U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT For the transition period from __________ to ____________ Commission File Number 0-18849 THE FEMALE HEALTH COMPANY (Exact Name of Small Business Issuer as Specified in Its Charter) Wisconsin 39-1144397 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 875 N. Michigan Avenue, Suite 3660, Chicago, IL 60611 (Address of Principal Executive Offices) (Zip Code) (312) 280-1119 (Issuer's Telephone Number, Including Area Code) Not applicable (Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report) Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter period that the issuer was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date: Common Stock, $.01 Par Value - 11,049,191 shares outstanding as of May 12, 1999 Transitional Small Business Disclosure Format (check one): Yes _________ No X FORM 10-QSB THE FEMALE HEALTH COMPANY AND SUBSIDIARIES INDEX Part I. Financial Information: Page Cautionary Statement Regarding Forward Looking Statements . . . . . . . . . . . . . . . . . . . . . 3 Unaudited Condensed Consolidated Balance Sheet - March 31, 1999 . . . . . . . . . . . . . . . . . 4 Unaudited Condensed Consolidated Statements of Operations - Six Months Ended March 31, 1999 and March 31, 1998 . . . . . . . . . . . . . . . 5 Unaudited Condensed Consolidated Statements of Cash Flows - Six Months Ended March 31, 1999 and March 31, 1998 . . . . . . . . . . . . . . . 6 Notes to Unaudited Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . 7 Management's Discussion and Analysis or Plan of Operation . . . . . . . . . . . . . . . . . . . . . 13 Part II. Other Information Exhibits and Reports on Form 8-K . . . . . . . . . . . 24 CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS Certain statements included in this Quarterly Report on Form 10-QSB which are not statements of historical fact are intended to be, and are hereby identified as, "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers that forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievement expressed or implied by such forward-looking statements. Such factors include, among others, the following: the Company's inability to secure adequate capital to fund operating losses, working capital requirements, advertising and promotional expenditures and principal and interest payments on debt obligations; factors related to increased competition from existing and new competitors including new product introduction, price reduction and increased spending on marketing; limitations on the Company's opportunities to enter into and/or renew agreements with international partners; the failure of the Company or its partners to successfully market, sell, and deliver its product in international markets; and risks inherent in doing business on an international level, such as laws governing medical devices that differ from those in the U.S., unexpected changes in the regulatory requirements, political risks, export restrictions, tariffs, and other trade barriers, and fluctuations in currency exchange rates; the disruption of production at the Company's manufacturing facility due to raw material shortages, labor shortages, and/or physical damage to the Company's facilities, the Company's inability to manage its growth and to adapt its administrative, operational and financial control systems to the needs of the expanded entity; and the failure of management to anticipate, respond to and manage changing business conditions, the loss of the services of executive officers and other key employees and the Company's continued ability to attract and retain highly-skilled and qualified personnel; the costs and other effects of litigation, governmental investigations, legal and administrative cases and proceedings, settlements and investigations, and developments or assertions by or against the Company relating to intellectual THE FEMALE HEALTH COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET March 31, 1999 ------------ ASSETS Current Assets: Cash and equivalents $ 432,912 Accounts receivable, net 832,649 Inventories, net 1,235,238 Prepaid expenses and other current assets 242,255 ----------- TOTAL CURRENT ASSETS 2,743,054 Intellectual property rights, net 825,065 Other assets 158,730 Property, Plant and Equipment 3,966,674 Less accumulated depreciation and amortization (1,792,225) ----------- Net property, plant, and equipment 2,174,449 ----------- TOTAL ASSETS $ 5,901,298 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable, related party, net of unamortized discount $ 1,049,740 Debt due within one year 675,086 Accounts payable 522,530 Accrued expenses and other current liabilities 359,691 Preferred dividends payable 68,377 ----------- TOTAL CURRENT LIABILITIES 2,675,424 Deferred gain on lease of facility (see Note 4) 1,645,929 Other long-term liabilities 117,391 ----------- TOTAL LIABILITIES 4,438,744 =========== STOCKHOLDERS' EQUITY: Convertible preferred stock 6,700 Common stock 108,532 Additional Paid-in-capital 44,641,314 Unearned consulting compensation (88,873) Accumulated deficit (43,296,150) Foreign currency translation gain 123,107 Treasury Stock, at cost (32,076) ----------- Total Stockholders' Equity 1,462,554 ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,901,298 THE FEMALE HEALTH COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended March 31, ------------------------ 1999 1998 ---------- ----------- Net revenues $1,093,722 $1,619,949 Cost of products sold 1,340,781 1,511,138 ----------- ----------- Gross profit (loss) (247,059) (108,811) Advertising & Promotion 82,380 110,307 Selling, general and administrative 710,401 686,914 ----------- ----------- Total Operating Expenses 792,781 797,221 ----------- ----------- Operating loss (1,039,840) (688,410) Interest, net and other expense 59,881 39,974 ----------- ----------- Pretax loss (1,099,721) (728,384) Provision for income taxes ---- ---- ----------- ----------- Net loss (1,099,721) (728,384) Preferred dividends accreted, Series 2 (see Note 8) ---- 817,000 Preferred dividends, Series 1 33,195 33,534 ----------- ----------- Net loss attributable to Common stockholders (1,132,916) (1,578,918) ========== =========== Basic and diluted net loss per common share outstanding $(0.11) $(0.17) Weighted average number of common shares outstanding 10,624,937 9,549,419 THE FEMALE HEALTH COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Six Months Ended March 31, ------------------------ 1999 1998 ---------- ----------- Net revenues $1,797,720 $2,925,753 Cost of products sold 2,202,232 3,091,792 ----------- ----------- Gross profit (loss) (404,512) (166,039) Advertising & Promotion 174,843 279,228 Selling, general and administrative 1,316,043 1,256,668 ----------- ----------- Total Operating Expenses 1,490,877 1,535,896 ----------- ----------- Operating loss (1,895,389) (1,701,935) Interest, net and other expense 130,817 85,606 ----------- ----------- Pretax loss (2,026,206) (1,787,541) Provision for income taxes ---- ---- ----------- ----------- Net loss (2,026,206) (1,787,541) Preferred dividends accreted, Series 2 (see Note 8) ---- 817,000 Preferred dividends, Series 1 68,750 67,813 ----------- ----------- Net loss attributable to Common stockholders (2,094,956) (2,672,354) ========== =========== Basic and diluted net loss per common share outstanding $(0.20) $(0.28) Weighted average number of common shares outstanding 10,532,073 9,546,883 THE FEMALE HEALTH COMPANY AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended March 31, ---------------------- 1999 1998 ----------- ----------- OPERATIONS: Net (loss) $(2,026,206) $(1,787,541) Adjusted for noncash items: Depreciation and amortization 275,918 296,733 Amortization of discounts on notes payable and convertible debentures 136,873 166,640 Reduction in inventory reserves (8,130) (589,388) Reduction in accounts receivable reserves 482 (101,580) Amortization of other assets -- 5,567 Changes in operating assets and liabilities (181,213) (904,193) ----------- ----------- Net cash (used in) operating activities (1,802,276) (1,105,376) INVESTING ACTIVITIES: Capital expenditures (22,933) (15,955) Proceeds from repayment of note receivable -- 750,000 ----------- ----------- Net cash provided by (used in) investing activities (22,933) 734,045 FINANCING ACTIVITIES: Proceeds from related-party notes issued 1,300,000 1,000,000 Payments on notes payable, related party (1,000,000) (1,033,270) Proceeds from the issuance of preferred stock -- 1,851,034 Purchase of Common Stock held in Treasury (12,746) -- Proceeds from the issuance of common stock 291,000 -- Proceeds from the issuance of common stock upon exercise of options and warrants 202,925 108,902 ----------- ----------- Net cash provided by financing activities 781,179 1,926,666 Effect of exchange rate change on cash and equivalents (3,345) 13,311 ----------- ----------- INCREASE (DECREASE) IN CASH AND EQUIVALENTS (1,047,375) 1,568,646 Cash and equivalents at beginning of period 1,480,287 1,633,467 ----------- ----------- CASH AND EQUIVALENTS AT END OF PERIOD $432,912 $3,202,113 ========== ========== THE FEMALE HEALTH COMPANY AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL INFORMATION MARCH 31, 1999 NOTE 1 - Basis of Presentation The accompanying financial statements are unaudited but in the opinion of management contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flow for the periods presented in conformity with generally accepted accounting principles for interim financial information and the instructions to Form 10-QSB and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Operating results for the three and six months ended March 31, 1999 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 1999. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-KSB for the fiscal year ended September 30, 1998. NOTE 2 - Earnings Per Share Basic and diluted net (loss) per Common share outstanding is based on the weighted average of shares of Common Stock outstanding during the period. As of March 31, 1999 the Company has 1,165,828 options and 1,648,534 warrants outstanding including 0 "in the money" options and warrants. As of March 31, 1998 the Company had 1,351,754 options and 1,133,534 warrants outstanding including 1,136,196 "in the money" options and warrants. As of March 31, 1999 and 1998 the Company also has 670,000 and 680,000 shares, respectively, of preferred stock outstanding which is convertible into an equal number of shares of common stock (see Note 6). The inclusion of the options, warrants and convertible preferred stock in the computation of diluted earnings per share would have resulted in a reduction of the loss per share (antidilutive) and therefore both basic and diluted earnings per share amounts were the same for each of the periods presented in the accompanying financial statements. NOTE 3 _ Comprehensive Income (Loss) Total Comprehensive Loss was $(1,263,840) and $(2,276,829) for the 3 and 6 month ended March 31, 1999 and $(1,561,384) and $(2,595,700) for the 3 month NOTE 4. - Lease of Manufacturing Facility On December 10, 1996, the Company entered into what is in essence a sale and leaseback agreement with respect to its 40,000 square foot manufacturing facility located in London, England. The Company received $3,365,000 (British pounds sterling 1,950,000) for leasing the facility to a third party for a nominal annual rental charge and for providing the third party with an option to purchase the facility for one pound during the period December 2006 to December 2027. Concurrent with this transaction, the Company repaid the mortgage loan on this property of $1,834,000 (British pounds sterling 1,062,500). As part of the same transaction, the Company entered into an agreement to lease the facility back from the third party for base rents of $336,000 (British pounds sterling 195,000) per year payable quarterly until 2016. The lease is renewable through 2027. The Company was also required to make a security deposit of $336,000 (British pounds sterling 195,000) to be reduced in subsequent years. The facility had a net book value of $1,398,819 (British pounds sterling 810,845) on the date of the transaction. The $1,966,181 (British pounds sterling 1,139,155) gain which resulted from this transaction will be recognized ratably over the initial term of the lease. Unamortized deferred gain as of March 31, 1999 was $1,645,929 (British pounds sterling 1,011,013). NOTE 5 - Inventories The components of inventory consist of the following: March 31, 1999 ------------ Raw Material and work in process $ 492,927 Finished Goods 773,200 ----------- Inventory, Gross 1,266,127 Less: Inventory reserves (30,889) ----------- Inventory, net $ 1,235,238 =========== NOTE 5 - Sale of Convertible