THE
FEMALE HEALTH COMPANY AND SUBSIDIARIES
NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 six months ended March 31, 2005 are not necessarily indicative
of the results that may be expected for the fiscal year ending September 30,
2005. 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, 2004.
Principles
of consolidation and nature of operations:
The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries, The Female Health Company - UK and The Female Health
Company - UK, plc. All significant intercompany transactions and accounts
have been eliminated in consolidation. The Female Health Company ("FHC" or the
"Company") is currently engaged in the marketing, manufacture and distribution
of a consumer health care product known as the female condom, "FC," in the U.S.
and "femidom," "femy" and "the female condom" outside the U.S. The Female Health
Company - UK, is the holding company of The Female Health Company - UK, plc,
which operates a 40,000 sq. ft. leased manufacturing facility located in London,
England.
Stock-Based
compensation:
The
Company accounts for its stock-based compensation plans under the recognition
and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation.
|
|
|
Six
Months Ended
March
31, |
|
|
|
|
2005 |
|
2004 |
|
|
|
|
|
|
|
|
Net
loss, as reported |
|
$ |
(1,161,292 |
) |
$ |
(1,389,157 |
) |
|
Deduct:
Total stock-based employee compensation
expense
determined under
fair value based method
for
all awards, net
of related tax effects |
|
|
(366,721 |
) |
|
(384,740 |
) |
|
Pro
forma net loss |
|
$ |
(1,528,013 |
) |
$ |
(1,773,897 |
) |
|
|
|
|
|
|
|
|
|
|
Loss
per share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
(0.05 |
) |
$ |
(0.07 |
) |
|
Pro forma |
|
$ |
(0.07 |
) |
$ |
(0.09 |
) |
NOTE 2 -
Earnings
Per Share
Earnings
per share (EPS): Basic EPS is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted EPS is computed giving effect to all dilutive potential common
shares that were outstanding during the period. Dilutive potential common shares
consist of the incremental common shares issuable upon conversion of convertible
preferred stock or convertible debt and the exercise of stock options and
warrants for all periods. Fully diluted (loss) per share is not presented since
the effect would be anti-dilutive.
NOTE 3 -
Comprehensive
Income (Loss)
Total
Comprehensive Income (Loss) was $149,838 and $(938,584) for the three and six
months ended March 31, 2005 and $(660,604) and $(1,137,626) for the three and
six months ended March 31, 2004.
NOTE 4 -
Inventories
The
components of inventory consist of the following:
| |
|
March 31, 2005 |
|
September
30,
2004 |
|
| |
|
|
|
|
|
|
|
|
Raw
material and work in process |
|
$ |
755,325 |
|
|
767,469
|
|
|
Finished
goods |
|
|
132,146 |
|
|
674,209
|
|
|
Inventory,
gross |
|
|
887,471 |
|
|
1,441,678
|
|
|
Less:
inventory reserves |
|
|
(44,736 |
) |
|
(28,363
|
) |
|
Inventory,
net |
|
$ |
842,735 |
|
|
1,413,315
|
|
Note
5. Acquired
Intangible Asset
The
Company follows SFAS 142, Goodwill
and Other Intangible Assets. The
following is a summary of acquired intangible assets at March 31, 2005 and
September 30, 2004:
|
Subject
to amortization: |
|
|
Gross
Carrying Amount |
|
|
|
|
|
Accumulated
Amortization |
|
| |
|
|
|
|
|
|
|
|
|
|
|
Patents
as of March 31, 2005 |
|
$ |
1,123,214 |
|
|
|
|
$ |
1,006,417 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
Patents
as of September 30, 2004 |
|
$ |
1,123,214 |
|
|
|
|
$ |
944,274 |
|
Amortization
expense recognized on all amortizable intangible assets totaled $70,589 and
$65,327 for the six months ended March 31, 2005 and 2004,
respectively.
