat with the Biofinity side. We will be rolling out about 10,000 fitting sets and which compared to Biofinity you may recall, we launched and rolled about 7,500 between June of last year and the end of last year.
So it will be a fairly robust launch. We certainly have the comfort level that, at least that level of launch can be supported by fast track, but very much to the extent that we ramp up on the Chin II line; the Puerto Rican line if you will, much faster, that would allow us to expand that roll out.
What we do not want to do is get fitting sets out there that we can’t support by the continuation of the production of the product. You know we are, if you will, cautious in our approach and we’ll enjoy the upside of it if it shows up.
Joanne Wuensch -BMO Capital Markets-US
Okay so I’m to assume that most of this is being manufactured in the US and outside the United States or, I mean obviously those are your two choices, but where? Is this PR or is this a UK based launch?
Robert Weiss
The initial fitting sets will be coming out of the UK at a fast track and we are in production, as I indicated, in Puerto Rico, but that production level after 12 days certainly does not warrant the putting together the fitting sets at this point in time. So, short term UK supply that we’ve built up, we were running at over 600,000 lenses a month on fast track, around 600,00 a month, so a pretty robust level in and of itself on one fast track line.
So we know we can, with that, support a product line approaching 10 million bucks.
Joanne Wuensch -BMO Capital Markets-US
Okay thank you, I’ll go back in the queue.
Albert White
Thank you. Jared Holtz…Jared are you there?
Jared Holt-Bear Stearns
Yes can you hear me? Hello.
Albert White
Yes go ahead.
Jared Holt-Bear Stearns
Great thanks. You just talked about your use of cash in the quarter, it seems like net debt was increased by 50 million, so can you just explain, you know kind of from an operational stand point what’s happening there, if you need to finance more debt in order to run the business going forward?
And then just secondly, on guidance it looks like you brought up guidance by 20 million on the top line on both the low and the high end, but are attributing about10 million to the Avaira product. So what is the other 10 million coming from?
Thanks.
Robert Weiss
Okay two comments, first of all on the cash use during the quarter, of course there are two things going on. One is heavy CapEx $40 plus million, two is still a lot of call outs and restructuring and things such as the wrapping up of the litigation with Ciba on the IP, which happened in November and if you see our call out list has like 3.4 million in cash that went out the door just for that litigation, you know, in one month alone if you will.
So there is still a lot of start up costs there for the expansion of Biofinity production. There is the early, if you will, getting the Puerto Rico Gen II line on Avaira going on, all of those are pretty intense on restructuring and in start up coupled with CapEx.
As I indicated going forward, we will have one more heavy CapEx quarter in the second quarter. We will have improving operating margins as the year progresses and by the time we get to the third quarter we will turn cash positive, free cash flow positive going forward.
Also in the first quarter we typically have a lighter, if you will, revenue number than most parts of the year because of the number of holidays that occur during that quarter, so typically we look a little lighter on the profitability point of view and some of that translates into cash. As far as the guidance going forward, we added 20 million to the bottom end, 10 million the top end, 10 million of that add is Avaira.
We are doing better with our general product launches via the one day and the fact that we now have an unlimited supply of Biofinity. So you’re seeing a more robust feeling about our expectation not only on Avaira, but other parts of the product line, Proclear 1-day and Biofinity.
Jared Holt-Bear Stearns
Okay great, thank you.
Robert Weiss
Perfect, Mike Weinstein?
Robert Weiss
Mike are you there?
Michael Weinstein-JP Morgan
Yes I’m here. Hopefully Bob now that we’ve transitioned to you, we can maybe work on the format of these calls, this call out system still seems a bit antiquated, but it’s working at least.
Let me just try and understand a couple items, I got lost a bit on the debt commentary. I understand the increase in some of the debt level during the course of the quarter, but I just want to better understand where do you think your debt levels peak at?
It sounds like you’re saying that your debt will peak in the third quarter and from there you’ll start to be able to work it down and I just want to get some sort of confidence around that. Then I just want to just understand a little bit in the quarter the production costs which were called out, which were a lot more than we had been modeling.
So I just would like to dive into that a little bit if you could, thanks.
Robert Weiss
First of all on when does the debt peak? It peaks at the end of April.