Preferred Stock In September 1997, the Company raised approximately $1.6 million net proceeds, after issuance costs of $96,252, in a private placement of 680,000 shares of 8% cumulative convertible Preferred Stock _ Series 1. In addition, warrants to purchase 52,000 shares of Common Stock were issued to the placement agents. Each share of Preferred Stock is convertible into one share of the Company's Common Stock on or after August 1, 1998. Annual Preferred Stock dividends will be paid if and as declared by the Company's Board of Directors. No dividends or other distributions will be payable on the Company's Common Stock unless dividends are paid in full on the Preferred Stock. The shares may be redeemed at the option of the Company, in whole or in part, on or after August 1, 2000, dividends. In the event of a liquidation or dissolution of the Company, the Preferred Stock _ Series 1 would have priority over the Company's Common Stock. On December 31, 1997, the Company completed a private placement of 729,927 shares of Class A Convertible Preferred Stock - Series 2 (the "Series 2 Preferred Stock") and Warrants to purchase 240,000 shares of Common Stock. The Series 2 Preferred Stock was sold at a per share price of $2.74, resulting in net proceeds to the Company of $1.82 million, after commissions and expenses. The Series 2 Preferred Stock automatically converted into Common Stock on a one-for-one basis, on April 3, 1998, the date in which the registration statement registering the resale of the Common Stock was declared effective by the SEC. The investors received four-year Warrants to purchase 240,000 shares of Common Stock exercisable at a price per share equal to the lesser of $3.425 or the average of the three closing bid prices per share of Common Stock for any three consecutive trading days chosen by the investor during the 30 trading day period ending on the trading day immediately prior to the exercise of the Warrants. Individuals providing services to the Company's placement agent for the above convertible Preferred Stock received Warrants to purchase 4,000 shares of Common Stock exercisable at any time prior to December 31, 2001, at $4.11 per share. NOTE 7 - Financial Condition The Company's consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company incurred a net loss of $3.4 million for the year ended September 30, 1998, a net loss of $2.0 million for the six months ended March 31, 1999 and as of March 31, 1999 had an accumulated deficit of $43.3 million. At March 31, 1999, the Company had working capital of $0.1 million and stockholders' equity of $1.5 million. In the near term, the Company expects operating and capital costs to continue to exceed funds generated from operations due principally to the Company's fixed manufacturing costs relative to current production volumes and the ongoing need to commercialize the Female Condom around the world. As a result, operations in the near future are expected to continue to use working capital. Management recognizes that the Company's continued operations depend on its ability to raise additional capital through a combination of equity or debt financing, strategic alliances and increased sales volumes. At various points during the developmental stage of the product, the Company was able to secure resources, in large part through the sale of equity and debt securities, to satisfy its funding requirements. As a result, the Company was able to obtain FDA approval, worldwide rights, manufacturing facilities and equipment and to commercially launch the Female Condom. Management believes that recent developments, including the Company's agreement with the UNAIDS, a joint United Nations program on HIV/AIDS, provide an indication of the Company's early success in broadening awareness and distribution of the Female Condom and may benefit from efforts to raise additional capital and to secure additional agreement to promote and distribute the Female Condom throughout other parts of the world. On September 29, 1997, the Company entered into an agreement with Vector Securities International, Inc. (Vector), an investment banking firm life-science companies. Pursuant to this agreement, for a one-year period, Vector will act as the Company's exclusive financial advisor for the purposes of identifying and evaluating opportunities available to the Company for increasing shareholder value. These opportunities may include selling all or a portion of the business, assets or stock of the Company or entering into one or more distribution arrangements relating to the Company's product. This agreement had been extended for an additional six months through March 29, 1999. Management is currently determining if there is further need to extend this arrangement. There can be no assurance that any such opportunities will be available to the Company or, if so available, that the Company will ultimately elect or be able to consummate any such transaction. To provide a potential ready source of capital for the Company, which the Company would use for general working capital purposes, effective November 19, 1998, the Company entered into a private Equity Line of Credit Agreement (the "Equity Line Agreement") with Kingsbridge Capital Limited, a private investor (the "Selling Stockholder"). Under the Equity Line Agreement, the Company has the right, subject to various conditions, to issue and sell to the Selling Stockholder, from time to time, shares of its Common Stock for cash consideration up to an aggregate of $6 million. The Equity Line Agreement gives the Company, in its sole discretion and subject to certain restrictions, the right to sell ("put") to the Selling Stockholder up to $6.0 million of the Company's Common Stock, subject to a minimum put of $1.0 million over the duration of the agreement. The Equity Line Agreement expires 24 months after the effective date of the registration statement filed to register the Selling Stockholder's public resale of any stock it purchases under the agreement. The Equity Line Agreement provides for, among other things, minimum and maximum puts ranging from $100,000 to $1,000,000 depending on the Company's stock price and trading volume. The timing and amount of puts under the Equity Line Agreement are totally at the Company's discretion, subject to certain conditions. The Company is required to put a minimum of $1 