Estimated
aggregate amortization expense for each of the next following years is as
follows:
Years
ending September 30: |
|
|
|
2005 |
|
$ |
70,589 |
|
|
2006 |
|
|
46,208 |
|
|
|
$ |
116,797 |
|
NOTE 6 -
Industry
Segments And Financial Information About Foreign and Domestic
Operations
The
Company currently operates primarily in one industry segment which includes the
development, manufacture and marketing of consumer health care products.
The
Company operates in foreign and domestic regions. Information about the
Company's operations by geographic area is as follows:
(Amounts
in Thousands)
| |
|
Net
Sales to External Customers |
|
|
Long-Lived Assets As of |
|
| |
|
For
the Six
Months Ended March 31, |
|
|
March 31, |
|
|
September 30, |
|
| |
|
2005 |
|
|
2004 |
|
|
2005 |
|
|
2004 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States |
$
|
864
|
|
$ |
1,321
|
|
$
|
86
|
|
$
|
103
|
|
|
Botswana |
|
467 |
|
|
* |
|
|
|
|
|
|
|
|
Venezuela
|
|
392
|
|
|
*
|
|
|
-
|
|
|
-
|
|
|
Congo
|
|
*
|
|
|
448
|
|
|
-
|
|
|
-
|
|
|
France
|
|
*
|
|
|
517
|
(1)
|
|
-
|
|
|
-
|
|
|
Kenya |
|
* |
|
|
375 |
|
|
- |
|
|
- |
|
|
South
Africa |
|
2,083 |
(1) |
|
415 |
|
|
- |
|
|
- |
|
|
United
Kingdom |
|
*
|
|
|
*
|
|
|
574
|
|
|
502
|
|
|
Zimbabwe
|
|
*
|
|
|
506
|
|
|
-
|
|
|
-
|
|
|
Other
|
|
1,345
|
|
|
952
|
|
|
-
|
|
|
-
|
|
|
|
$
|
5,151
|
|
$
|
4,534
|
|
$
|
660
|
|
$
|
605
|
|
* Less
than 5 percent of total net sales.
(1)Comprised
of a single customer considered to be a major customer (exceeds 10% of net
sales).
NOTE 7 -
Contingent
Liabilities
The
testing, manufacturing and marketing of consumer products by the Company entail
an inherent risk that product liability claims will be asserted against the
Company. The Company maintains product liability insurance coverage for claims
arising from the use of its products. The coverage amount is currently
$5,000,000 for FHC's consumer health care product.
THE
FEMALE HEALTH COMPANY AND SUBSIDIARIES
MANAGEMENT'S
DISCUSSION AND ANALYSIS
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.
The
female condom has undergone extensive testing for efficacy, safety and
acceptability, not only in the United States but also in many countries around
the world. Certain of these studies show that having the female condom available
allows women to have more options, resulting in an increase in protected sex
acts and a decrease in STDs, including HIV/AIDS.
The
product is currently sold or available in various venues. It is commercially
marketed in 21 countries by various FHC country specific partners, including the
United States, United Kingdom, Japan, Canada, Holland, France, and Brazil.
Currently there are programs and/or pilot studies ongoing in 87 developing
countries.
Product
The
female condom is made of polyurethane, a thin but strong material which is
resistant to rips and tears during use. The female condom consists of a soft,
loose fitting sheath and two flexible O rings. One of the rings is used to
insert the device and helps to hold it in place. The other ring remains outside
the vagina after insertion. The female condom lines the vagina, preventing skin
from touching skin during intercourse. The female condom is pre-lubricated and
disposable and is intended for use during only one sex act.
Raw
Materials
Polyurethane
is the principal raw material the Company uses to produce the female condom. The
Company has entered into a supply agreement with Deerfield Urethane, Inc. for
the purchase of all of the Company's requirement of polyurethane. Under this
agreement, the parties negotiate pricing on an annual basis. The term of the
agreement expires on December 31, 2005 and automatically renews for
additional one year periods unless either party gives at least 12 months prior
written notice of termination.
Global
Market Potential
It is
more than twenty years since the first clinical evidence of AIDS was noted.
