Business Context and Reporting Period
Company: The Cooper Companies, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 31, 2006 (Third Quarter of Fiscal Year 2006)
Business Overview: The Company operates two primary business units: CooperVision (CVI), which markets and manufactures contact lenses, and CooperSurgical (CSI), which produces medical devices and surgical instruments for gynecologists and obstetricians. The Company is currently integrating the Ocular Sciences, Inc. acquisition (completed January 2005) and managing the phase-out of corneal health products.
Key Financial Metrics
| Metric | Three Months Ended July 31, 2006 | Nine Months Ended July 31, 2006 |
|---|---|---|
| Net Sales | $225.8 million | $642.9 million |
| Gross Profit | $137.8 million (61% margin) | $398.3 million (62% margin) |
| Operating Income | $32.3 million (14% margin) | $90.5 million (14% margin) |
| Net Income | $21.0 million | $52.6 million |
| Diluted EPS | $0.45 | $1.14 |
| Cash and Equivalents | $12.7 million | $12.7 million (Balance Sheet) |
| Operating Cash Flow (9mo) | N/A | $119.1 million |
| Total Debt | $759.0 million | $759.0 million (Balance Sheet) |
| Working Capital | $203.2 million | $203.2 million (Balance Sheet) |
Material Changes vs. Prior Period
- Revenue: Net sales increased 1% ($2.9 million) in the quarter and 10% ($57 million) year-to-date compared to the prior year. Growth was driven by CooperSurgical (up 17% quarterly, 14% YTD), while CooperVision sales were flat quarterly (down 1%) but up 9% YTD.
- Profitability: Operating income decreased 30% in the quarter and 20% year-to-date. This decline is attributed to increased Selling, General, and Administrative (SGA) expenses, restructuring costs, and stock-based compensation.
- Earnings Per Share: Diluted EPS fell from $0.80 to $0.45 in the quarter and from $1.87 to $1.14 year-to-date, driven by higher expenses and a 5% increase in diluted share count.
- Expenses: SGA expenses rose 11% in the quarter and 19% YTD. Restructuring costs increased significantly, totaling $5.6 million in the quarter and $7.8 million YTD. Research and Development (R&D) expenses increased 71% YTD, largely due to a $7.5 million charge for acquired in-process R&D from the NeoSurg acquisition.
- Balance Sheet: Inventory increased by $40.7 million to $226.4 million, reflecting a build-up for new product launches and distribution center consolidation. Total debt increased to $759.0 million.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Product Strategy: The Company is focusing on launching silicone hydrogel contact lenses and multi-focal lenses. Initial customer reaction to the silicone hydrogel launch in Europe and the U.S. has been favorable, though manufacturing ramp-up costs are impacting margins.
- Portfolio Optimization: In May 2006, the Company decided to phase out corneal health products to focus specifically on contact lenses. Strategic alternatives for these products are being assessed.
- Capital Expenditures: Expected fiscal 2006 capital expenditures are $150-$160 million, primarily for manufacturing capacity expansion (70%), Gen II platform conversion (20%), and IT (10%).
- Liquidity: Management believes cash on hand, operating cash flow, and the $139.6 million available under the syndicated credit facility are sufficient to fund operations, dividends, and smaller acquisitions.
Risks and Contingencies
- Securities Litigation: A consolidated securities class action lawsuit (In re Cooper Companies, Inc. Securities Litigation) alleges improper accounting for the Ocular acquisition, specifically regarding the allocation of $100 million to goodwill versus amortizable intangibles. The Company intends to vigorously defend the matter.
- Derivative Litigation: Multiple shareholder derivative suits allege breach of fiduciary duty and gross mismanagement related to the Ocular acquisition and internal controls.
- Intellectual Property: The Company is involved in patent litigation with Bausch & Lomb regarding toric contact lenses and with CIBA Vision regarding silicone hydrogel patents (Biofinity and O2Optix lines).
- Tax Litigation: The IRS has asserted a deficiency of $44.8 million plus penalties regarding Ocular's tax returns for 1999-2001. The Company contests this, believing the outcome will not be materially adverse.
- Accounting Changes: The adoption of SFAS 123R (Share-Based Payment) in November 2005 resulted in a $11.1 million reduction in pre-tax income for the nine-month period compared to the prior method.
Investor Verification Checklist
- Goodwill Valuation: Verify the Company's defense regarding the $100 million allocation of Ocular assets to goodwill versus amortizable intangibles, as this is central to the pending securities litigation.
- Restructuring Costs: Monitor the execution of the $25-$30 million integration plan for Ocular, specifically the timeline for facility shutdowns and severance payments.
- Silicone Hydrogel Ramp-Up: Assess the timeline and cost efficiency of the new silicone hydrogel manufacturing platform, as delays or inefficiencies could further pressure margins.
- Inventory Levels: Review the justification for the 7.7 months of inventory on hand (up from 7.1) to ensure it aligns with new product launch schedules and does not indicate obsolescence risk.
- Debt Covenants: Confirm compliance with the amended credit facility covenants, specifically the leverage ratio (currently 3.2 to 1) and EBITDA to fixed charges ratio (1.2 to 1).