million during the two-year period. If the Company does not put the minimum, the Company is required to pay the investor a 12% fee on that portion of the $1 million minimum not put at the end of the two-year period. As of March 31, 1999, the Company had placed two puts for the combined cash proceeds of $291,000 providing Kingsbridge with a total of 286,862 shares of the Company's Common Stock. Each put was executed while the Company's stock price was below $2.00 per share. While the Company believes that its existing capital resources (including expected proceeds from sales of Common Stock pursuant to the Equity Line Agreement) will be adequate to fund its currently anticipated capital needs, if they are not, the Company may need to raise additional capital until its sales increase sufficiently to cover operating expenses. In addition, there can be no assurance that the Company will satisfy the conditions required for it to exercise puts under the Equity Line Agreement. Accordingly, the Company may not be able to realize all of the funds available to it under the Equity Line Agreement. Further, there can be no assurances, assuming the Company successfully raises additional funds or enters into business agreements with third parties, that the Company will achieve profitability or positive cash flow. If the Company is unable to obtain adequate financing, management will be required to sharply curtail the Company's efforts to commercialize the Female Condom and to curtail certain other of its operations or, ultimately, cease operations. The Company's $2.0 million private placement of convertible Preferred Stock _ Series 2 on December 31, 1997 included a beneficial conversion feature valued at $500,000 and four-year warrants to purchase additional shares of common stock valued at $317,000. In accordance with SEC reporting requirements for such transactions, the Company recorded the value of the beneficial conversion feature and warrants, a total of $817,000 as additional paid-in capital. The corresponding discount of $817,000, associated with the issuance of the convertible preferred stock is a one-time, nonrecurring charge that has been fully amortized and reflected as preferred dividends accreted in the consolidated statements of operations for the quarter and six months ended March 31, 1998. The dividend accretion had no impact on the Company's cash MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION GENERAL The Female Health Company ("FHC" or the "Company") manufactures, markets and sells The Female Condom, the only FDA-approved product under a woman's control which can prevent unintended pregnancy and sexually transmitted diseases ("STDs"), including HIV/AIDS. Safety and Efficacy Based on use of the product in clinical trials and five years of worldwide marketing, the Female Condom has been proven as safe and effective. The following information reflects the results of various trials: Reduction in STDs(1) 34% (Results when female condom was available as an option vs. when only the male condom was available.) Reduction in Acts of Unprotected Sex(1) 25% Effectiveness in Preventing Pregnancy(2) 95%(3) (When used properly with every sex act) (1) Supported by UNAIDS (2) Supported by The U.S. Agency for International Development (USAID) and conducted by Family Health International (FHI) (3) Recent studies completed in Japan evaluating the female condom's effectiveness in preventing pregnancy, which were submitted to the Japanese regulatory authorities in connection with their review of the product, showed the female condom to be approximately 98% effective when used consistently and correctly. Cost Effectiveness Results of the UNAIDS supported evaluation of the cost-effectiveness of providing the Female Condom in developing countries has been published and also presented at various professional meetings. The results indicate that making the Female Condom available is highly effective in reducing public health costs in developing countries. Endorsements Currently, the Female Condom is endorsed for use by the World Health Organization (WHO), the United Nations Joint Programme on AIDS (UNAIDS), the U.S. Agency for International Development (USAID), many NGO's (non-government organizations) around the world, and a number of city and state public health At the June 1998 World AIDS Conference in Geneva, Switzerland the Female Condom appeared in over 50 studies, speeches and exhibition booths. Global Market The pandemic of STDs, including HIV/AIDS continues to be a major public health issue worldwide. The need for prevention methods, male and female condoms is escalating. The World Health Organization (WHO) estimates the new cases of STDs worldwide to be approximately 300 million annually, excluding HIV/AIDS. UNAIDS estimates that there are currently approximately 33 million people worldwide who are infected with HIV/AIDS, of which 86% are in developing countries. In the United States, the center for Disease Control and Prevention noted that in 1995, five of the ten most frequently reported diseases were STD's. The Center also has noted that one in five Americans over the age of 12 has Herpes and 1 in every 3 sexually active people will get an STD by age 24. Women are currently the fastest growing group infected with HIV and are expected to comprise the majority of the new cases by the year 2000. The following information highlights the substantial and growing market for protection against STDs. Worldwide: Number of people with HIV/AIDS(*) 34 million Number of new cases of HIV/AIDS daily(*) 16,000 Number of children expected to be orphaned by AIDS by 2010 (at current rate)(*) 40 million Examples of decreases in life expectancy due to HIV/AIDS(*) Zimbabwe 22 years Cote d'Ivoire 11 years Number of Sub-Saharan African countries where more than 10% of population is HIV positive(*) 13 Most people infected with HIV/AIDS 10-24 years old (*) Source: UNAIDS United States: Number of top ten most frequently reported diseases in the United States in 1995 that were STDs(1) 5 Ratio of individuals over 12 years of age with Herpes(1) 1 in 5 Annual expenditures to treat STDs(2) $17 billion Dollars spent on STD treatment for every $1.00 spent on prevention(2) $43 The United States has one of the highest rates of teenage pregnancy in Western nations--Each year one in nine teenage women (ages 15-19) becomes pregnant(3) (1) Source: