Introduction
This report will examine Cochlear Limited, an Australian company trading on the ASX (COH). The most recent annual report available is for financial year 2010-2011, which ended on 31 July 2011. Questions Q 1. a. Provide a description of your company and its core business activity.

Cochlear Limited (COH) is a manufacturer and marketer of cochlear implants which offer solutions to address different types of hearing impairment. Cochlear is the global leader in implantable hearing solutions. Cochlear has a global team of more than 2,500 people who deliver the gift of sound to the hearing impaired in over 100 countries around the world.

b. What industry does your company operate in?

Operating in the Health Care sector of the Health Care Equipment & Services industry,

c. Name one competitor of your company.

COH has approximately 70% market share for cochlear implants, which are funded by government health authorities and charities. Currently the major competitors of COH are Swiss hearing aid company Sonova and Med El is another competitor in European and US markets.

d. List the countries/areas in which your firm operates. With direct operations in more than 20 countries, COH distributes into over 100 countries with a focus on the Americas, Asia Pacific, and Europe, Middle East and Africa. e. In which country/area does your company make most of its profit? The majority of Cochlear profits are made in Americas (Table 1). Its Return On Total Assets (ROA) in the Americas far outstrips the other geographic locations. This information was sourced from the Regional Update section of the 2011 Cochlear Limited Annual Report. Table 1. COH Revenue and Return On Asset (ROA) by Geographic Market Geography | Revenue (m) | ROA (%) | Americas | 317 | 181 | Europe | 293 | 72 | Asia Pacific | 122 | 84 |

Q 1. f. Who are the Chief executive officer and Managing Director of your company?

Dr Chris G Roberts, CEO/President, age 57. BE (Hons), MBA, PhD, Hon DSc (Macq), FAICD, FTSE, FIEAust – Appointed 1 February 2004

Cochlear do not have a Managing Director.

g. What are their roles in the company?

The role of the CEO/President in the company is to plan, develop and realise the strategic plan of Cochlear in the most cost effective and efficient manner.

h. What is their relevant experience in the industry in which your firm operates?
Dr Roberts has worked in the medical device industry for more than 35 years in a number of senior management positions. He is a member of the Medical Science Committee and Technology and Innovation Committee. He has been a Director of ResMed Inc since 1992 and Chairman of Research Australia (2004 – 2010). i. What are their respective histories with your company?
Dr Chris G Roberts, first started with COH on appointment as CEO/President on the 1st February 2004. j. How is the CEO/President compensated? As outlined by the Directors’ Report, COHs remuneration structure stipulates that the CEO salary is made up of 42% fixed remuneration (i.e. salary, superannuation, and retirement benefits), 29% short term incentive and 29% long term equity incentive. In the reported period the CEO remuneration totalled $2,495,293.00.

k. Do you think that they are being paid too much (not enough)? (Explain your view)

There was one recent issue with a product recall (FY12) that I suspect will affect the business and therefore his bonus for FY12. However, the product recall was handled well and taking into account COH performance under Dr Roberts which has resulted in consistent increases in dividend payments, consistent high returns (profit ratios), a reasonably strong share price (massive fluctuation in 11/12 due to product recall), a strong balance sheet and comparable remuneration of other company CEO/managing Directors (e.g. CSL Managing Director received $5.4m) this remuneration package is reasonable.

Q 2.
How has your company performed over the past five years? Provide a discussion about your company’s performance and use tables and graphs to illustrate your analysis of the company’s performance.

Financial ratios provide a quick measure of the financial health of a business. Table 2 illustrates the Ratio Analysis of COH key financial performance indicators. The results indicate the company has performed strong and has remained very profitable over the past five years (table 2; fig. 1). Strong ROE and ROA shows an ability to turn capital into earnings.

