filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Note numbers refer to “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
RESULTS OF OPERATIONS
We discuss below the results of our operations for fiscal 2014 compared with fiscal 2013 and the results of our operations for fiscal 2013 compared with fiscal 2012. Certain prior period amounts have been reclassified to conform to the current period's presentation. We discuss our cash flows and current financial condition under “Capital Resources and Liquidity.”
Outlook
Overall, we remain optimistic about the long-term prospects for the worldwide contact lens and women’s healthcare markets. However, events affecting the economy as a whole, including the uncertainty and instability of global markets driven by United States and European debt concerns, the Affordable Care Act, including the trend of consolidation within the healthcare industry, and the economic downturn in Japan together with foreign currency volatility, particularly the yen, euro and the pound, impact our current performance and continue to represent a risk to our performance for fiscal year 2015.
CooperVision - We compete in the worldwide contact lens market with our spherical, toric and multifocal contact lenses offered in a variety of materials including using silicone hydrogel Aquaform® technology and phosphorylcholine technology (PC) Technology™. We believe that there will be lower contact lens wearer dropout rates as technology improves and enhances the wearing experience through a combination of improved designs and materials and the growth of preferred modalities such as single-use and monthly wearing options. CooperVision is focused on greater worldwide market penetration as we introduce new products and continue to expand our presence in existing and emerging markets, including through acquisitions.
Sales of contact lenses utilizing silicone hydrogel materials, a major product material in the industry, have grown significantly. Our ability to compete successfully with a full range of silicone hydrogel products is an important factor to achieving our desired future levels of sales growth and profitability. CooperVision markets monthly and two-week silicone hydrogel spherical and toric lens products under our Biofinity® and Avaira® brands, a monthly multifocal silicone hydrogel lens under Biofinity and a single-use spherical silicone hydrogel lens under MyDayTM.
We believe that the global market for single-use contact lenses will continue to grow and that competitive silicone hydrogel single-use products are gaining market share and that they represent a risk to our business. We compete with MyDay, our single-use spherical silicone hydrogel lens, and our Proclear 1 Day products including Proclear® 1 Day multifocal. We forecast increasing demand for our existing and future single-use products. To meet this anticipated demand, in fiscal 2015 we plan to continue the implementation of capital projects to invest in increased single-use manufacturing capacity.
Consistent with this strategy, on August 6, 2014, we acquired Sauflon Pharmaceuticals Limited (Sauflon), a privately-held European manufacturer and distributor of soft contact lenses and aftercare solutions. The acquisition of Sauflon expands our contact lens product portfolio particularly with Sauflon's clariti® 1day brand of single-use sphere, toric and multifocal silicone hydrogel lenses. Clariti lenses received United States FDA clearance in August 2013. Sauflon is headquartered in the United Kingdom and has a global presence with manufacturing facilities in the United Kingdom and Hungary.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
We paid approximately $1,131.1 million for Sauflon, consisting of approximately $1,073.2 million in cash and approximately $58.0 million in the form of loan notes. We financed the acquisition with available offshore cash and credit facilities along with funds from the new $700.0 million term loan facility described below and in the notes to consolidated financial statements. We are in the process of determining the purchase price allocation for this acquisition which is described in more detail in the notes to consolidated financial statements.
The Sauflon acquisition is intended to accelerate the growth in sales of our single-use products by enabling a multi-tier, single-use strategy with a full suite of hydrogel and silicone hydrogel product offerings in the major product categories of sphere, toric and multifocal lenses. This acquisition is also intended to provide for enhanced relationships with key European retailers and opportunities for operational synergies.
CooperSurgical - Our CooperSurgical business competes in the highly fragmented medical device segment of the women's healthcare market. CooperSurgical has steadily grown its market presence and distribution system by developing products and acquiring companies and products that complement its business model. In October 2014, CooperSurgical acquired EndoSee Corporation, a developer of an office-based disposable hysteroscopy system that has FDA clearance. We paid $44.0 million for EndoSee and expect the acquisition to be neutral to earnings per share excluding acquisition costs and related amortization. We intend to continue to invest in CooperSurgical's business through acquisitions of companies and product lines. CooperSurgical product sales are categorized based on the point of healthcare delivery including products used in medical office and surgical procedures by obstetricians and gynecologists (ob/gyns) that represented 65% of CooperSurgical's net sales in fiscal 2014. CooperSurgical's remaining sales are products used in fertility clinics that now represent 35% of CooperSurgical's net sales compared to 33% in fiscal 2013.
Capital Resources - On August 4, 2014, we entered into a three-year, $700.0 million senior unsecured term loan agreement by and among the Company, the lenders party thereto and KeyBank National Association as administrative agent. This syndicated credit facility will mature and the balance is payable on August 4, 2017. There is no amortization of principal and we may prepay loan balances from time to time, in whole or in part, without premium or penalty. We utilized this facility to fund the acquisition of Sauflon Pharmaceuticals Limited, as well as to provide working capital and for general corporate purposes.
At October 31, 2014, we had $25.2 million in cash, primarily outside the United States, and $720.3 million available under our existing revolving Credit Agreement. The $700.0 million term loan entered into on August 4, 2014, and the $300.0 million term loan entered into on September 12, 2013, remain outstanding as of October 31, 2014. In our fiscal fourth quarter of 2014, we completed the acquisition of Sauflon for $1.13 billion, discussed above. Looking forward, our cash and availability under existing credit facilities will be reduced due to the use of cash outside the United States and the use of existing credit facilities to fund the acquisition of Sauflon. We believe that our cash and cash equivalents, cash flow from operating activities and borrowing capacity under existing credit facilities, including the August 4, 2014, $700.0 million term loan, will fund operations both in the next 12 months and in the longer term as well as current and long-term cash requirements for capital expenditures, acquisitions, share repurchases and cash dividends. However, depending on the size or timing of these business activities, we may seek to raise additional debt financing.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
2014 Compared with 2013
Highlights: 2014 vs. 2013
| • | Net sales up 8% to $1.72 billion from $1.59 billion in fiscal year 2013 |
| • | Gross margin 64% of net sales down from 65% |
| • | Operating income up 0.2% to $306.5 million from $305.9 million |
| • | Interest expense down 13% to $8.0 million from $9.2 million |
| • | Diluted earnings per share down 8% to $5.51 from $5.96 |
| • | Operating cash flow $454.8 million up 9% from $415.9 million |
Fiscal 2014 pre-tax results include $35.7 million for amortization of intangible assets and $62.8 million of acquisition, integration and restructuring costs primarily related to the acquisition of Sauflon. We expect amortization of intangible assets will recur in future periods; however, the amounts are affected by the timing and size of our acquisitions. Expenses such as the acquisition related and integration expenses generally diminish over time with respect to past acquisitions. However, we generally will incur similar expenses in connection with any future acquisitions. We incurred significant expenses in connection with our acquisitions and also incurred certain other operating expenses or income, which we generally would not have otherwise incurred in the periods presented as a part of our continuing operations. Many of these costs relate to our acquisition of Sauflon in our fiscal fourth quarter of 2014. Acquisition related and integration expenses consist of personnel related costs for transitional employees, other acquired employee related costs and integration related professional services. Restructuring expenses consist of employee severance, product rationalization, facility and other exit costs.