HIV/AIDS is the most devastating pandemic that humankind has faced in recorded
history. The Joint United Nations Programme on HIV/AIDS (“UNAIDS”) reported that
at the end of 2004, 40 million people globally are living with HIV. Women
now comprise the majority of the new cases. UNAIDS estimates that if further
action isn’t taken up to 100 million people will have died of AIDS by 2020.
Currently
there are only two products that prevent the transmission of HIV/AIDS through
sexual intercourse--the latex male condom and the female condom.
The
Condom Market
Estimates
for the global annual market for male condoms are between 6-9 billion units. In
addition, given the rapid spread of HIV/AIDS in India and China, UNAIDS
estimates that the need for condoms, both male and female, may be as high as 29
billion units in the next 6 years.
The
Female Condom and the Male Condom
The
female condom is currently the only available barrier contraceptive method
controlled by women which allows them to protect themselves from unintended
pregnancy and STDs, including HIV/AIDS. The most important advantage is that
using the female condom, a woman has a prevention method she controls 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 much stronger than latex, reducing the probability that the
female condom sheath will tear during use. 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 date 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
sexual intimacy than the male condom which requires sexual arousal for
application.
Numerous
clinical and behavioral studies have been conducted regarding use of the female
condom. Studies show that the female condom is found acceptable by women and
their partners in many cultures. Importantly studies also show that when the
female condom is made available with male condoms there is a significant
increase in protected sex acts. The increase in protected sex acts varies
by country and averages between 25% and 35%.
Cost
Effectiveness
A study
entitled "Cost-effectiveness of the female condom in preventing HIV and STDs in
commercial sex workers in South Africa" was reported in the Journal
of Social Science and Medicine in 2001.
This study shows that making the female condom available is highly cost
effective in reducing public health costs in developing countries as well as in
the U.S.
Female
Condom Reuse
Studies
have shown that the Female Condom can be reused up to five times. The World
Health Organization (the “WHO”) has noted the procedure to use regarding the
washing and preparation of the female condom if it is going to be reused, on its
website. WHO, UNAIDS and FHC all make the statement that the female condom
should only be reused when a new female condom is not available.
Worldwide
Regulatory Approvals
The
female condom received Pre-Market Approval ("PMA") as a Class III Medical Device
from the U.S. Food and Drug Administration ("FDA") in 1993. The extensive
clinical testing and scientific data required for 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 ("EU") and in most countries of the world. In
addition to the United States and the EU, several other countries have formally
reviewed and approved the female condom for sale, including Canada, Australia,
Japan and India.
The
Company believes that the female condom's PMA 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.
Strategy
The
Company's strategy is to act as a manufacturer, selling the female condom to the
global public sector, United States public sector and commercial partners for
country-specific marketing. The public sector and commercial partners assume the
cost of shipping and marketing the product. As a result, as volume increases,
the Company's operating expenses will not increase significantly.
The
Company filed a patent on a second generation product (FC2) in 2003 and
initiated a development program. Various regulatory approvals for FC2 are
ongoing. It is expected that having FC2 available will result in a meaningful
reduction in cost to manufacture the female condom, and thus ultimately reduce
the cost to customers based on the purchase of sufficient volume. It is the
Company’s objective to use this opportunity to accelerate market
penetration.
Commercial
Markets
The
Company markets the product directly in the United Kingdom. The Company has
distribution agreements with commercial partners in 16 countries with major
programs in 12 countries, including the United States, Canada, Brazil, Mexico,
Spain, France and India. The agreements are generally exclusive for a single
country. Under these agreements, each partner markets and distributes The Female
Condom in a single country and the Company manufacturers The Female Condom and
sells the product to the partner for distribution in that country.
The
Company is in discussions with Fuji Latex, one of the largest male condom
manufacturers and distributors in Japan and with whom the Company has previously
signed an agreement to manage the importation and quality control of the female
condom under Japanese regulatory requirements. The potential new relationship
would broaden Fuji Latex’s involvement with the female condom to include
marketing and distribution in Japan.