So the third quarter will be cash positive and we’ll start shrinking our debt level. As far as the call up activity or the start up activity and the call outs during the quarter, some of those start up costs reflect the, we really had things going on on three fronts.
We still had basically a tale end of some of the conversion on start up on Proclear 1-day or PC 1-day product line, which entailed moving it onto new Gen II lines as we rolled that out. But to a bigger extent, it’s Biofinity, as Biofinity became a bigger product and more robust lines.
Up until really the end of the calendar year, it was in a start up cost mode. And as we converted those lines or upgraded those lines for what we learned to our R&D line in the end of the calendar year, we now are in a mode where the call outs from Biofinity are basically a more expensive cost that are flowing through the inventory to a certain extent are going to actually reverse the other way.
With our 50% yield and our 70% utilization we now have our cost below what we expected for the year.
Michael Weinstein-JP Morgan
That’s it, see our challenge is we look at you’re reporting this adjusted number and it looks like it’s in line with generally where people were at, but with the GAAP numbers it was $0.11 below what we were modeling and I don’t know what {indiscernible} and it’s just hard for us to see how you come up with the production start up costs numbers that you back that every quarter, because it seems that’s such an arbitrary number.
Robert Weiss
Mike to that point, we’re sensitive to the fact that people were struggling with the start up costs. We’re putting equal weight on GAAP and quite frankly we beat the GAAP number substantially internally.
And that was partly a frustration with, of course we give annual guidance and the only thing we say about quarterly is keep in mind that earnings are always, always, always going to be weak in the first quarter because we have a lot less billing days. We had three four day weekends in the first quarter, Thanksgiving, Christmas and New Years were all four day weekends.
That translates to 5% less billing days in the first quarter than the rest of the year. That coupled with a number of other things, we were trying to say, remember that this is our weakest quarter and build your models accordingly.
Some times we succeeded and sometimes we didn’t succeed, but internally we’re ahead of what we thought would happen.
Michael Weinstein-JP Morgan
Okay last question and I’ll let others jump in here. The revenue commentary for the year, which you increased, it would seem just based on the dollar, which we’re all aware of, that since your December call that the currency to your OUS business would have increased over that time.
So shouldn’t you be raising guidance by more than you are just because of what’s happened with the dollar. And it certainly seems like, at least in this quarter, the currency contribution was greater than we expected and then that should model out as we go into Q2 and beyond.
Thanks.
Albert White
I know there was someone else that had that question out there, but quite frankly on December 11, when we had the last conference call, you may recall the pound was 203, today it’s 198, it actually went down from a revenue point of view. The euro was 147 couple days ago, in late February it’s at 148 and it has now of course the last couple of days moved up to 152 if it were to hold there.
You know the yen was 11 in December, it’s 103 today. and the Canadian dollar, where we of course have pretty good franchise in Canada, was $0.99 and now it’s a dollar.
So the net movement really hasn’t been all that much since mid December compared to where we are today. So there’s a little more revenue in that number, but it’s not materially significant.
Michael Weinstein-JP Morgan
Okay great, thanks for taking my questions.
Albert White
Larry, Larry Biegelsen?
Larry Biegelsen -Wachovia
Hi can everyone hear me? Thanks for taking my call.
Could you talk about the status of the manufacturing distribution center in Asia that you were considering? When will you make the decision and was that part of the CapEx guidance you gave us?
Robert Weiss
Great question, the answer is it’s still on our radar screen; we still are doing homework on looking at Asia Pac. We are doing it in a go slow, orderly manner.
It will be our next footprint, but it is not something we need over the next couple years. Not only, not because revenue isn’t exceeding expectation, but because we are finding a lot more efficiency within our footprint that will allow us to buy forward probably one to two years.
So it is on our radar screen, there is a number of what if’s going on. From a CapEx point of view, that capital will not really show up in ’08 or ’09 and probably not even in 2010, maybe toward the latter half, but it’s part of that push out if you will of capital requirements.
Larry Biegelsen -Wachovia
For the toric silicone hydrogel, it sounds like you’re saying you don’t expect start up charges for this lens and if not, will you absorb some of the, will you absorb some of the inefficiencies into cogs?