Center for Disease Control and Prevention (2) Source: National Academy of Sciences (3) Source: Alan Guttmacher Institute At the 1998 World AIDS Conference in Geneva, Switzerland, the following points - - New drugs help some AIDS patients in Western nations. However, they are of little value in developing countries due to their cost and the complexity of their administration. - - Simple, inexpensive treatments for HIV/AIDS --or a vaccine to prevent infection from HIV --are unlikely in the near term. - - Prevention is essential. Currently, there are only two products that prevent the transmission of HIV/AIDS through sexual intercourse _ the latex male condom and the Female Condom. Male Condom Market: It is estimated the global annual market for male condoms is 4.7 billion units. However, the majority of all acts of sexual intercourse, excluding those intended to result in pregnancy, are completed without protection. As a result, it is estimated the potential market for barrier contraceptives is much larger than the identified male condom market. The market potential for the Female Condom is larger and growing as highlighted by the following: - - New cases of STDs each year: 333 million - - Estimated Annual Male Condom Market: 4.7 billion units Advantages vs. the Male Condom The Female Condom is currently the only available barrier method controlled by women which allows them to protect themselves from unintended pregnancy and STDs, including HIV/AIDS. This is an important advantage as many men do not like to wear male condoms and may refuse to do so. The polyurethane material that is used for the Female Condom, offers a number of benefits over latex, the material that is most commonly used in male condoms. Polyurethane is 40% stronger than latex, reducing the probability that the Female Condom sheath will tear during use. Clinical studies and everyday use have shown that latex male condoms can tear as much as 8% of the times they are used. Unlike latex, polyurethane quickly transfers heat, so the Female Condom immediately warms to body temperature when it is inserted, which may result in increased pleasure and sensation during use. The product offers an additional benefit to the 7% to 20% of the population that is allergic to latex and who, as a result, may be irritated by latex male condoms. To the Company's knowledge, there is no reported allergy to polyurethane. The Female Condom is also more convenient, providing the option of insertion hours before sexual arousal and as a result is less disruptive during sex than the male condom which requires sexual arousal for application. Strategy/Goals The Company's strategy is to act as a manufacturer selling the Female Condom to the global public sector, the U.S. public sector and commercial partners for country specific marketing. The public sector customers and partners assume the cost of shipping and marketing. As a result, as volume increases, expenses Commercial Markets The Company markets the product directly in the United States and the United Kingdom. The Company has commercial partners which have recently launched the product in Canada, Holland, Brazil, Venezuela, South Korea and Taiwan. The Company has signed distribution agreements in Japan and Bangladesh, where launches are expected during the coming year. Japanese Market In Japan, the market for male condoms exceeds 600 million units. Oral contraceptives have not been approved in Japan and, as a result, 96% of Japanese couples use male condoms. The Company's partner in Japan, is Taiho Pharmaceuticals, a $1 billion Japanese health care company. The agreement between the Company and Taiho requires Taiho to perform clinical testing of the product in Japan and obtain necessary regulatory approvals to market the product. After approval, expected during the Company's 1999 fiscal year, the Company will manufacture the product and supply it to Taiho, which will have the responsibility for marketing and distributing the Female Condom in Japan. Taiho plans to market the Female Condom under the name "Mylura Femy." Relationships and Agreements with Public Sector Organizations Currently, it is estimated that worldwide more than 1.7 billion male condoms per year are distributed by the public sector. The Female Condom is seen as an important addition to prevention strategies by the public sector because studies show that the availability of the Female Condom decreases the amount of unprotected sex by as much as 25% over the rate when only male condoms are available. The Company has a multi-year agreement with UNAIDS to supply the Female Condom to developing countries at a reduced price which is negotiated each year based on volume. The current price per unit is approximately $0.64 or British pounds sterling O.38. During the last year, the Female Condom has been launched in the countries of Kenya, Zimbabwe, Tanzania, Bolivia, Haiti, South Africa and Zambia. It is anticipated that multiple product launches will occur in several countries during the next two years, including in the countries of Nigeria, Uganda, Ghana, Cambodia, Bangladesh, Columbia, and Central American countries. In a meeting on January 15, 1999, UNAIDS advised the Company that based on results to date in countries where the Female Condom has been launched they plan to include it in all male condom distribution programs. It is estimated that approximately 1.7 billion male condoms are used in such programs. In the United State, the product is marketed to city and state public health clinics as well as not-for-profit organizations such as Planned Parenthood. Currently, 10 major city and 15 state governments, including the states of New York, Pennsylvania, Florida, Connecticut, Hawaii, Louisiana, Maryland, New Jersey, South Carolina, Illinois, and Washington and the cities of Chicago, Philadelphia, New York City, and Houston have purchased the product for distribution with a number of others expressing interest. All major cities and states have reordered product after initial shipments. Worldwide Regulatory Approvals The Female Condom received PMA approval as a Class III Medical Device from the FDA approval laid the foundation for approvals throughout the rest of the world, including receipt of a CE Mark in 1997 which allows the Company to market The Female Condom throughout the European Union. In addition to the United States