Relationships
and Agreements with Public Sector Organizations
The
Company has an agreement with UNAIDS to supply the female condom to developing
countries at a reduced price which is negotiated each year based on the
Company's cost of production. The current price per unit is approximately £0.38
(pounds), or approximately $0.72. Under the agreement, UNAIDS and the Company
cooperate in education efforts and marketing the female condom in developing
countries. Sales of the female condom are made directly to public health
authorities in each country at the price established by the agreement with
UNAIDS. The term of the agreement currently expires on December 31, 2005,
but automatically renews for additional one-year periods unless either
party gives at least 90 days' prior written notice of termination. The female
condom is available in 87 countries through public sector distribution.
In the
United States, the product is marketed to city and state public health clinics,
as well as not-for-profit organizations such as Planned Parenthood.
State-of-the-Art
Manufacturing Facility
The
Company manufactures the female condom in a 40,000 square-foot leased facility
in London, England. The facility is currently capable of producing
60 million units per year.
Government
Regulation
In the
U.S., the female condom is regulated by the FDA. Pursuant to section 515(a)(3)
of the Safe Medical Amendments Act of 1990 (the "SMA Act"), the FDA may
temporarily suspend approval and initiate withdrawal of the PMA if the FDA finds
that the female condom is unsafe or ineffective, or on the basis of new
information with respect to the device, which, when evaluated together with
information available at the time of approval, indicates a lack of reasonable
assurance that the device is safe or effective under the conditions of use
prescribed, recommended or suggested in the labeling. Failure to comply with the
conditions of FDA approval invalidates the approval order. Commercial
distribution of a device that is not in compliance with these conditions is a
violation of the SMA Act.
Competition
The
Company's female condom participates in the same market as male condoms but is
not seen as directly competing with male condoms. Rather, the Company believes
that providing the female condom is additive in terms of prevention and choice.
Latex male condoms cost less and have brand names that are more widely
recognized than the female condom. In addition, male condoms are generally
manufactured and marketed by companies with significantly greater financial
resources than the Company. It is also possible that other parties may develop a
female condom. These competing products could be manufactured, marketed and sold
by companies with significantly greater financial resources than those of the
Company.
Patents
and Trademarks
The
Company currently holds product and technology patents in the United States,
Japan, the United Kingdom, France, Italy, Germany, Spain, the European Patent
Convention, Canada, the People's Republic of China, South Korea and Australia.
These patents expire between 2005 and 2013. Additional patent applications are
pending in the U.S. and in other countries around the world through the Patent
Cooperation Treaty. The applications cover the key aspects of the second
generation female condom, FC2, including its overall design and manufacturing
process. The Company has the registered trademark “FC Female Condom” in the
United States.
The
Company has also secured, or applied for, 12 trademarks in 22 countries to
protect the various names and symbols used in marketing the product around the
world. These include "femidom" and "femy," "Reality" and others. In addition,
the experience that has been gained through years of manufacturing the female
condom has allowed the Company to develop trade secrets and know-how, including
certain proprietary production technologies, that further secure its competitive
position.
RESULTS
OF OPERATIONS
THREE
MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004
The
Company had net revenues of $3,605,764 and net income attributable to common
stockholders of $61,973 or $0.00 per share for the three months ended
March 31, 2005 compared to net revenues of $2,205,565 and a net loss
attributable to common stockholders of $(733,865) or $(0.04) per share for the
three months ended March 31, 2004.
Gross
profit increased $768,658, or 96%, to $1,565,450 for the three months ended
March 31, 2005 from $796,792 for the three months ended March 31, 2004. The
increase was a result of increased net revenues coupled with a less than
proportionate increase in cost of products sold.
Net
revenues increased $1,400,199 for the three months ended March 31, 2005, or
63%, compared with the same period last year. The higher net revenues occurred
because of higher unit sales shipped to global public customers coupled with an
increase of the average selling price per unit due to sales mix. The improvement
in each of these areas was a result of two shipments to South Africa during the
current quarter which made up the majority of the quarter’s global public sector
sales.