The fiscal 2014 integration and restructuring costs include $16.5 million in charges to cost of sales primarily for product rationalization arising from the acquisition of Sauflon. The charge for product rationalization is based on our review of products, materials and manufacturing processes of Sauflon. Included in our selling, general and administrative expense (SGA) is $44.5 million in costs for CooperVision's acquisition of Sauflon and the related integration and restructuring activities, severance costs in our CooperSurgical fertility business along with other acquisition costs. Research and development expense includes $0.6 million of severance costs related to integration and restructuring activities.
Fiscal 2013 pre-tax results include $30.2 million for amortization of intangible assets, a $21.1 million loss on divestiture of Aime, $14.1 million of insurance proceeds related to a business interruption claim and $0.6 million of costs, included in SGA expense, related to the acquisition of Origio.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Selected Statistical Information – Percentage of Net Sales
| Years Ended October 31, | 2014 | 2014 vs. 2013 % Change | 2013 | 2013 vs. 2012 % Change | 2012 | |||||||||
| Net sales | 100 | % | 8 | % | 100 | % | 10 | % | 100 | % | ||||
| Cost of sales | 36 | % | 12 | % | 35 | % | 8 | % | 36 | % | ||||
| Gross profit | 64 | % | 6 | % | 65 | % | 11 | % | 64 | % | ||||
| Selling, general and administrative expense | 40 | % | 12 | % | 38 | % | 8 | % | 39 | % | ||||
| Research and development expense | 4 | % | 13 | % | 4 | % | 14 | % | 4 | % | ||||
| Amortization of intangibles | 2 | % | 18 | % | 2 | % | 26 | % | 1 | % | ||||
| Loss on divestiture of Aime | — | — | 2 | % | — | — | ||||||||
| Operating income | 18 | % | 0.2 | % | 19 | % | 8 | % | 20 | % |
Net Sales
Our two business units, CooperVision and CooperSurgical, generate all of our sales.
| • | CooperVision develops, manufactures and markets a broad range of soft contact lenses for the worldwide vision correction market. |
| • | CooperSurgical develops, manufactures and markets medical devices and procedure solutions to improve healthcare delivery to women. |
Net Sales Growth by Business Unit
Our consolidated net sales grew by $130.0 million in fiscal 2014 and $142.6 million in 2013:
| ($ in millions) | 2014 vs. 2013 | % Change | 2013 vs. 2012 | % Change | |||||||||
| CooperVision | $ | 124.3 | 10 | % | $ | 79.1 | 7 | % | |||||
| CooperSurgical | 5.7 | 2 | % | 63.5 | 25 | % | |||||||
| $ | 130.0 | 8 | % | $ | 142.6 | 10 | % |
CooperVision Net Sales
The contact lens market has two major product categories:
| • | Spherical lenses including lenses that correct near- and farsightedness uncomplicated by more complex visual defects. |
| • | Toric and multifocal lenses including lenses that, in addition to correcting near- and farsightedness, address more complex visual defects such as astigmatism and presbyopia by adding optical properties of cylinder and axis, which correct for irregularities in the shape of the cornea. |
In order to achieve comfortable and healthy contact lens wear, products are sold with recommended replacement schedules, often defined as modalities, with the primary modalities being single-use, two-week and monthly. CooperVision offers spherical, aspherical, toric, multifocal and toric multifocal lens products in most modalities.
The contact lens market consists primarily of single-use and frequently replaced lenses. Single-use lenses are designed for daily replacement and frequently replaced lenses are designed for two-week or monthly replacement. Significantly, the market for spherical lenses is growing with value-added spherical lenses to
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
alleviate dry eye symptoms as well as lenses with aspherical optical properties or higher oxygen permeable lenses such as silicone hydrogels.
CooperVision’s Proclear brand aspheric, toric and multifocal contact lenses, manufactured using PC Technology, help enhance tissue/device compatibility and offer improved lens comfort.
CooperVision’s Biofinity brand silicone hydrogel spherical, toric and multifocal contact lenses, Avaira brand spherical and toric products and MyDay, our silicone hydrogel single-use products, are manufactured using proprietary Aquaform technology to increase oxygen transmissibility for longer wear. We believe the clariti single-use silicone hydrogel lens products acquired with Sauflon are important to address increased pressure from multifocal and single-use silicone hydrogel products offered by our major competitors.
CooperVision fiscal 2014 net sales increased 10% from fiscal 2013 to $1.4 billion including Sauflon's net sales, subsequent to the acquisition, of $49.7 million. CooperVision net sales growth included increases in total sphere lenses up 9%, representing 56% of net sales, the same as the prior year, and total toric lenses up 11%, representing 31% of net sales, the same as in the prior year. Total multifocal lenses grew 21% to 11% of net sales up from 10% in the prior year on increased sales of Biofinity monthly and Proclear single-use multifocal products. Total silicone hydrogel products, including MyDay, our single-use silicone hydrogel lens, and Sauflon's silicone hydrogel products, including clariti, grew 27%, representing 49% of net sales up from 43% in the prior year. Excluding Sauflon, silicone hydrogel products grew 21%. Proclear product sales grew 6% and represented 24% of net sales compared to 25% in the prior year. CooperVision's older conventional lens products, including cosmetic lenses, declined 12% and now represent 2% of net sales compared to 3% in the prior year. The year over year comparison of net sales also reflects no sales in fiscal 2014 of Aime products, divested on October 31, 2013, as compared to $25.8 million of net sales in fiscal 2013.
CooperVision competes in the worldwide soft contact lens market and services three primary regions: the Americas, EMEA (Europe, Middle East and Africa) and Asia Pacific.
CooperVision Net Sales by Geography
| ($ in millions) | 2014 | 2013 | % Change | |||||||
| Americas | $ | 585.2 | $ | 546.2 | 7 | % | ||||
| EMEA | 533.9 | 439.4 | 22 | % | ||||||
| Asia Pacific | 273.5 | 282.7 | (3 | )% | ||||||
| $ | 1,392.6 | $ | 1,268.3 | 10 | % |
CooperVision’s worldwide net sales grew 10% in the year-to-year comparison, including Sauflon as discussed above. Americas net sales grew 7%, primarily due to market gains of CooperVision’s silicone hydrogel contact lenses along with single-use sphere and multifocal products. EMEA net sales increased 22% primarily driven by increased sales of silicone hydrogel lenses including Sauflon's silicone hydrogel single-use products. Net sales to the Asia Pacific region decreased 3% due to the negative impact of the weakening of the Japanese yen compared to the United States dollar. Excluding the impact of currency, sales in the Asia Pacific region grew on market gains of silicone hydrogel lenses and single-use products, including Proclear multifocal single-use lenses.