and the European Union, several other countries have approved the Female Condom for sale, including Canada, Russia, Australia, South Korea and Taiwan. The Company expects the Female Condom to receive approval in Japan in 1999. The Company believes that the Female Condom's PMA approval and FDA classification as a Class III Medical Device create a significant barrier to entry. The Company estimates that it would take a minimum of four to six years to implement, execute, and receive FDA approval of a PMA to market another type of Female Condom. The Company believes there are no material issues or material costs associated with the Company's compliance with environmental laws related to the manufacture and distribution of the Female Condom. RESULTS OF OPERATIONS Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998 The Female Health Company had revenues of $1,093,722 and a net loss of $1,099,721 for the three months ended March 31, 1999 compared to revenues of $1,619,949 and a net loss of $728,384 for the three months ended March 31, 1998. As discussed more fully below, the increase in the Company's net loss was principally related to decreased sales volume, which was not coupled with a proportional decrease in cost of good sold. For the current quarter, sales decreased $526,227, or 32%, compared with the same period last year. Net sales for the prior year were significantly higher because of product launches by new country specific partners associated with UNAIDS. The Company expects significant quarter to quarter variation due to the timing of receipt of large orders, subsequent production scheduling, and shipping of products as various countries launch the product. It believes this variation between quarters will continue for several quarters to come until reorders form an increasing portion of total sales. Net sales for the current quarter included the product shipped for the Kenya launch. Cost of goods sold decreased $170,357, or 11%, to $1,340,781 in the current quarter from $1,511,138 for the same period last year. Cost of goods sold for the prior year included a $300,000 reduction resulting from an adjustment of the Company's reserve for inventory obsolescence. Because no material inventory reserve adjustment occurred in the current quarter, the percentage decline in cost of goods sold between the comparative quarters is not proportionate with the sales decline. Advertising and promotional expenditures decreased $27,927 to $82,380 in the current quarter from $110,307 for the same period in the prior year. Advertising and promotion relates almost exclusively to the U.S. consumer market, and includes the costs of print advertising, trade and consumer promotions, product samples and other marketing costs. Through expenditures to date, the Company has established that the Female Condom is responsive to promotion; but due to the Company's size, it doesn't possess the resources to potential U.S. partners that have the resources to penetrate the consumer market. Selling, general and administrative expenses increased $23,487, or 3%, to $710,401 in the current quarter from $686,914 for the same period last year. The small increase reflected higher legal and professional fees related to the Company's efforts to raise capital and communicate with the investor community. Net interest and nonoperating expenses increased $19,907 to $59,881 for the current period from $39,974 for the same period the prior year. The increase is due to higher interest expense attributable to a increased level of debt outstanding during the quarter. Additionally, interest income, an offset to interest expense, declined in the current quarter as a result of significantly lower average cash balances invested in interest bearing accounts during the current period compared with the same period in the prior year. Six Months Ended March 31, 1999 Compared to Six Months Ended March 31, 1998 The Female Health Company had net revenues of $1,797,720 and a net loss of $2,026,206 for the six months ended March 31, 1999 compared to revenues of $2,925,753 and a net loss of $1,787,541 for the six months ended March 31, 1998. As discussed in more detail in the following paragraphs, the increase in the Company's net loss was principally related to decreased sales volume, offset by a less than proportionate decline in cost of goods and a reduction in advertising and promotional expenses. For the six months ended March 31, 1999, sales decreased $1,128,033, or 39%, compared with the same period last year. The lower sales resulted from decreased unit sales shipped to domestic public sector agencies and to the global public sector. Cost of goods sold decreased $889,560, or 29%, to $2,202,232 for the six months ended March 31, 1999 from $3,091,792 for the same period last year. Decreases in the costs of goods sold were a result of lower sales volume, offset, in part, by a change between years in the Company's reserve for inventory obsolescence. During the six months ended March 31, 1998 a $589,388 reduction in the Company's reserve for inventory obsolescence occurred. The FDA's decision to extend the useful life of the Female Condom to five years from three years and the reduction of finished goods inventories resulting from the increased level of sales were the factors leading to the inventory reserve adjustment in the prior year. The Company did not materially adjust inventory reserves during the same period this year. Advertising and promotional expenditures decreased $104,385, or 37%, to $174,843 for the six months ended March 31, 1999 from $279,228 for the same period in the prior year. Advertising and promotion relates almost exclusively to the U.S. consumer market, and includes the costs of print advertising, trade and consumer promotions, product samples and other marketing costs. Through expenditures to date, the Company has established that the Female Condom is responsive to promotion; but due to the Company's size, it doesn't possess the resources to conduct a significant marketing program. Accordingly, the Company is in discussions with potential partners for the U.S. that have the resources to conduct such a marketing program. Selling, general and administrative expenses increased $59,366, or 5%, to The increase reflected higher legal and professional fees related to the Company's effort to raise capital and communicate with the