Significant
quarter to quarter variations result from time to time due to the timing and
shipment of large orders and not any fundamental change in the business. The
Company routinely notes the potential for such variations in its press releases
and SEC filings.
Cost of
products sold increased $631,541, or 45%, to $2,040,314 for the three months
ended March 31, 2005 from $1,408,773 for the same period last year. Cost of
products sold as a percentage of net revenues declined to 57% for the three
months ended March 31, 2005 compared to 64% for the same period last year. The
lower costs were largely a result of the Company operating at a higher, more
efficient production levels throughout the current quarter as compared to the
same period last year and lower fixed costs. The lower fixed costs were a result
of a significant number of the Company’s fixed assets becoming fully depreciated
during the first quarter of fiscal 2005.
Advertising
and promotion expenditures decreased $756 to $14,020 for the three months ended
March 31, 2005 from $14,776 for the same period in the prior year.
Selling,
general and administrative expenses increased $230,874, or 22%, to $1,280,682
for the three months ended March 31, 2005 from $1,049,808 for the same period
last year. However, selling, general and administrative expenses as a percentage
of net revenues declined to 36% from 48% during the prior year’s second quarter.
The dollar increase that was experienced in the current quarter was due to a
rise in consulting fees, executive staff compensation and an overall increase in
UK operating expenses. The higher consulting fees represented services related
to the documentation stage necessary to design an internal control environment
to comply with Section 404 of the Sarbanes-Oxley Act. During the current quarter
expenses relating to the Sarbanes-Oxley implementation totaled $63,468. The
additional executive costs relate to the hiring of a Global Development Vice
President during the fourth quarter of the prior fiscal year. The position was
vacant for the first three quarters of that fiscal year. The higher UK operating
costs were largely a result of adverse exchange rate fluctuations experienced
during the current quarter.
Research
and development cost increased $19,246 to $63,389 for the three months ended
March 31, 2005 from $44,143 for the same period in the prior year. The Company
filed a patent on a second generation product (FC2) in the latter part
of fiscal 2003. The Company initiated a development program related to FC2
in fiscal 2004. The increase in costs during the second quarter of fiscal 2005
is due to the timing of services rendered related to the safety and
acceptability studies for the FC2 program.
Non-cash
stock compensation costs increased $56,173 to $104,072 for the three months
ended March 31, 2005 compared to $47,899 for the same period last year. The
higher costs during the second quarter were a result of the Company recording
charges related to shares of common stock and stock purchase warrants
issued as an incentive for exercising existing stock warrants during the
second quarter of fiscal 2005 as well as increased compensation for investor
relation services. During
the second quarter of the prior year the Company did not incur any charges
related to issuance of incentive shares or warrants as inducement to exercise
the Company’s common stock warrants.
Net
interest and other expenses decreased $349,144 to $1,779 for the three months
ended March 31, 2005 from $350,923 for the same period last year. The current
quarter decrease was due to the Company eliminating its debt outstanding during
the first quarter of fiscal 2005. The result is a significantly lower amount of
both interest paid and non-cash expenses incurred from the amortization of
discounts on notes payable during the current quarter than the same period in
the prior year.
Preferred
dividends increased $16,427 to $39,535 for the three months ended March 31, 2005
compared to $23,108 for the same period last year. The increase occurred as a
result of the Company’s issuance of 473,377 shares of Series 3 Preferred Stock
to eleven investors during February 2004 which thereby impacted the entire
current quarter but only a portion of the prior year’s second quarter.
SIX
MONTHS ENDED MARCH 31, 2005 COMPARED TO SIX MONTHS ENDED MARCH 31, 2004
The
Company had net revenues of $5,151,422 and net loss attributable to common
stockholders of $(1,161,292) or $(0.05) per share for the six months ended
March 31, 2005 compared to net revenues of $4,534,313 and a net loss
attributable to common stockholders of $(1,389,157) or $(0.07) per share for the
six months ended March 31, 2004.