CooperVision’s net sales growth was driven primarily by increases in the volume of lenses sold, including recently introduced silicone hydrogel products and products from the acquisition of Sauflon. While unit growth and product mix have influenced CooperVision’s sales growth, average realized prices by product have not materially influenced sales growth.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
CooperSurgical Net Sales
CooperSurgical participates in the market for women's healthcare with its diversified product lines used in fertility procedures and by gynecologists and obstetricians in surgical procedures and in the medical office. With the July 2012 acquisition of Origio a/s, a global in-vitro fertilization (IVF) medical device company, CooperSurgical develops, manufactures and distributes highly specialized products that target IVF treatment with a goal to make fertility treatment safer, more efficient and convenient.
| Year Ended October 31, ($ in millions) | 2014 | % Net Sales | 2013 | % Net Sales | % Change | ||||||||||||
| Office and surgical procedures | $ | 211.9 | 65 | % | $ | 213.4 | 67 | % | (1 | )% | |||||||
| Fertility | 113.2 | 35 | % | 106.0 | 33 | % | 7 | % | |||||||||
| $ | 325.1 | 100 | % | $ | 319.4 | 100 | % | 2 | % |
CooperSurgical's net sales of fertility products increased primarily due to market gains of disposable products partially offset by slower growth in sales of medical equipment. The decline in net sales of medical office and surgical procedures by ob/gyns was primarily due to declines in sales of medical equipment offset in part by growth in sales of disposable products.
CooperSurgical’s sales primarily comprise women’s healthcare products used in fertility procedures and by gynecologists and obstetricians in surgical procedures and in the medical office. The balance consists of sales of medical devices outside of women’s healthcare which CooperSurgical does not actively market. Unit growth and product mix, primarily sales of fertility products, along with increased average realized prices on disposable products influenced sales growth.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
2013 Compared with 2012
Highlights: 2013 vs. 2012
| • | Net sales up 10% to $1.6 billion from $1.4 billion in fiscal year 2012 |
| • | Gross margin 65% of net sales up from 64% |
| • | Operating income up 8% to $305.9 million from $283.4 million |
| • | Interest expense down 22% to $9.2 million from $11.8 million |
| • | Diluted earnings per share up 18% to $5.96 from $5.05 |
| • | Operating cash flow $415.9 million up 32% from $315.1 million |
Fiscal 2013 pre-tax results included $30.2 million for amortization of intangible assets, a $21.1 million loss on divestiture of Aime, $14.1 million of insurance proceeds related to a business interruption claim and $0.6 million of costs related to the acquisition of Origio.
Fiscal 2012 pre-tax results included $24.0 million for amortization of intangible assets, a $1.4 million loss related to the May 31, 2012, amendment to our revolving Credit Agreement, and costs related to the acquisition of Origio consisting of $4.9 million in direct acquisition costs and a $0.4 million net gain related to the repayment of debt acquired recorded in interest expense.
Selected Statistical Information – Percentage of Net Sales
| Years Ended October 31, | 2013 | 2013 vs. 2012 % Change | 2012 | 2012 vs. 2011 % Change | 2011 | |||||||||
| Net sales | 100 | % | 10 | % | 100 | % | 9 | % | 100 | % | ||||
| Cost of sales | 35 | % | 8 | % | 36 | % | (1 | )% | 40 | % | ||||
| Gross profit | 65 | % | 11 | % | 64 | % | 15 | % | 60 | % | ||||
| Selling, general and administrative expense | 38 | % | 8 | % | 39 | % | 10 | % | 38 | % | ||||
| Research and development expense | 4 | % | 14 | % | 4 | % | 19 | % | 3 | % | ||||
| Amortization of intangibles | 2 | % | 26 | % | 1 | % | 17 | % | 2 | % | ||||
| Loss on divestiture of Aime | 2 | % | — | — | — | — | ||||||||
| Operating income | 19 | % | 8 | % | 20 | % | 25 | % | 17 | % |
Net Sales Growth by Business Unit
Our consolidated net sales grew by $142.6 million in fiscal 2013 and $114.3 million in 2012:
| ($ in millions) | 2013 vs. 2012 | % Change | 2012 vs. 2011 | % Change | |||||||||
| CooperVision | $ | 79.1 | 7 | % | $ | 68.1 | 6 | % | |||||
| CooperSurgical | 63.5 | 25 | % | 46.2 | 22 | % | |||||||
| $ | 142.6 | 10 | % | $ | 114.3 | 9 | % |
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
CooperVision Net Sales
CooperVision fiscal 2013 net sales growth included increases in total sphere lenses up 4%, representing 56% of net sales and total toric lenses up 9%, representing 31% of net sales. Total multifocal lenses grew 29% to 10% of net sales up from 8% in the prior year on increased sales of Biofinity monthly and Proclear single-use multifocal products. Silicone hydrogel products, including MyDay, our single-use silicone hydrogel lens, grew 26% worldwide, representing 43% of net sales up from 36% in the prior year. Proclear product sales grew 6% as compared to the prior year and represented 25% of net sales, the same as the prior year. Older conventional lens products, including cosmetic lenses, declined 12% and represented 3% of net sales, the same as the prior year.
CooperVision competes in the worldwide soft contact lens market and services three primary regions: the Americas, EMEA (Europe, Middle East and Africa) and Asia Pacific.
CooperVision Net Sales by Geography
| ($ in millions) | 2013 | 2012 | % Change | |||||||
| Americas | $ | 546.2 | $ | 498.9 | 9 | % | ||||
| EMEA | 439.4 | 402.3 | 9 | % | ||||||
| Asia Pacific | 282.7 | 288.0 | (2 | )% | ||||||
| $ | 1,268.3 | $ | 1,189.2 | 7 | % |
CooperVision’s fiscal 2013 worldwide net sales grew 7% in the year-to-year comparison. Americas net sales grew 9%, primarily due to market gains of CooperVision’s silicone hydrogel contact lenses along with single-use sphere and multifocal products. EMEA net sales increased 9% primarily driven by sales of silicone hydrogel lenses and single-use sphere and multifocal products. Net sales to the Asia Pacific region decreased 2% due to the negative impact of the weakening of the Japanese yen compared to the United States dollar. Excluding the impact of currency, sales in the Asia Pacific region grew on market gains of silicone hydrogel lenses and single-use products.
CooperVision’s net sales growth was driven primarily by increases in the volume of lenses sold and introduction of new products, primarily silicone hydrogel lenses. While unit growth and product mix have influenced CooperVision’s sales growth, average realized prices by product have not materially influenced sales growth.