Albert White
The answer to that is we’ll be taking the same production now how, in other wards we know how to make a steel lens and then we put different steel inserts in and then make a toric lens. So there will be some start up costs, not much, because you don’t have to worry about the robustness as the machine we work can make a lens come out the end.
So the, will it go straight to cogs or will it be just a higher cost that goes on the balance sheet and then slows in with the sale of the product? The initial couple months, there might be some that go to the P&L, it’s not going to be anything compared to what we’re doing with all new Avaira line, you know the $30 million piece of equipment in Puerto Rico as well as the Biofinity, what that was about.
Larry Biegelsen -Wachovia
And lastly, I was a little surprised by the guidance of 10 million for Avaira in ’08 if you’re already producing it on the Gen II platform. You sold 10 million of Biofinity in 2007, you know could you talk about that a little bit and then I’ll drop thanks.
Albert White
Okay, well I guess part of it is we’re really going to get going in April, so that’s six months to generate that 10 million. The roll out number that we put in guidance is really, depicts what we know we can make already, as far as we can make enough lenses to support 10 million on the fast track in the UK.
We are, as I indicated, we are into production in Puerto Rico, but only 12 days and so it’s too early to say how much will those yields really ramp up. No red flags whatsoever, but having said that, we’ve learned from Murphy in the past to be a little cautious and we’re going to stay cautious on that front.
Larry Biegelsen -Wachovia
Thank you.
Robert Weiss
Peter Bye, Peter?
Peter Bye-SG Cowen
Hi thanks guys, appreciate it, just a couple questions on the CapEx. You know we followed you guys for a few years, CapEx numbers bounce around.
It always seemed Bob that you were higher than Tom and Tom was low and then it always came in above you guys and then Steve threw out some high numbers and Steve’s gone and now they’re low numbers. Last year you guided to 150 to 160 was what, to 184 or something.
Just can you give us some help? I thought a lot of it was about daily disposable production, not just the Biofinity silicone hydrogel, maybe some more clarity there?
Robert Weiss
Yes, the higher numbers were not only Steve’s, they were mine in the past. I really did believe with our push into the one day side that we would have higher capital requirements and than my push into Asia Pac sooner rather than later would exacerbate capital requirements.
Since Asia Pac is pushed out two years heavily, because of operating efficiency, we’re just doing, Biofinity is way quicker than we really thought a year ago it would be. So we got to that magic number.
The fact that we now have the capacity within Biofinity productions to generate $200 million of revenue, so we don’t have to worry about CapEx there anymore; and I think when we just cut through we had the six projects, of which three are done and the fourth will be done in July and they were all major CapEx requirements. When we looked at improving efficiency to and including on the one day production side on Proclear 1-day costs are coming down, efficiency is going up, we like what we see.
And quite frankly, we’ve just completed or we’re in the middle of completing, I should say, a very detailed strategic plan that really asked all those questions. Really looked out over the next four years and aligned, if you will, market expectations, what we expect to do in the market with what our production plans could deliver in; we really felt good about that exercise and it gave us a better picture of what our CapEx requirements are going forward.
Peter Bye-SG Cowen
Can you just tell me how that process was different than you’ve done it the last three years?
Robert Weiss
Well, I think number one is our plants over the last two years, not so much in ‘05 but ‘06, ‘07 and ‘08, starting in ’06 --
Peter Bye-SG Cowen
Just let me interrupt one time, because we were down in Puerto Rico with you, and there was a little bit of a discussion between yourself and Tom about what your fiscal ‘07 CapEx was going to be. I believe Tom threw out a number like $75 million, $100 million and you said it was going to be $125 million to $150 million.
And so, just in that context, I think you probably remember that discussion on the podium on the front. So just in that whole context as well – not just ‘05 but that was fall ’06.
Robert Weiss
Yes. You are right.
In the context of the $125 million to $150 million, I was right, Tom was wrong, okay? And the second piece was I was low because --
Peter Bye-SG Cowen
No, no, no. That was fiscal ‘07.
You were both -- it was $184 million. So that was about the following year about what it was.
You talked about how much you had to go into R&D into the lines and that sort of front. So that wasn’t about a fiscal ‘06 number.
