COO

Business Context and Reporting Period

Company: The Cooper Companies, Inc. (Cooper)
Filing Type: Form 10-K (Annual Report)
Period Ended: October 31, 2006
Business Overview: Cooper operates two primary business units: CooperVision, Inc. (CVI), a global manufacturer of soft contact lenses, and CooperSurgical, Inc. (CSI), a developer of medical devices for women's healthcare. The company is a large accelerated filer incorporated in Delaware.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net sales increased 6% to $859 million. CVI sales grew 5% (driven by the Ocular acquisition and specialty lens growth), while CSI sales grew 15% (driven by acquisitions of Inlet and NeoSurg).
• Profitability Decline: Operating income decreased 17% to $112.9 million, and Net Income dropped 28% to $66.2 million. Diluted EPS fell 29% to $1.44.
• Margin Compression: Gross margin decreased slightly to 61% due to production start-up costs for silicone hydrogel products and lower margins on single-use lenses. Operating margin declined to 13%.
• One-Time and Non-Recurring Costs: Results were impacted by approximately $66 million in specific costs, including:
  • $13.6 million in stock option expenses (first year of SFAS 123R adoption).
  • $7.5 million write-off of acquired in-process R&D (NeoSurg).
  • $10.1 million in distribution rationalization costs.
  • $12.1 million in other restructuring and integration costs.
  • $8.9 million in losses/costs for phasing out corneal health products.
• Tax Rate: The effective tax rate decreased to 9.7% from 15.4%, primarily due to a higher percentage of income being taxed in lower-rate foreign jurisdictions.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• CVI Strategy: Management expects continued growth in specialty lenses (toric, multifocal) and single-use products. The company is ramping up manufacturing for silicone hydrogel lenses (Biofinity brand), which are critical for long-term competitiveness but currently face manufacturing constraints and litigation risks. Revenue contribution from silicone hydrogel products is not expected until the second half of 2007.
• CSI Strategy: CSI continues to consolidate the women's healthcare market through acquisitions (e.g., Lone Star Medical Products acquired Nov 2006) and organic growth, targeting the hospital and surgical segments.
• Liquidity: The company expects cash from operations and its $750 million credit facility (with $144.4 million available as of Oct 31, 2006) to fund operations, capital expenditures, and smaller acquisitions.

Risks and Contingencies

• Legal Proceedings:
  • Securities Litigation: A consolidated putative securities class action alleges improper accounting for the Ocular acquisition (specifically goodwill allocation) and inflated earnings guidance. The company intends to vigorously defend.
  • Patent Litigation: Active lawsuits with Bausch & Lomb (infringement claims) and CIBA Vision (mutual infringement claims regarding silicone hydrogel and toric lenses).
  • Tax Litigation: Ongoing IRS audit of Ocular's pre-acquisition tax returns (1999-2001) asserting $44.8 million in additional taxes plus penalties.
• Operational Risks:
  • Supply Chain: Reliance on a sole supplier (Asahi) for silicone hydrogel raw materials.
  • Integration: Risks associated with integrating recent acquisitions (Ocular, Inlet, NeoSurg, Lone Star) and IT system implementations.
  • Regulatory: Extensive FDA and foreign regulatory oversight; potential for product recalls or delays in new product approvals.
• Financial Risks: High indebtedness ($742.7 million) limits financial flexibility; exposure to foreign currency fluctuations (Euro, British Pound, Yen).

Investor Verification Checklist

• Goodwill Valuation: Verify the $1.2 billion goodwill balance and the company's defense against the securities class action alleging improper allocation of Ocular assets.
• Silicone Hydrogel Progress: Monitor the ramp-up of Biofinity manufacturing capacity and the resolution of patent litigation with CIBA Vision, as these are critical to future growth.
• Debt Covenants: Review compliance with the credit facility covenants, specifically the debt-to-EBITDA ratio (currently 3.17:1, limit 3.25:1 through Oct 2007).
• Tax Exposure: Assess the potential impact of the IRS audit on Ocular's pre-acquisition years and the utilization of $143.4 million in net operating loss carryforwards.
• Integration Costs: Track the remaining restructuring costs (estimated total $45-50 million for Ocular integration) and their impact on future margins.