investor community Net interest and nonoperating expenses increased $45,211 to $130,817 for the current period from $85,606 for the same period the prior year. During the prior year the Company had a higher level of debt outstanding during the current fiscal year. Additionally, interest income, an offset to interest expense, was less in the current year as a result of significantly lower average cash balances invested in interest bearing accounts during the current fiscal year compared to the same period in the prior year. LIQUIDITY AND SOURCES OF CAPITAL Historically, the Company has incurred cash operating losses relating to expenses incurred to develop and promote the Female Condom. During the first six months of fiscal 1999, cash used in operations totaled $1.8 million. The Company used existing cash balances in order to fund cash used in operations; thereby reducing its cash position by $1.1 million. To provide a potential ready source of capital for the Company, which the Company would use for general working purposes, effective November 19, 1998, the Company entered into a private equity line of credit agreement (the "Equity Line Agreement") with Kingsbridge Capital Limited., a private investor (the "Selling Stockholder"). Under the Equity Line Agreement, the Company has the right, subject to various conditions, to issue and sell ("put") to the Selling Stockholder shares of the Company's Common Stock for cash consideration up to an aggregate of $6,000,000. Any stock sold by the Company to the Selling Shareholder under the Equity Line Agreement will be sold at a discount to the stock's market price as determined pursuant to the agreement. The discount is 12% if the market price of a share of the Company's Common Stock at the time of the sale is $2.00 or more and 18% if the price is less than $2.00. The Equity Line Agreement gives the Company the right to determine, in its sole discretion, the degree to which it desires to utilize the Equity Line, subject to a minimum Put of $1,000,000 over the life of the Agreement. The Equity Line Agreement expires 24 months after the effective date of the registration statement filed to register the Selling Shareholder's public resale of any stock purchases under the Agreement. The Equity Line Agreement provides for, among other things, minimum and maximum Puts ranging from $100,000 to $1,000,000 depending on the Company's stock price and trading volume. The timing and amount of the stock sales under this line of credit are totally at the Company's discretion, subject to certain conditions. The Company is required to draw down a minimum of $1,000,000 during the two-year period. If the Company does not draw down the minimum, the Company is required to pay the Selling Stockholder a 12% fee on the portion of the $1,000,000 minimum, not drawn down at the end of the two-year period. As of March 31, 1999, the Company had placed two puts for the combined cash proceeds of $291,000 providing Kingsbridge with a total of 286,862 shares of the Company's Common Stock. Each put was executed while the Company's stock price was below $2.00 per share. While the Company believes that its existing capital resources (including expected proceeds from sales of Common Stock pursuant to the Equity Line Agreement) will be adequate to fund its currently anticipated capital needs, if they are not, the Company will need to raise additional capital until its sales increase sufficiently to cover operating expenses. Until internally generated funds are sufficient to meet cash requirements, the Company will remain At March 31, 1999, the Company had current liabilities of $2.7 million including a $1.0 million note payable due March 25, 2000 and a $250,000 note payable due February 12, 2000 both to Mr. Dearholt, a Director of the Company. As of March 31, 1999, Mr. Dearholt beneficially owns 1,514,784 shares of the Company's Common Stock. The Company also secured a $50,000 note payable due February 18, 2000 from Mr. Parrish, the Chairman of the Board and Chief Executive Officer of the Company. As of March 31, 1999, Mr. Parrish beneficially owns 494,001 shares of the Company's Common Stock. As of April 6, 1999 the Company restructured the $602,360 (British pounds sterling 370,000) Auge V. Jensen Charity Foundation loan note payable. The terms included immediate payment of $177,000 (British pounds sterling 110,000) as of the date of the restructuring agreement and requires nine installment payments beginning April 15, 1999 and concluding on December 10, 1999. The first eight monthly installment payments are for $49,500 (British pounds sterling 30,000) each while the last monthly installment is for $33,000 (British pounds sterling 20,000). In the near term, the Company's management expects operating and capital costs to continue to exceed funds generated from operations, due principally to the Company's fixed manufacturing costs relative to current production volumes and the ongoing need to commercialize the Female Condom around the world. It is estimated that the Company's cash burn rate, without revenues, is approximately $0.6 million per month. While management believes that revenue from sales of the Female Condom will eventually exceed operating costs, and that, ultimately, operations will generate sufficient funds to meet capital requirements, there can be no assurance that such level of operations ultimately will be achieved, or be achieved in the near term. Likewise, there can be no assurance that the Company will be able to source all or any portion of its required capital through the sale of debt or equity or, if raised, the amount will be sufficient to operate the Company until sales of the Female Condom generate sufficient revenues to fund operations. In addition, any funds raised may be costly to the Company and/or dilutive to stockholders. If the Company is not able to source the required funds or any future capital which becomes required, the Company may be forced to sell certain of its assets or rights or cease operations. Further, if the Company is not able to source additional capital, the lack of funds to promote the Female Condom may significantly limit the Company's ability to realize value from the sale of such assets or rights or otherwise capitalize on the investments made in the Female Condom. DELISTING ON THE AMERICAN STOCK EXCHANGE On February 5, 1999, the Company's