That was Puerto Rico fall ‘06 about a fiscal ‘07 number.
Robert Weiss
Yes and I understand that. What I was going to say is the major thing that happened from that point throughout ‘07 was called foreign exchange.
All of our equipment is euro and pound based. The dollars crashes a lot.
All of that, the cost of that equipment goes up 20% plus. So that was what drove up CapEx.
The numbers we are giving you now are off where we are today, as far as conversion rates. So if the euro went back down to $1.18, $1.19, whatever it was then there would be some pick up on less cash requirements.
But the fact of the matter is we are heavily sensitive to exchange on that front. Why are we in spite of that feeling more bullish?
It’s because of the efficiency factor. I won’t get into what’s new.
All the details of what can happen in the plant, but we’ve put a lot of money in people that look at the production side like the line 5 that went to R&D and they really work hand-in-hand next to manufacturing and it is amazing what creative thoughts come out of that. I’ll give you one of the three major factors, would be our footprint.
We married CooperVision and Cooper Ocular’s footprints together. When it comes to how we cure the product, we are able to substantially reduce the footprint by the Cooper, not the Ocular vertical ovens, which save a lot of space and get a lot more equipment in the same footprint.
So that’s one reason we don’t need to expand outside the walls as early. Another has to do with, basically, cycle times that we’re tweaking.
Cycle times come down in shorter periods then we can get a lot more throughput out of the same equipment. The other thing is how good are your yields?
If yields go up, we get a lot more out of the same equipment. All of those are coming together with a strong organization that’s working hand-in-hand, R&D and manufacturing.
Peter Bye-SG Cowen
Great. Thanks for the specifics on that.
That’s actually pretty helpful. Just one last one on Biofinity, it seems like production is up or at least your capacity is up a fair amount from the fall.
We had always heard a little bit that there were lot more orders than there are capacity and now capacity is up a lot, and you took up revenue a little bit for Avara but not this. What are your expectations for Biofinity now that you have so much capacity?
Robert Weiss
Well, we are really two months into this. And I say that, we didn’t realize when we came out of the chute after the December shutdown all of a sudden we went from 2 million lenses a month and we shot up to 3.5 million in January.
So it was like, is this real or not real? Then when we made 3.8 million lenses in February and yields went from 40% in January to 50% in February, we said this is really real.
So it’s pretty fresh information. It isn’t like we had a buffer stock we were sitting on and really worrying a lot about that.
What else can we do? How do we roll out?
So the marketing units were not told until about two weeks ago, sell; you’re not constrained. You want it some place in the world where it is approved to be sold.
You have it. We are doing things to expand its attractiveness as a product.
For example, expanding the range of the parameters is high on the agenda to kind of copycat or match the other product lines that are out there, that have been out there for a number of years. So that’s a high priority to expand the demand for that product line as we go forward.
But as of today we are ramping up pretty quickly and as I indicated we sold $4.4 million in the month of January, which basically is at a $53 million run rate.
Peter Bye-SG Cowen
Great. But the ramp up, the expanded capacity is not in guidance because it was just recent?
Robert Weiss
There is a little bit in guidance. But as I indicated currency is a very small piece almost non existent.
Biofinity and Proclear and Avaira, 10 million is Avaira and of the, the bottom end of the range that we took up 20 million, of that other 10 million you’re really talking about Biofinity and you’re talking about Proclear One Day.
Peter Bye-SG Cowen
All right great. Thanks.
I’ll jump in queue.
Albert White
Jeff Johnson?
Jeff Johnson - Robert W. Baird
Gene made the comment that the gross margin drag in the quarter was one day and it was offset by Biofinity and some other things, Proclear, Multifocal. Does that imply then Biofinity gross margins up into the upper 50% range?
If that is true, then do they go even higher here with these February efficiency gains and yield gains that you’re talking about Bob? That is number one.
Number two you also made the comment in the call, I think Bob you did, about a two-week silicone hydrogel toric. Does that mean the decision obviously has been made between whether or not it would be the Avaira material or the Biofinity material?
You’ve decided to go the two-week route? I think that was still up in the air.