CooperSurgical Net Sales
CooperSurgical’s fiscal 2013 net sales increased 25% from fiscal 2012 to $319.4 million with net sales growth excluding acquisitions of 3%. Sales of products used in fertility clinics now represent 33% of net sales compared to 16% in the prior year due to the acquisition of Origio in July 2012. Sales of products used in medical office and surgical procedures by ob/gyns declined 1% as compared to the prior year and now represent 67% of CooperSurgical's net sales compared to 84% in the prior year. CooperSurgical’s sales primarily comprise women’s healthcare products used in fertility procedures and by gynecologists and obstetricians in surgical procedures and in the medical office. The balance consists of sales of medical devices outside of women’s healthcare which CooperSurgical does not actively market. Unit growth and product mix, primarily sales of fertility products, along with increased average realized prices on disposable products influenced organic sales growth.
Acquisition of Origio: On July 11, 2012, we completed a voluntary tender offer for the outstanding shares of Origio a/s at a purchase price of Norwegian krone (NOK) 28 per share in cash, or $147.4 million, and acquired about 97% of the outstanding shares. During our fiscal fourth quarter of 2012 and our fiscal first
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
quarter of 2013, we completed a mandatory redemption to obtain the remaining shares in accordance with the Danish Companies Act. We, through our subsidiaries, financed the acquisition with available offshore cash and credit facilities. Origio is a global in-vitro fertilization (IVF) medical device company that develops, manufactures and distributes highly specialized products that target IVF treatment with a goal to make fertility treatment safer, more efficient and convenient. Based in Malov, Denmark, Origio had approximately 320 employees. We assumed about $45.4 million of Origio's debt that we repaid concurrent with the acquisition. Our allocation of the purchase price at fair value included amortizable intangible assets of $107.7 million and goodwill of $103.7 million. We incurred $4.9 million of acquisition costs which were primarily reported as selling, general and administrative expense in our Consolidated Statement of Income. See Note 2 for additional information.
2014 Compared to 2013 and 2013 Compared to 2012
Cost of Sales/Gross Profit
| Gross Profit Percentage of Net Sales | 2014 | 2013 | 2012 | |||||
| CooperVision | 63 | % | 65 | % | 63 | % | ||
| CooperSurgical | 64 | % | 64 | % | 66 | % | ||
| Consolidated | 64 | % | 65 | % | 64 | % |
The decrease in CooperVision's gross margin was primarily attributable to acquisition-related items, start-up costs of MyDay, our single-use silicone hydrogel contact lens, and the effects of foreign currency changes. Sales of lower gross margin products from the August 2014 acquisition of Sauflon represented 4% of net sales in the year, and we expect Sauflon gross margin to be about mid-fifty percent in the near term. Gross margin was negatively impacted by inventory and equipment charges to rationalize products, primarily our Avaira toric contact lenses, based on our review of Sauflon's products, materials and manufacturing processes. Gross margin was also impacted by start-up costs of MyDay as this new product has only recently achieved low double-digit gross margin that includes the impact of building new manufacturing capacity. Foreign currency unfavorably impacted gross margin as we reported lower net sales on products sold in Japan due to the weakening of the Japanese yen as compared to the United States dollar, particularly in our fiscal fourth quarter of 2014. The decreases in gross margin were partially offset by the increase in sales of higher margin Biofinity products and the favorable impact on gross margin due to the divestiture of Aime in October 2013.
CooperSurgical's gross margin remained flat for fiscal 2014 as compared to fiscal 2013 primarily due to favorable product mix, offset by restructuring costs in the fertility business. A greater percentage of our sales were higher margin disposable products and the percentage of lower margin equipment sales within fertility products declined as well.
Selling, General and Administrative Expense (SGA)
| ($ in millions) | 2014 | % Net Sales | % Change | 2013 | % Net Sales | % Change | 2012 | % Net Sales | ||||||||||||||||||
| CooperVision | $ | 518.2 | 37 | % | 16 | % | $ | 448.2 | 35 | % | 3 | % | $ | 433.5 | 36 | % | ||||||||||
| CooperSurgical | 113.4 | 35 | % | (4 | )% | 118.5 | 37 | % | 27 | % | 93.0 | 36 | % | |||||||||||||
| Corporate | 51.5 | — | 17 | % | 44.0 | — | 15 | % | 38.4 | — | ||||||||||||||||
| $ | 683.1 | 40 | % | 12 | % | $ | 610.7 | 38 | % | 8 | % | $ | 564.9 | 39 | % |
Consolidated SGA increased to 40% of net sales in fiscal 2014 from 38% of net sales in fiscal 2013 and 39% of net sales in fiscal 2012.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The increase in CooperVision's SGA in fiscal 2014 compared to fiscal 2013 in absolute dollars and as a percentage of net sales is primarily due to operating expenses of Sauflon and approximately $42.3 million of acquisition, restructuring and integration costs, largely made up of legal fees, professional fees and severance costs expensed in fiscal 2014. In addition to the acquisition and integration activities related to Sauflon, CooperVision continues to invest in sales and marketing to promote our silicone hydrogel products, including MyDay, to reach new customers and support geographic expansion.
The 3% increase in CooperVision's SGA in fiscal 2013 compared to fiscal 2012 in absolute dollars is primarily due to our investment in sales and marketing, including increased headcount, to reach new customers and support geographic expansion. Programs included the promotion of our silicone hydrogel products, including MyDay, our single-use spherical silicone hydrogel lens, and Proclear 1 Day multifocal in Japan.
The decrease in CooperSurgical's SGA in fiscal 2014 compared to fiscal 2013 in absolute dollars and as a percentage of net sales is primarily due to efficiencies as a result of cost control measures in fiscal 2014 and costs included in fiscal 2013 for acquisition and integration activities related to Origio. CooperSurgical continues to invest in sales activities to promote our products, with emphasis on products used in surgical procedures, and to reach new customers. The medical excise tax that became effective on January 1, 2013, on sales of CooperSurgical's products in the United States was $2.9 million in fiscal 2014 compared to $2.4 million in fiscal 2013.
The 27% increase in CooperSurgical's SGA in absolute dollars in fiscal 2013 as compared to fiscal 2012 and the increase as a percentage of net sales is primarily due to operating expenses related to Origio, including approximately $0.6 million of acquisition costs in fiscal 2013.
Corporate headquarters’ SGA increased 17% in absolute dollars in fiscal 2014 primarily due to increased share-based compensation costs and acquisition-related professional service costs. The 15% growth in absolute dollars in fiscal 2013 as compared to fiscal 2012 was primarily due to increased share-based compensation costs.
Research and Development Expense (R&D)
| ($ in millions) | 2014 | % Net Sales | % Change | 2013 | % Net Sales | % Change | 2012 | % Net Sales | ||||||||||||||||||
| CooperVision | $ | 52.3 | 4 | % | 13 | % | $ | 46.4 | 4 | % | 10 | % | $ | 42.3 | 4 | % | ||||||||||
| CooperSurgical | 14.0 | 4 | % | 12 | % | 12.4 | 4 | % | 32 | % | 9.4 | 4 | % | |||||||||||||
| $ | 66.3 | 4 | % | 13 | % | $ | 58.8 | 4 | % | 14 | % | $ | 51.7 | 4 | % |
The sequential increases in CooperVision's R&D in absolute dollars over the fiscal years presented are primarily due to investments in new technologies, clinical trials and increased headcount. CooperVision’s R&D activities are primarily focused on the development of new contact lens designs and now include Sauflon's R&D activities related to product and manufacturing improvements and new contact lens designs.