Profitability ratios | Jun-07 | Jun-08 | Jun-09 | Jun-10 | Jun-11 | Net Profit Margin | 18.44% | 19.85% | 18.34% | 22.29% | 23.81% | ROE | 38.39% | 36.08% | 35.84% | 35.40% | 34.94% | ROA | 18.56% | 20.34% | 20.13% | 21.79% | 24.54% | ROIC | 27.98% | 50.49% | 45.35% | 41.54% | 54.10% |
Table 2. COH Profitability Ratios from 2007 to present (Data source FinAnalysis)

Figure 1.COH Profitability Ratios from 2007 to present (Data source FinAnalysis)

Cents Per Share

Figure 2.COH Earnings Per Share (EPS)(Cents per share) and Gross Dividend Performance (Cents per share) 2007-2012. (Data source FinAnalysis)

A$

Figure 3.COH Earnings Before Interest and Tax (EBIT) (A$) 2007-2012. (Data source FinAnalysis)
Excellent growth results in Fig 2. show EPS increased by 15% and a Dividend that increased by 13%. A strong EBIT (Fig 3) result all point to a healthy company earning economic profits.
Net profit after tax (NPAT) of $180.1 million, was up 16%. Cochlear implant unit sales were up 17% to 24,661 implants, with over 70% of cochlear implants sold being Cochlear Nucleus 5, the latest generation device. Given the long product life cycle of COH products the last five years has seen COH maintain a high net profit margin to ensure economic profits are made from large front end investments in Research and Development. Two further key indicators, ROA up 3% to 24% and ROE steady at 35%, further highlight COHs successful financial performance in generating substantial profits from their assets. Finally, the ROIC, a measure of how much capital a business uses to produce its profits. Over the past few years, the negative trend started reversing in FY2010 and continued to improve with a 5 year high of 54%. This is further proof of a strong company. .

Q 3. l. What are the main expenses of your business?

The major expense of COHs business in the current period was: (1) Cost of sales $282,486,000; (2) Research and Development $108,935,000; (3) Employee Benefits $201,045,000; (4) Income tax $55,023,000; and (5) Administration $43,699,000

m. Do any of these expenses stand out as unusual in size or nature?

Research and Development is a large number but given the field and history of COH the expenses listed do not stand out as unusual in size or nature.

Q 4. n. What is the company’s working capital balance in the current year? How has it changed over the last year?
In the current year COHs assets total $741,047,000, while liabilities total $237,764,000, giving them an Asset/Debt ratio of 3.12. The Current Ratio (Current Assets/Current Liabilities) is equal to 1.9 (i.e. 429.9/223.5). These ratios indicate a number of factors. Firstly, being a manufacturing business Cochlear holds stocks of finished goods and work in progress. It also sells goods on credit, which results in accounts receivable. It also provides guidance in that it is lowly leveraged and should be able to meet its debt payments. The changes reflect the global economic outlook and movements by companies to minimise debt levels. It also shows that management are gaining economic profits from a long run product cycles.

o. Describe the types of liabilities your company has.
The types of liabilities that COH has include: * Trade and other payables, * Loans and borrowings, * Current tax liabilities, * Provisions, * Deferred revenue/tax liabilities.

p. Does your company reveal any other commitments or contingent liabilities in the notes to the accounts? (List these and their value.) COH has listed contingent liabilities. The first is a Patent infringement (total of two patent infringements) complaint which was lodge during the year ended 30 June 2008, by the Alfred E. Mann Foundation. The Company believes the Mann Foundation’s allegations are without merit and is vigorously defending the complaint. No provision has been established against settlement because the probability of a significant outflow is considered unlikely. The second contingent liability is in the form of Guarantees. Cochlear has a secured $30.0 million multi-option credit facility, and a GBP1.0 million bank guarantee line. A letter of credit of US$10.0 million (expiring 1st June 2012) facilitating a loan by Wells Fargo Bank funding joint research operations with Otologics LLC. Q 5. q. What are the main cash outflows for your company in the current year?
Main cash outflows for the current year are for the following:
Operating activities: * Cash paid to suppliers/employees $468,300,000 * Income tax $50,590,000
Investing activities * Acquisition of plant, property and equipment $91,510,000
Financing activities * Repayment of borrowings $247,340,000 * Dividends paid out $118,959,000

r. Would you expect these to remain at the same level next year? (Explain your answer.)
The figures from operating activities would be expected to remain similar as COH operations are not planning major changes. However, as the company sells/acquires assets and repays/secures loans the financing and investing figure will differ in the next year. The only addition to the outflows of cash would be the realisation of any items identified in the contingent liabilities section. Q 6. s. How does your company fund its investing and operating activities? (i.e. What are the sources of capital for the company?)

