April 5 - Overview -- U.S.-based medical device company Cooper's financial profile has meaningfully strengthened over the past few years as a result of debt paydown, sales growth, and margin improvement -- We are raising our rating on Cooper to 'BBB-' from 'BB+' -- Our stable rating outlook reflects our expectation that the company will maintain a "modest" financial risk profile with conservative financial policies. Rating Action On April 5, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Pleasanton, Calif.-based Cooper Cos. Inc. to 'BBB-' from 'BB+'. The rating outlook is stable. Rationale The upgrade reflects operational and financial strengthening over the past year, which has led us to revise our view of Cooper's financial risk to "modest" from "intermediate." We expect that management will maintain financial parameters consistent with "modest" financial risk as per our criteria. Debt protection metrics have already stabilized at the stronger end of this range for the past four quarters. Adjusted debt to EBITDA and funds from operations (FFO) to adjusted debt were 1.4x and 68%, respectively, for the 12 months ended Jan. 30, 2012, and we expect little change in fiscal 2012. We believe that EBITDA and cash flow will continue to improve. Cooper should be able to grow soft contact lens sales a few hundred basis points above the industry growth rate (estimated at 4% to 5%) as it introduces new silicone hydrogel (SiH) lens categories, such as Avaira toric, and expands in new geographies, such as Japan. The EBITDA margin could be negatively affected in fiscal 2012 by the Avaira recall; however, we generally expect the EBITDA margin to strengthen by 50 to 100 basis points annually, reflecting manufacturing improvements and trade-up of customers from hydrogel to higher-margin SiH lenses. This margin improvement will be slightly offset as the single wear lenses, which have lower margins but higher profit per customer, grow relative to two-week and monthly modalities. We expect free operating cash flow to exceed $200 million in 2012, and increase at a greater rate of growth than revenues thereafter, reflecting margin improvement. We believe that Cooper will deploy the majority of cash flow to acquisitions, and a lesser amount to fund share repurchases. Under our base case, we believe the company could execute a debt-financed acquisition of up to $600 million and maintain the 'BBB-' rating. Our view of Cooper's business risk profile as "fair" reflects a lack of product diversity, given that CooperVision (CVI) represents 83% of total sales, only partially offset by some diversity within the category. The company manufactures and markets a variety of soft contact lenses, including value-added specialty products such as toric lenses (to correct astigmatism), multifocal, and more commodity-like spherical contact lenses. CVI has distinguished itself as a leader in toric lenses, which represent 30% of sales. Offering a variety of technologies, SiH lenses and Proclear lenses reflect 26% and 32%, respectively, of soft contact lens sales. The company's global footprint provides some diversity for the otherwise narrowly focused business, with the Americas, Europe/Middle East, and Asia/Pacific representing 39%, 36%, and 25% of sales, respectively. Cooper's "fair" business profile also reflects competition from much larger players in the $7 billion contact lens industry, such as the Vision Care division of Johnson & Johnson (over 40% market share) and CIBA Vision (owned by Novartis AG). With a market share of about 17%, CVI has overtaken Bausch & Lomb for the No. 3 spot in global sales, and holds a No. 2 market share in the U.S. Despite its lack of dominance in the industry, customer switching between contact lens brands is typically low. Cooper recently announced that it will introduce a daily SiH in the second half of 2012. Japan, which is the second largest contact lens market (after the U.S.), is the fastest growing single-use lens market. CooperSurgical (CSI) produces women's health care products. Although it contributes only 17% of total revenues, CSI has grown organically and through a series of acquisitions over the past several years. Margins have steadily strengthened and, given minimal capital expenditure needs, this business has been a strong cash flow generator. Expanding its customer base, products for surgical procedures now comprise 23% of sales. This served to modestly insulate CSI from the recession, given that GYN office visits declined. Office products comprise 31% of sales. We expect CSI to remain acquisitive and that tuck-in acquisitions will be financed with internally generated cash. Liquidity We believe Cooper currently has "strong" liquidity to meet its needs over the next two to three years. Our view of the company's liquidity profile incorporates the following expectations: -- We expect liquidity sources (consisting of discretionary cash flow and revolver availability) to exceed uses by over 1.5x over the coming year. -- We expect liquidity sources to continue exceeding uses, even if EBITDA declines by 30%. -- We believe Cooper can absorb a high-impact, low-probability event. -- We believe Cooper will not breach its covenants in the event of a 30% revenue decline, given its current covenant cushion in excess of 30%. -- Given Cooper's January 2011 refinancing, the company appears to have solid bank relationships, and the appreciation of its stock price over the past two years indicates potentially favorable access to equity markets. Cooper typically maintains a negligible cash balance. Its $750 million revolving credit facility (unrated), matures in January 2016; $604 million was available at Jan. 31, 2012. Despite the capital intensity of its business, Cooper generated $305 million of operating cash flow in fiscal 2011, relative to $95 million of capital expenditures and $58 million of acquisitions during the fiscal year. The company benefits from a low effective tax rate, which was 9% in fiscal 2011, and it expects the rate to range between 10% and 12% in fiscal 2012. We expect capital expenditures to be approximately $130 million annually over the next several years, and assume about $150 million of aggregate acquisition spending annually. CSI's acquisitions likely will be similar in scale to those made over the past several years, and funded from internally generated cash. In December 2011, the company announced a share repurchase program of up to $150 million, which will run through December 2012. In the first fiscal quarter of 2012, Cooper purchased $46 million of common stock. We expect share repurchase to be opportunistic, and made with excess funds when no attractive acquisition opportunities are available. Outlook Our stable rating outlook reflects our expectations that the company will maintain a "modest" financial risk profile. Although we expect tuck-in acquisitions, largely at CSI, to be financed with internally generated cash, the rating provides some cushion for incurrence of debt for a larger scale opportunity, perhaps at CVI. An upgrade would likely be predicated on increasing diversification. We do not anticipate that operational difficulties would result in a downgrade. Rather, a downgrade would more likely be the result of a material debt-financed acquisition, or increased capital spending on manufacturing plant expansion that would cause debt to EBITDA to rise to over 2.0x for a protracted period. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded To From Cooper Cos. Inc. Corporate Credit Rating BBB-/Stable/-- BB+/Positive/-- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.