The sequential increases in CooperSurgical's R&D in absolute dollars over the fiscal years presented include the shift toward investment in projects to develop new products along with the upgrade of existing products. CooperSurgical's research and development activities include in-vitro fertilization product development and the design and upgrade of surgical procedure devices.
Divested Operation
On October 31, 2013, we completed a transaction to sell Aime, our rigid gas-permeable contact lens and solutions business in Japan, to Nippon Contact Lens Inc. The business was originally obtained as part of the December 1, 2010, acquisition which included obtaining the rights to market Biofinity in Japan. The divestiture was consistent with CooperVision’s strategy to focus on its core soft contact lens business.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Additionally, Aime revenue had declined in recent periods, and the products had lower than average company margins.
We recorded a pre-tax loss of approximately $21.1 million in our Consolidated Statement of Income for fiscal 2013. Results from operations of Aime are included in our Consolidated Statements of Income for fiscal 2013 and 2012, and we have not segregated the results of operations or net assets of Aime on our financial statements for any period presented. The disposition of the assets and liabilities of Aime did not qualify for classification as discontinued operations as CooperVision maintains continuing involvement through a distribution arrangement with Aime for a minimum of three years post divestiture.
Amortization of Intangibles
Amortization of intangibles was $35.7 million in fiscal 2014, $30.2 million in fiscal 2013 and $24.0 million in fiscal 2012. The 18% increase in fiscal 2014 as compared to fiscal 2013 and the 26% increase in fiscal 2013 as compared to fiscal 2012 were primarily due to intangible assets from acquisitions primarily the acquisition of Sauflon in August 2014 and Origio in July 2012. We expect amortization in fiscal 2015 to be approximately $13.7 million in the fiscal first quarter and $12.8 million in each of the fiscal second through fourth quarters primarily due to intangible assets acquired with Sauflon, offset by intangible assets related to acquired technology which will become fully amortized.
Settlements
On December 2, 2011, CooperVision and Rembrandt Vision Technologies, L.P. entered into a settlement agreement under which CooperVision agreed to make a lump sum payment of $10.0 million to Rembrandt, and Rembrandt executed a covenant not to sue regarding patent infringement claims. We recorded a charge in selling, general and administrative expense for the settlement in our fiscal fourth quarter of 2011.
Operating Income
Operating income grew about $0.6 million in fiscal 2014 from fiscal 2013 and increased $22.5 million or 8% in fiscal 2013 from fiscal 2012.
| ($ in millions) | 2014 | % Net Sales | 2014 vs. 2013 % Change | 2013 | % Net Sales | 2013 vs. 2012 % Change | 2012 | % Net Sales | ||||||||||||||||||
| CooperVision | $ | 289.0 | 21 | % | — | $ | 289.3 | 23 | % | 10 | % | $ | 262.8 | 22 | % | |||||||||||
| CooperSurgical | 69.0 | 21 | % | 14 | % | 60.6 | 19 | % | 3 | % | 59.0 | 23 | % | |||||||||||||
| Corporate | (51.5 | ) | — | (17 | )% | (44.0 | ) | — | (15 | )% | (38.4 | ) | — | |||||||||||||
| $ | 306.5 | 18 | % | 0.2 | % | $ | 305.9 | 19 | % | 8 | % | $ | 283.4 | 20 | % |
The consolidated operating income in fiscal 2014 remained flat as compared to fiscal 2013 primarily due to the increase in gross profit of 6%, offset by the increase in operating expenses of 9%. The decreases in consolidated and CooperVision operating income as a percentage of sales in fiscal 2014 as compared to fiscal 2013 was due to the acquisition, restructuring and integration costs primarily related to Sauflon, discussed above, recorded in cost of sales and operating expenses. CooperSurgical's operating income in fiscal 2014 increased in absolute dollars and as a percentage of net sales due to the increase of gross profit of 2% and decrease of total operating expense of 3%.
The increase in consolidated operating income in fiscal 2013 as compared to fiscal 2012 in absolute dollars was primarily due to the increase in gross profit of 11%, partially offset by the increase in operating expenses of 13%. The decrease in consolidated operating income as a percentage of sales in fiscal 2013 as compared to fiscal 2012 was primarily due to the $21.1 million loss on divestiture of Aime, discussed above, recorded in operating expenses for CooperVision.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Interest Expense
Interest expense decreased 13% to $8.0 million in fiscal 2014 representing 0.5% of net sales in fiscal 2014 as compared to 0.6% of net sales in fiscal 2013. The fiscal 2014 decrease reflects lower average debt and lower average interest rates in the current fiscal year. We expect to have higher interest expense in the near term on higher average debt as a result of debt incurred in connection with the August 2014 acquisition of Sauflon. The $700.0 million term loan, entered into on August 4, 2014 and discussed above, the $300.0 million term loan, entered into on September 12, 2013, as well as about $279.7 million drawn on our existing revolving Credit Agreement were outstanding as of October 31, 2014 compared to $300.2 million in debt outstanding as of October 31, 2013.
Interest expense decreased 22% to $9.2 million in fiscal 2013 constituting 0.6% of net sales in fiscal 2013 as compared to 0.8% of net sales in fiscal 2012. The fiscal 2013 decrease reflects lower average debt and lower average interest rates.
Insurance Proceeds
On October 28, 2011, a manufacturing building in the United Kingdom experienced an incident in which a pipe broke in our fire suppression system, causing water and fire retardant foam damage to the facility. While this incident did not substantially impact our existing customers, the repairs to the facility and resultant decrease in manufacturing capacity impacted the timing of marketing initiatives to generate additional sales. In January 2013, we resolved our business interruption claim with our insurer for a total of $19.1 million. We received payments of $5.0 million in our fiscal fourth quarter of 2012. In our fiscal first quarter of 2013, we recorded the remaining $14.1 million in our Consolidated Statement of Income of which we received payment of $2.9 million during the fiscal first quarter of 2013 and payment of the remaining $11.2 million in the fiscal second quarter of 2013.
Losses on Extinguishment of Debt
In fiscal 2012, we recorded a $1.4 million loss related to the amendment to our revolving Credit Agreement on May 31, 2012.
Other Expense (Income), Net
| Years Ended October 31, (In millions) | 2014 | 2013 | 2012 | ||||||||
| Foreign exchange loss (gain) | $ | 2.9 | $ | (0.1 | ) | $ | 1.5 | ||||
| Other, net | (0.9 | ) | (1.3 | ) | (1.7 | ) | |||||
| $ | 2.0 | $ | (1.4 | ) | $ | (0.2 | ) |
The fiscal 2014 foreign exchange loss includes a loss of $1.1 million on forward contracts related to the acquisition of Sauflon.