Gross
profit increased $423,583, or 25%, to $2,094,605 for the six months ended
March 31, 2005 from $1,671,022 for the six months ended March 31, 2004. The
increase was a result of an increase in net revenues coupled with a less than
proportionate increase in cost of products sold.
Net
revenues increased $617,109 for the six months ended March 31, 2005, or 14%,
compared with the same period last year. The higher net revenues occurred
because of higher unit sales shipped to global public customers coupled with the
impact of a higher weighted average exchange rate for the first six months of
the current fiscal year compared to the same period of the prior fiscal year.
Significant
quarter to quarter variations result from time to time due to the timing and
shipment of large orders and not any fundamental change in the business. The
Company routinely notes the potential for such variations in its press releases
and SEC filings.
Cost of
products sold increased $193,526, or 7%, to $3,056,817 for the six months ended
March 31, 2005 from $2,863,291 for the same period last year. Cost of products
sold as a percentage of net revenues declined to 59% in the current period
compared to 63% for the same period of the prior year. The dollar increase
was a result of higher labor and indirect production costs incurred during the
current fiscal year as a result of costs
related to increased production levels and the timing of maintenance and repair
costs. The increases were partially offset by lower depreciation costs during
the current fiscal year as a result of a significant number of the Company’s
fixed assets becoming fully depreciated during the first quarter of fiscal 2005.
Advertising
and promotion expenditures decreased $7,642 to $18,608 during the six months
ended March 31, 2005 from $26,250 for the same period in the prior year.
Selling,
general and administrative expenses increased $360,584, or 17%, to $2,527,249
during the six months ended March 31, 2005 from $2,166,665 for the same period
last year. The increase in the current period was a result of a rise in outside
legal and consulting fees and executive staff compensation. The additional legal
fees were due to non-recurring costs pertaining to banking transactions while
the higher consulting fees incurred represented services related to the planning
and documentation stages necessary to design an internal control environment to
comply with Section 404 of the Sarbanes-Oxley Act. During the six months
ended March 31, 2005, the Company incurred $136,670 in expenses related to the
Sarbanes-Oxley implementation. The additional executive costs relate to the
hiring of a Global Development Vice President during the fourth quarter of the
prior fiscal year. The position was vacant for the first three quarters of that
fiscal year.
Research
and development cost increased $2,885 to $81,075 during the six months ended
March 31, 2005 from $78,190 for the same period in the prior year. The
Company filed a patent on a second generation product (FC2) in the latter part
of fiscal 2003. The Company initiated a development program related to FC2 in
fiscal 2004. The costs during the first six months of fiscal 2005 related to the
safety and acceptability studies for the FC2 program.
Non-cash
stock compensation costs increased $414,422 to $510,219 during the six months
ended March 31, 2005 compared to $95,797 for the same period last year. The
higher costs during the current fiscal year were a result of the Company
recording charges related to shares of common stock and stock purchase warrants
issued as an incentive for exercising existing stock warrants during the
two quarters of fiscal 2005 as well as increased compensation for investor
relation services. During
the prior fiscal year the Company did not incur any charges related to issuance
of incentive shares or warrants as inducement to exercise the Company’s common
stock warrants.
Net
interest and other expenses decreased $628,737 to $38,384 for the six months
ended March 31, 2005 from $667,121 for the same period last year. The decrease
was due to the Company having a lower level of debt outstanding during the first
six months of fiscal 2005 than the same period last year. The
result is a lower amount of both interest paid and non-cash expenses incurred
from the amortization of discounts on notes payable during the first six months
of fiscal 2005 than the same period in the prior year.
Preferred
dividends increased $54,206 to $80,362 for the six months ended March 31, 2005
compared to $26,156 for the same period last year. The increase occurred as a
result of the Company’s issuance of 473,377 shares of Series 3 Preferred Stock
to eleven investors during February 2004 which thereby impacted the first two
quarters of the current year but not the first four months of the same period in
the prior year.