Last question, just as you push out the timing of the Asia Pacific efforts, could you at all quantify how much of CapEx coming down over the next couple of years is due to that push out versus maybe some of these efficiency gains that you’ve have talked about?
Robert Weiss
Gross margin. The gross margin, you are correct, will be going up rapidly with Biofinity.
Once the, if you will, the production costs move through inventory which it does on a [inaudible] effect to the P&L. So the costs we see in January and February will happen not so much in the second quarter, more in the third quarter.
That’s a favorable direction for gross margins, clearly. Going the other way, of course, just to remind we have very, very rapid growth in one day products and the one day product has less than a 50% gross margin.
And clearly there are things that we are doing, that are improving the gross margins of that family. But Proclear has been, if you will, on a new ramp up mode a year ago, I want to say we were making less than 2 or 3 million units.
Today we’re making a lot more than 13 million units a month. So, the learning curve has hugely increased over the last six months, which is leading to reducing our costs.
So, gross margins, I can’t say they will go up or down beyond the 61% to 63% range. It will be a function of product mix.
There is nothing that I see that would cause me to back off of saying within really two years we will have our silicone hydrogel product family if not in the 70s approaching the 70 percentile. That’s still as I see it in the cards, but that is not necessarily going to translate to a gross margin going way up because of the one day pulling it back down.
We’re more focused on operating margin improvement, which I still believe will move into the 20s from where we are today. As far as the two week versus the one month, excellent question.
As I sit here today, the discussion continues robustly on that. What are the tradeoffs and should we try to do both or should we go with one and put a lot more energy behind the one?
And if so, which one would it be? The leaning would clearly be towards the two-week.
But there are a variety of considerations that go into that, to and including the amount of capacity we now have on the Biofinity side which kind of says, well there is a lot of capacity there, do you go with a known capacity or not? All I can I say is stay tuned, that debate will continue over the next month to two months and we’ll see where it takes us.
Clearly we are intent on getting the a silicone hydrogel toric out on the market in the first half of the next fiscal year and we are clearly intent on being in production with one and/or two silicone hydrogels by the end of this fiscal year. The third one on CapEx for Asia-Pac, I would say, think of it as ballpark, 20 million a year being pushed out two years, and that would be over multiple years and that was going be in 2009 and would move out beyond 2010.
Jeff Johnson - Robert W. Baird
Okay, great. That’s all I have got guys.
Thanks.
Albert White
Time for one last call. Larry, are you there?
Larry Biegelsen - Wachovia
I wanted to just touch on two things. Just wanted to get a little clarity on some things that are moving around on the balance sheet.
Your other current liabilities were down by about $47 million, long-term debt was up by roughly the same amount, and then your other liabilities were up by $31 million over the last three months. So if you could just point me the direction of what’s moving around with those couple of items?
Steve had spoke that the call outs would be done for this year and certainly tailing off in that second half. I want to make sure that is still the way you are thinking about it?
Robert Weiss
I will take the latter one first and I’ll defer at least one of those to Gene. The call outs, we are still on track to do away with call outs after this fiscal year.
The calls outs are very much weighted in the first six months of this year, so they will be dropping off in the third quarter and the fourth quarter. Part and parcel, that’s what will start driving, increasing GAAP operating income and cash flow.
As far as the liabilities there are two factors in the liabilities. Gene do you want to address the tax one?
Eugene Midlock
Certainly. The biggest change was attributable to FIN 48.
In the past under FAS 109, most companies, if not all, kept their tax uncertainty reserve, their risk reserve in the current liabilities. Under FIN 48 you can almost reflect that as long term to the extent you don’t expect to pay the cash money out in the next 12 months.
So we moved around $19 million plus from short term other current liabilities to long term. The other piece is part of, again, the negative cash flow we experienced in the early part of the year as Bob mentioned that we will hopefully turn around in Q4.
Larry Biegelsen - Wachovia
Right, the PPEs and the inventories, etcetera on the negative cash flow.
Robert Weiss
Negative cash flow is basically off the cash flow statement. Our debt has gone up during the quarter.
Larry Biegelsen - Wachovia
Right. Great.
Thanks so much.
Albert White
Thank you, everyone. That will conclude today’s call.
We appreciate the phone calls and the interest.