Provision for Income Taxes
We recorded income tax expense of $24.7 million in fiscal 2014 compared to $15.4 million in fiscal 2013. Our effective tax rate (ETR) (provision for income taxes divided by pretax income) for fiscal 2014 was 8.3% and 4.9% for fiscal 2013. The increase in the ETR in fiscal 2014 reflects the inclusion in the fiscal 2013 ETR of several discrete items causing a reduction in that year. These items related primarily to the statutory income tax rate reduction in the United Kingdom and the renewal of the R&D tax credit in the United States.
The ETR is below the United States statutory rate as a majority of our income is earned in foreign jurisdictions with lower tax rates reflecting the shift in the geographic mix of income during recent periods with income
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
earned in foreign jurisdictions increasing as compared to income earned in the United States. As a result, the ratio of domestic income to worldwide income has decreased over recent fiscal years effectively lowering the overall tax rate due to the fact that the tax rates in the majority of foreign jurisdictions where we operate are significantly lower than the statutory rate in the United States.
The impact on our provision for income taxes of income earned in foreign jurisdictions being taxed at rates different than the United States federal statutory rate was a benefit of approximately $85.5 million and a foreign effective tax rate of approximately 2.6% in our fiscal year 2014 compared to $97.0 million and a foreign effective tax rate of approximately 0.6% in our fiscal year 2013. The foreign jurisdictions with lower tax rates as compared to the United States federal statutory rate that had the most significant impact on our provision for foreign income taxes in the fiscal years presented include the United Kingdom, Barbados and Puerto Rico. See the notes to consolidated financial statements for additional information.
Share Repurchases
In December 2011, our Board of Directors authorized a share repurchase program and subsequently amended the total repurchase authorization to $500.0 million. The program has no expiration date and may be discontinued at any time. During fiscal 2014, we repurchased 572 thousand shares of our common stock for $75.8 million at an average purchase price of $132.49 per share. During fiscal 2013, we repurchased 1.4 million shares of our common stock for $167.3 million at an average purchase price of $117.78 per share. At October 31, 2014, we had remaining authorization to repurchase about $185.7 million of our common stock. See the notes to consolidated financial statements for additional information.
Share-Based Compensation Plans
We grant various share-based compensation awards, including stock options, performance shares, restricted stock and restricted stock units. The share-based compensation and related income tax benefit recognized in the consolidated financial statements in fiscal 2014 was $38.7 million and $11.7 million, respectively, compared to $30.4 million and $8.8 million, respectively, in fiscal 2013. As of October 31, 2014, there was $54.0 million of total unrecognized share-based compensation cost related to non-vested awards: $4.9 million for stock options; $40.9 million for restricted stock units; and $8.2 million for performance shares. The unrecognized compensation is expected to be recognized over weighted average remaining vesting periods of 3.0 years for nonvested stock options, 3.4 years for restricted stock units and 1.6 years for performance shares. Cash received from options exercised under all share-based compensation arrangements for fiscal 2014, 2013 and 2012 was $8.6 million, $19.3 million and $55.1 million, respectively.
We estimate the fair value of each stock option award on the date of grant using the Black-Scholes valuation model, which requires management to make estimates regarding expected option life, stock price volatility and other assumptions. The use of different assumptions could lead to a different estimate of fair value. The expected life of the stock option is based on the observed and expected time to post-vesting forfeiture and/or exercise. Groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. If our assumption for the expected life increased by one year, the fair value of an individual option granted in fiscal 2014 would have increased by approximately $3.50. To determine the stock price volatility, management considers implied volatility from publicly-traded options on the Company's stock at the date of grant, historical volatility and other factors. If our assumption for stock price volatility increased by one percentage point, the fair value of an individual option granted in fiscal 2014 would have increased by less than $1.
We estimate stock option forfeitures based on historical data for each employee grouping and adjust the rate of expected forfeitures periodically. The adjustment of the forfeiture rate will result in a cumulative catch-up adjustment in the period the forfeiture estimate is changed.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
We grant performance units that provide for the issuance of common stock to certain executive officers and other key employees if the Company achieves specified long-term performance goals over a three-year period. We estimate the fair value of each award on the date of grant based on the current market price of our common stock. The total amount of compensation expense recognized reflects our initial assumptions of the achievement of the performance goals and the estimated forfeiture rates. We review our assessment of the probability of the achievement of the performance goals each fiscal quarter. If the goals are not achieved or it is determined that achievement of the goals is not probable, previously recognized compensation expense is adjusted to reflect the expected achievement. If we determine that achievement of the goals will exceed the original assessment, additional compensation expense is recognized.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAPITAL RESOURCES AND LIQUIDITY
2014 Highlights
| • | Operating cash flow $454.8 million up from $415.9 million in fiscal 2013 |
| • | Expenditures for purchases of property, plant and equipment $238.1 million up from $178.1 million in fiscal 2013 |
| • | Cash payments for acquisitions, primarily Sauflon, totaled $1.1 billion compared to $13.3 million in fiscal 2013 |
| • | Total debt increased to $1.4 billion at the end of fiscal 2014 from $344.7 million at the end of fiscal 2013 |
Comparative Statistics
| Years Ended October 31, ($ in millions) | 2014 | 2013 | |||||
| Cash and cash equivalents | $ | 25.2 | $ | 77.4 | |||
| Total assets | $ | 4,458.3 | $ | 3,137.3 | |||
| Working capital | $ | 349.4 | $ | 426.0 | |||
| Total debt | $ | 1,382.4 | $ | 344.7 | |||
| Stockholders’ equity | $ | 2,588.4 | $ | 2,423.5 | |||
| Ratio of debt to equity | 0.53:1 | 0.14:1 | |||||
| Debt as a percentage of total capitalization | 35 | % | 12 | % |
Working Capital
Working capital in fiscal 2014 includes $55.1 million of loan notes issued related to the acquisition of Sauflon. Excluding these loan notes that are reported in short-term debt, the decrease in working capital at the end of fiscal 2014 from the end of fiscal 2013 was primarily due to the decrease in cash and increases in accounts payable and short term debt. This decrease was partially offset by increases in accounts receivable and inventories.
The $42.6 million increase in inventory was primarily related to $38.3 million of inventory at Sauflon, acquired in August 2014, and the increased production of single-use lenses including MyDay, our single-use silicone hydrogel contact lens. At October 31, 2014, our inventory months on hand (MOH) were 6.6, after adjusting for product rationalization costs related to the acquisition of Sauflon, representing a decrease from 6.9 at October 31, 2013. Our unadjusted inventory MOH at October 31, 2014 were 6.1. The $46.7 million increase in trade accounts receivable was primarily related to Sauflon's $38.4 million accounts receivable balance at October 31, 2014, and timing of collections. Our days sales outstanding (DSO) remained at 53 days at October 31, 2013, the same as at October 31, 2013.