Common Stock was delisted from the American Stock Exchange since it did not meet all of the criteria for continued listing. Commencing on or before February 9, 1999, the Common Stock has been quoted on the OTC Bulletin Board under the symbol "FHCO". Although the Company believes the OTC Bulletin Board will provide an efficient market for the purchase and sale of the Company's Common Stock, investors may find it more difficult to obtain accurate quotations of the price of the Company's Common Stock and to listed on the American Stock Exchange. In addition, companies whose stock is listed on the American Stock Exchange must adhere to the rules of such exchange. These rules include various corporate governance procedures which, among other items, require the company to obtain shareholder approval prior to completing certain transactions such as, among others, issuances of common stock equal to 20% or more of the company's then outstanding common stock for less than the greater of book or market value or the issuance of certain stock options. Companies whose stock is quoted on the OTC Bulletin Board are not subject to these or any comparable rules. IMPACT OF INFLATION AND CHANGING PRICES Although the Company cannot accurately determine the precise effect of inflation, the Company has experienced increased costs of product, supplies, salaries and benefits, and increased selling, general and administrative expenses. Historically, the Company has absorbed increased costs and expenses without increasing selling prices. FOREIGN CURRENCY AND MARKET RISK The Company manufactures the Female Condom in a leased facility located in London, England. Further, a material portion of the Company's future sales are likely to be in foreign markets. Manufacturing costs and sales to foreign markets are subject to normal currency risks associated with changes in the exchange rate of foreign currencies relative to the United States Dollar. In addition, some of the Company's future international sales may be in developing nations where dramatic political or economic changes are possible. Such factors may adversely affect the Company's results of operations and financial condition. YEAR 2000 COMPLIANCE The Company's State of Readiness. The Company's main financial and manufacturing hardware and software systems have been tested and are Year 2000 compliant. This was accomplished primarily through system upgrades and maintenance done over the last few years. The Company is in the process of surveying major customers and suppliers regarding their Year 2000 readiness and, to date, the Company is not aware of any significant Year 2000 issue at these entities that would materially affect the Company's business. The Company believes that if a Year 2000 problem develops at any of the Company's vendors whereby the vendor becomes unable to address the Company's needs, alternative vendors are readily available that could furnish the Company with the same or similar supplies without material undue delay or expense. Costs to Address the Company's Year 2000 Issues. The majority of the Company's Year 2000 issues were corrected either through system upgrades or normal maintenance contracts. The cost of these improvements to date has been approximately $38,200. Risks to the Company for Year 2000 Issues. With regard to systems under the Company's control, the Company knows of no significant exposure that the Company has to the Year 2000 issue since, if necessary, the Company's systems are capable of accepting manually entered data. The Company believes the worst case scenario is that the Company would have to revert back to certain manual systems. The Company believes that its customers and vendors are at various stages of compliance but the Company has not been made aware of any significant Year 2000 issues that would materially affect its business with them. The vendors throughout 1999 but it will not be able to achieve the same degree of certainty that it can with its own internal systems. The Company's Contingency Plan. To the extent that the Company discovers minor internal systems that are not Year 2000 compliant by Mid-1999, it will have time to implement manual systems by year-end 1999 which the Company believes Part II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Number Description 3.1 Amended and Restated Articles of Incorporation. (1) 3.2 Amended and Restated By-Laws. (2) 4.1 Amended and Restated Articles of Incorporation. (1) 4.2 Articles II, VII, and XI of the Amended and Restated By-Laws (included in Exhibit 3.2). (2) 10.1 Agreement between Kingsbridge Capital Limited and the Company dated February 12, 1999. 10.2 Consulting Agreement between the Company and Kingsbridge Capital Limited dated February 12, 1999. 10.3 Registration Rights Agreement between Kingsbridge Capital Limited and the Company dated February 12, 1999. 10.4 Warrant for 100,000 shares of the Company's Common Stock issued to Kingsbridge Capital Limited as of February 12, 1999. 10.5 Change of Control Agreement dated January 27, 1999, between The Female Health Company and Michael Pope. 10.6 Company Promissory Note to Stephen M. Dearholt for $250,000 dated February 12, 1999, and related Note Purchase and Warrant Agreement, Warrants and Stock Issuance Agreement. 10.7 Company Promissory Note to O.B. Parrish for $50,000 dated February 18, 1999 and related Note Purchase and Warrant Agreement, Warrants and Stock Issuance Agreement. 10.8 Company Promissory Note to Stephen M. Dearholt for $1 million dated March 25, 1999, and related Note Purchase and Warrant Agreement, Warrants and Stock Issuance Agreement. 27 Financial Data Schedule _____________________________ (1) Incorporated herein by reference to the Company's Registration Statement on Form S-3, filed with the Securities and Exchange Commission on February 13, 1998. (2) Incorporated herein by reference to the Company's 1995 Form (3) Incorporated herein by reference to the Company's Registration Statement on Form SB-2 initially filed December 8, 1998. (b) Report on Form 8-K - No reports on Form 8-K were filed during the quarter SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE FEMALE HEALTH COMPANY DATE: May 10, 1999 /s/O.B. Parrish _ --------------------------- O. B. Parrish, Chairman and Chief Executive Officer and Acting Principal Accounting Officer /s/ Robert R. Zic ---------------------------