There are three streams from which COH derived its cash to fund its investing and operating activities in FY2011:
Cash flows from operating activities: * Cash receipts from customers $724,443,000; * Interest received $821,000. * Grant and other income received $1,742,000.00 Cash flows from investing activities: * Sale of PP&E (Headquarters sold following construction) $130,300,000.00 Cash flows from Financing activities: * Proceeds from share issues $2,721,000.00 * Proceeds from borrowing $153,530,00.00

t. What proportion of profit did your company pay as a dividend in each of the current year and previous years?

COH paid out the following amounts in dividends in each of the current and previous years: 2011 - $118,948,000; 2010 - $107,089,000; and the proportion of the profits paid as dividend in theses years equated to 66% and 69% respectively.

u. Is it likely that the company can maintain its current dividend payout?

Given the historical performance of paying approximately 70% of NPAT out in dividends over the last 3 years along with an excellent debt/asset ratio, COH is well placed to maintain this current level of dividend payout.

Q 7. a) Describe the corporate governance mechanism the company has in place to protect the interests of its shareholders?
COH has a corporate governance mechanism that meets the ASX Corporate Governance Councils Corporate Governance Principles and Recommendations. They are:
Principle 1: Lay solid foundations for management and oversight
Principle 2: Structure the board to add value
Principle 3: Promote ethical and responsible decision-making
Principle 4: Safeguard integrity in financial reporting
Principle 5: Make timely and balanced disclosure
Principle 6: Respect the rights of shareholders
Principle 7: Recognise and manage risk
Principle 8: Remunerate fairly and responsibly

b) Where did you find your company’s corporate governance statement?
In the Editorial, Corporate Governance Section of the Fy2011 Annual Report.

c) Do you believe that the company has a strong or a weak governance structure in place?
I believe it has a strong governance structure in place for the following reasons: * The Board has assessed the independence of the non-executive directors in light of their interests and relationships and considers that all of the non-executive directors are independent (Rec 2.1). With the exception of the CEO/President, all directors on the Board are independent directors (Rec 2.1). An independent director is a non-executive director who is not a member of management and who is free of any business or other relationship that could materially interfere with, or could reasonably be perceived to materially interfere with, the independent exercise of their judgement. * The ASX Corporate Governance Councils Corporate Governance Principles and Recommendations checklist indicates compliance. * My only initial concern is around the services of KPMG. They audit as well as provide additional services. The FY2011 report outlines this statement to clarify the issue - During the year, KPMG, the Company's auditor, has performed certain other services in addition to its statutory duties. The Board has considered the non-audit services provided during the year by the auditor and in accordance with written advice provided by resolution of the Audit Committee, is satisfied that the provision of those non-audit services during the year by the auditor is compatible with, and did not compromise, the auditor independence requirements of the Corporations Act 2001 for the following reasons.

Q 8. v. What information has your company’s management disclosed about the outlook for the next year? There was very little detail on the outlook for the following year. The Chairman and CEO/Presidents reports both paint a positive outlook for COH. Moving into the Company's global headquarters at a purpose-built facility at Macquarie University in Sydney strengthens their ties to multidisciplinary health experts that will further boost their innovation capacity. They are also positive that further penetration into the Asia pacific market (in particularly China and India) will provide further economic benefits to the company. There are still ongoing concerns on the effect the high Australian dollar is having on its exports. Continued innovation is evident in information provided around the Phase 1a clinical trial of DACS (Direct Acoustic Cochlear Stimulator). DACS remains an area of significant research and development, and an important addition to the portfolio of implantable devices for the hearing impaired.