We have reviewed our needs in the United States for possible repatriation of undistributed earnings or cash of our foreign subsidiaries. We presently intend to continue to indefinitely invest all earnings and cash outside of the United States of all foreign subsidiaries to fund foreign investments or meet foreign working capital and property, plant and equipment requirements.
Operating Cash Flow
Cash flow provided by operating activities in fiscal 2014 continued to be our major source of liquidity, at $454.8 million compared to $415.9 million in fiscal 2013 and $315.1 million in fiscal 2012. Fiscal 2014 results include $271.8 million of net income and non-cash items primarily made up of $138.2 million related to depreciation and amortization, $36.5 million of expense and $19.3 million of excess tax benefits both
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
related to share-based compensation, $20.3 million related to gain in currency translation and $8.0 million related to impairment of property, plant and equipment. Results also include changes in operating assets and liabilities, which primarily reflect the increases in accounts receivable, inventories and other assets of $8.7 million, the increases in accounts payable and other liabilities of $41.1 million, and the increase of $2.1 million relating to taxes. The $38.9 million increase in cash flow provided by operations in fiscal 2014 as compared to fiscal 2013 is primarily due to favorable changes in working capital.
For fiscal 2014, our primary source of cash flows provided by operating activities was cash collections from our customers for purchase of our products. Our primary uses of cash flows from operating activities were for personnel and material costs along with cash payments of $4.1 million for interest.
For fiscal 2013, our primary source of cash flows provided by operating activities was cash collections from our customers for purchase of our products and the $14.1 million for insurance proceeds received. Our primary uses of cash flows from operating activities were for personnel and material costs along with cash payments of $5.4 million for interest.
Investing Cash Flow
Cash used in investing activities of $1,346.4 million in fiscal 2014 was for payments of $1,109.7 million related to acquisitions, primarily the acquisition of Sauflon, and capital expenditures of $238.1 million, primarily to increase manufacturing capacity, partially offset by the $1.4 million insurance recovery related to facility repairs. We forecast increasing demand for our existing and future single-use products. To meet this anticipated demand, in fiscal 2015 we plan to continue the implementation of capital projects to invest in increased single-use manufacturing capacity.
Cash used in investing activities of $189.9 million in fiscal 2013 was for capital expenditures of $178.1 million, primarily to increase manufacturing capacity, and payments of $13.3 million related to acquisitions, partially offset by the $1.3 million insurance recovery related to facility repairs.
Financing Cash Flow
The changes in cash flows from financing activities primarily relate to borrowings and payments of debt as well as share repurchases and share-based compensation awards. Cash provided by financing activities of $842.2 million in fiscal 2014 was driven by $887.9 million from net borrowings of debt, $19.3 million in excess tax benefits from share-based compensation awards, $12.2 million of proceeds from a construction allowance and $8.6 million of proceeds from exercise of share-based compensation awards. Cash provided by financing activities was partially offset by $75.8 million in payments for share repurchases under our share repurchase plan, a $3.8 million payment for contingent consideration, $2.9 million for dividends, $2.4 million of distributions to noncontrolling interests, and $0.9 million of debt acquisition costs associated with obtaining the new term loan.
In fiscal 2013, the changes in cash flows from financing activities primarily related to borrowings and payments of debt as well as share repurchases and share-based compensation awards. Cash used in financing activities of $161.6 million in fiscal 2013 was driven by $25.8 million for net repayments of debt, $167.3 million in payments for share repurchases under our share repurchase plan, $5.2 million to purchase Origio shares and other distributions to noncontrolling interests, a $3.6 million payment for contingent consideration and $2.9 million for dividends. Cash used in financing activities was partially offset by $37.4 million from the exercise of share-based compensation awards and $5.9 million from a construction allowance.
At October 31, 2014, we had $25.2 million in cash, primarily outside the United States, and $720.3 million available under our existing revolving Credit Agreement. The $700.0 million term loan entered into on August 4, 2014, and the $300.0 million term loan entered into on September 12, 2013, remain outstanding as of October 31, 2014. We are in compliance with our financial covenants including the Interest Coverage
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Ratio at 70.49 to 1.00 and the Total Leverage Ratio at 2.45 to 1.00. As defined, in both the Credit Agreement and term loans, the Interest Coverage Ratio is the ratio of Consolidated Proforma EBITDA to Consolidated Interest Expense with the requirement to be at least 3.00 to 1.00 and the Total Leverage Ratio is the ratio of Consolidated Funded Indebtedness to Consolidated Proforma EBITDA with the requirement to be no higher than 3.75 to 1.00.
OFF BALANCE SHEET ARRANGEMENTS
None.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
As of October 31, 2014, we had the following contractual obligations and commercial commitments:
| Payments Due by Period (In millions) | Total | 2015 | 2016 & 2017 | 2018 & 2019 | 2020 & Beyond | ||||||||||||||
| Contractual obligations: | |||||||||||||||||||
| Long-term debt | $ | 1,280.8 | $ | — | $ | 980.1 | $ | 300.4 | $ | 0.3 | |||||||||
| Interest payments | 36.9 | 12.7 | 22.1 | 2.1 | — | ||||||||||||||
| Operating leases | 157.1 | 25.3 | 39.8 | 31.3 | 60.7 | ||||||||||||||
| Contingent consideration | 3.0 | 0.5 | 1.0 | 1.0 | 0.5 | ||||||||||||||
| Total contractual obligations | 1,477.8 | 38.5 | 1,043.0 | 334.8 | 61.5 | ||||||||||||||
| Commercial commitments: | |||||||||||||||||||
| Stand-by letters of credit | 2.9 | 2.9 | — | — | — | ||||||||||||||
| Total | $ | 1,480.7 | $ | 41.4 | $ | 1,043.0 | $ | 334.8 | $ | 61.5 |
The expected future benefit payments for pension plans through 2024 are disclosed in Note 10. Employee Benefits.
We are unable to reliably estimate the timing of future payments related to uncertain tax positions; therefore, about $35.5 million of our long-term income taxes payable have been excluded from the table above. However, other long-term liabilities, included in our consolidated balance sheet, include these uncertain tax positions. See Note 6 for additional information.
Inflation and Changing Prices
Inflation has had no appreciable effect on our operations in the last three fiscal years.
Accounting Pronouncements Issued and Not Yet Adopted
In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. When a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available, or the entity does not intend to use the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. We do not anticipate the adoption of these amendments, which are effective for the
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Company for the fiscal year beginning on November 1, 2014, will have a material impact on our consolidated results of operations, financial condition or cash flows.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 sets forth a new revenue recognition model that requires identifying the contract, identifying the performance obligations, determining the transaction price, allocating the transaction price to performance obligations and recognizing the revenue upon satisfaction of performance obligations. The amendments in the ASU can be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the update recognized at the date of the initial application along with additional disclosures. We are currently evaluating the impact of ASU 2014-09, which is effective for the Company in our fiscal year beginning on November 1, 2017.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Estimates and Critical Accounting Policies
Management estimates and judgments are an integral part of financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We believe that the critical accounting policies described in this section address the more significant estimates required of management when preparing our consolidated financial statements in accordance with GAAP. We consider an accounting estimate critical if changes in the estimate may have a material impact on our financial condition or results of operations. We believe that the accounting estimates employed are appropriate and resulting balances are reasonable; however, actual results could differ from the original estimates, requiring adjustment to these balances in future periods.
| • | Revenue recognition - We recognize product net sales, net of discounts, returns and rebates in accordance with related accounting standards and SEC Staff Accounting Bulletins. As required by these standards, we recognize revenue when it is realized or realizable and earned, based on terms of sale with the customer, where persuasive evidence of an agreement exists, delivery has occurred, the seller's price is fixed and determinable and collectability is reasonably assured. For contact lenses as well as CooperSurgical medical devices, diagnostic products and surgical instruments and accessories, this primarily occurs when title and risk of ownership transfers to our customers. We believe our revenue recognition policies are appropriate in all circumstances, and that our policies are reflective of our customer arrangements. We record, based on historical statistics, estimated reductions to revenue for customer incentive programs offered including cash discounts, promotional and advertising allowances, volume discounts, contractual pricing allowances, rebates and specifically established customer product return programs. The Company records taxes collected from customers on a net basis, as these taxes are not included in net sales. |
| • | Net realizable value of inventory - In assessing the value of inventories, we make estimates and judgments regarding aging of inventories and other relevant issues potentially affecting the saleable condition of products and estimated prices at which those products will sell. On an ongoing basis, we review the carrying value of our inventory, measuring number of months on hand and other indications of salability. We reduce the value of inventory if there are indications that the carrying value is greater than market, resulting in a new, lower-cost basis for that inventory. Subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. While estimates are involved, historically, obsolescence has not been a significant factor due to long product dating and lengthy product life cycles. We target to keep, on average, five to seven months of inventory on hand to maintain high customer service levels given the complexity of our contact lens and women's healthcare product portfolios. |
| • | Valuation of goodwill - We account for goodwill and evaluate our goodwill balances and test them for impairment annually during the fiscal third quarter and when an event occurs or circumstances change such that it is reasonably possible that impairment may exist in accordance with related accounting standards. We performed our annual impairment test in our fiscal third quarter of 2014, and our analysis indicated that we had no impairment of goodwill. We performed our annual impairment test in our fiscal third quarter of 2013 and concluded that we had no impairment of goodwill in that year. |
In fiscal 2014 and 2013, we performed qualitative assessments to test each reporting unit's goodwill for impairment. Qualitative factors considered in this assessment include industry and market considerations, overall financial performance and other relevant events and factors affecting each reporting unit. Based on our qualitative assessment, if we determine that the fair value of a reporting unit is more likely than not to be less than its carrying amount, the two-step impairment test will be performed.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Initially, we compare the book value of net assets to the fair value of each reporting unit that has goodwill assigned to it. If the fair value is determined to be less than the book value, a second step is performed to compute the amount of the impairment. A reporting unit is the level of reporting at which goodwill is tested for impairment. Our reporting units are the same as our business segments - CooperVision and CooperSurgical - reflecting the way that we manage our business.
Goodwill impairment analysis and measurement is a process that requires significant judgment. If our common stock price trades below book value per share, there are changes in market conditions or a future downturn in our business, or a future annual goodwill impairment test indicates an impairment of our goodwill, the Company may have to recognize a non-cash impairment of its goodwill that could be material, and could adversely affect our results of operations in the period recognized and also adversely affect our total assets, stockholders' equity and financial condition.
| • | Business combinations - We routinely consummate business combinations. Results of operations for acquired companies are included in our consolidated results of operations from the date of acquisition. We recognize separately from goodwill, the identifiable assets acquired, including acquired in-process research and development, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date fair values as defined by accounting standards related to fair value measurements. As of the acquisition date, goodwill is measured as the excess of consideration given, generally measured at fair value, and the net of the acquisition date fair values of the identifiable assets acquired and the liabilities assumed. Direct acquisition costs are expensed as incurred. |
| • | Income taxes - We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. |
As part of the process of preparing our consolidated financial statements, we must estimate our income tax expense for each of the jurisdictions in which we operate. This process requires significant management judgments and involves estimating our current tax exposures in each jurisdiction including the impact, if any, of additional taxes resulting from tax examinations as well as judging the recoverability of deferred tax assets. To the extent recovery of deferred tax assets is not likely based on our estimation of future taxable income in each jurisdiction, a valuation allowance is established. Tax exposures can involve complex issues and may require an extended period to resolve. Frequent changes in tax laws in each jurisdiction complicate future estimates. To determine the tax rate, we are required to estimate full-year income and the related income tax expense in each jurisdiction. We update the estimated effective tax rate for the effect of significant unusual items as they are identified. Changes in the geographic mix or estimated level of annual pre-tax income can affect the overall effective tax rate, and such changes could be material.
Regarding accounting for uncertainty in income taxes, we recognize the benefit from a tax position only if it is more likely than not that the position would be sustained upon audit based solely on the technical merits of the tax position. We measure the income tax benefits from the tax positions that are recognized, assess the timing of the derecognition of previously recognized tax benefits and classify and disclose the liabilities within the consolidated financial statements for any unrecognized
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
tax benefits based on the guidance in the interpretation of related accounting guidance for income taxes. The interpretation also provides guidance on how the interest and penalties related to tax positions may be recorded and classified within our Consolidated Statement of Income and presented in the Consolidated Balance Sheet. We classify interest and penalties related to uncertain tax positions as additional income tax expense.
| • | Share-Based Compensation - We grant various share-based compensation awards, including stock options, performance unit shares, restricted stock and restricted stock units. Under fair value recognition provisions, share-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating Cooper's stock price volatility, employee exercise behaviors and related employee forfeiture rates. |
The expected life of the share-based awards is based on the observed and expected time to post-vesting forfeiture and/or exercise. Groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. In determining the expected volatility, management considers implied volatility from publicly-traded options on the Company's stock at the date of grant, historical volatility and other factors. The risk-free interest rate is based on the continuous rates provided by the United States Treasury with a term equal to the expected life of the award. The dividend yield is based on the projected annual dividend payment per share, divided by the stock price at the date of grant.
As share-based compensation expense recognized in our Consolidated Statement of Income is based on awards ultimately expected to vest, the amount of expense has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant, based on historical experience, and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
If factors change and we employ different assumptions in the application of the fair value recognition provisions, the compensation expense that it records in future periods may differ significantly from what it has recorded in the current period.
THE COOPER COMPANIES, INC. AND SUBSIDIARIES
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