w. Discuss the implications of this outlook for the growth of the company over the next year (and beyond). The implications of the outlook provided by COHs management for the growth of the company over the next few years are promising. However, they do provide a hint of uncertainty. They highlight the fact that COH is spread across the world and as such is influence by both global and local economic conditions. They are also exposed to natural disasters in the locality they are operating in. An example of this is the Japanese earthquake, tsunami and subsequent nuclear disaster. Although these disasters did not affect COH production levels it highlighted that there is no “back-up” if a key production source is taken out. The outlook also implies that the Asia region of COH is looking set to take off with further penetration into two of the world’s fastest growing economies of China and India. This may shift focus to protecting Intellectual Property when going into the Chinese market which has a history of reverse engineering products.

x. Are there any broader economic factors that are likely to impact the performance of your company over the next year? Describe these and discuss their impact.
The outlook also cushions the shareholders to the effects of the high Australia dollar and its subsequent impact on the bottom line of the business. The growth of the India and China economies look set to become the next areas of business that COH want further penetration. As the economies rise so too does its health care system. This rise in the quality of health care will bring with it a natural partner in the COH offering. However, if the global economic conditions deteriorate so to might the government/charity funding for using their products or upgrading of old COH technology in existing recipients.

Q 9. y. Based on the information you have discussed above and any additional information you have collected on the company, what do you think that the outlook is for the company in the short to intermediate term (the next 3 to 5 years)?
COH has done the research and development in getting a product that is best in class accepted in world healthcare systems. It is now focussing on production efficiencies and further market penetration. It has a long run product cycle with minor upgrades that allow it to gain additional revenue from existing customers. A long run product cycle makes COH keep the product in the market for longer periods to ensure it recoups the cost of research and development. Manufacturing efficiencies reduce the cost of producing one more unit to ensure economic profits are also realised.

History is the best predictor of what will happen in the next 3 to 5 years. Given the steady increase year on year in all the profitability ratios, improved liquidity and gearing ratios all indicate that COH will continue to be a profitable business in the coming 3 to 5 years. Gearing ratios indicate a well balanced financial structure with the majority of assets being financed through equity. A high ROIC further strengths management resolve in knowing that the business strategy for the current world economic conditions is working. .
Focussing on operating efficiency was a natural progression for COH and the results show high levels of turnover, ensuring resources are utilized to generate revenues and economic profits. A recent product recall (occurred in current FY12) will provide further learning for the operations to ensure any faults with the process or technology do not happen again.

z. Would you recommend that an investor purchase shares in the company? Why or why not?
Currently trading $63.36 (as at 21st May 2012, 10.30am)

Fig 4. Total Returns Chart COH Versus the Market (Data source FinAnalysis)

Fig 5. COH Share Price vs. EPS Chart (Data source FinAnalysis)

A strong balance sheet with a fail forward culture all point towards a company that is setting itself to be in the emerging markets of India and China over the coming years. The recent product recall was the time to buy in with shares sliding 33%. The way the recall was handled and the governance around its core capability of learning and innovation means this type of issue will not occur again. If there is a company that can continually improve and learn from mistakes it’s an innovative company that is designed and set up to do so. Fig 5 highlights the continued growth in EPS (prior to FY12) with an estimated decline in the FY12 (most likely due to product recall) and then continued growth in FY2013. Fig 4 highlights the performance against the market which indicates COH outperforming the market over the last 3 years.

COH already has a vast innovation network and it just got better with the move into its new headquarters at Macquarie University in Sydney. Of which Macquarie University is building the Australian Hearing Hub, a similar size building that will house its audiology department and allied disciplines. This is a competitive advantage that COH will use to continually develop incremental innovation in existing products and build new products that meet the health needs of the community. This competitive advantage will take some time for their competitors to replicate.

Recommend – Buy.

Reference List
Cochlear Limited 2011, Annual Report 2011.
FinAnalysis – Cochlear Limited