Factors
That May Affect Operating Results and Financial Condition
The
Company's future operating results and financial condition are dependent on the
Company's ability to increase demand for and to cost-effectively manufacture
sufficient quantities of the female condom. Inherent in this process is a number
of factors that the Company must successfully manage in order to achieve
favorable future results and improve its financial condition.
Reliance
on a Single Product
The
Company expects to derive the vast majority, if not all, of its future revenues
from the female condom, its sole current product. While management believes the
global potential for the female condom is significant, the product is in the
early stages of commercialization and, as a result, the ultimate level of
consumer demand around the world is not yet known. To date, sales of the female
condom have not been sufficient to cover the Company's operating costs on an
annual basis.
Distribution
Network
The
Company's strategy is to act as a manufacturer and to develop a global
distribution network for the product by completing partnership arrangements with
companies with the necessary marketing and financial resources and local market
expertise. To date, this strategy has resulted in numerous in-country
distributions in the public sector, particularly in Africa, Latin America and
recently in India. Several partnership agreements have been completed for the
commercialization of the female condom in private sector markets around the
world. However, the Company is dependent on country governments as well as city
and state public health departments within the United States to continue their
commitment to prevention of STDs, including AIDS, by including female condoms in
their programs. The Company is also dependent on finding appropriate partners
for the private sector markets around the world. Once an agreement is completed,
the Company is reliant on the effectiveness of its partners to market and
distribute the product. Failure by the Company's partners to successfully market
and distribute the female condom or failure of country governments to implement
prevention programs which include distribution of barrier methods against the
AIDS crisis, or an inability of the Company to secure additional agreements for
AIDS crisis, or an inability of the Company to secure additional agreements for
new markets either in the public or private sectors could adversely affect the
Company's financial condition and results of operations.
As part
of this strategy, on September 30, 2003, the Company entered into an
agreement with the U.S. Agency for International Development (USAID). Under this
agreement, the Company may supply up to 25 million units of FC Female
Condoms to USAID through December 31, 2006 principally for use in family
planning programs supported by USAID in developing countries. USAID has ordered
3 million units of FC Female Condoms for delivery between
September 30, 2003 and December 31, 2004. USAID also has the option to
order up to 8 million units of FC Female Condoms for the 2005 and 2006
calendar years. USAID has the right to terminate the agreement at any time for
its sole convenience, and no assurance can be given as to the amount of FC
Female Condoms that USAID will purchase during the term of the agreement. As of
May 13, 2005, USAID has purchased 3.2 million units.
On March
25, 2004, the Company appointed Global Protection Corporation ("Global") as the
exclusive distributor of the female condom for public sector sales within a 9
state region in the eastern United States. Global is required to purchase 2.6
million units within a three year period to retain exclusive distribution
rights. As of May 13, 2005, Global has purchased 302,000 units.
Inventory
and Supply
All of
the key components for the manufacture of the female condom are essentially
available from either multiple sources or multiple locations within a source.
Global
Market and Foreign Currency Risks
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. For the first six
months of fiscal 2005, 84% of the Company’s net revenues, 92% of the Company’s
cost of products sold and 40% of the Company’s operating expenses were affected
by changes in the exchange rate of foreign currencies relative to the United
States dollar. Approximately 40% of net revenues in the first six months of
fiscal 2005 were to the Company’s customers in South Africa. On an ongoing
basis, management continues to evaluate its commercial transactions and is
prepared to employ currency hedging strategies when it believes such strategies
are appropriate. 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. For the first six months of fiscal 2005, the
Company estimates that the net impact of the favorable exchange rate
fluctuations was approximately $64,000.
Government
Regulation
The
female condom is subject to regulation by the FDA, pursuant to the federal Food,
Drug and Cosmetic Act (the "FDC Act"), and by other state and foreign regulatory
agencies. Under the FDC Act, medical devices must receive FDA clearance before
they can be sold. FDA regulations also require the Company to adhere to certain
"Good Manufacturing Practices," which include testing, quality control and
documentation procedures. The Company's compliance with applicable regulatory
requirements is monitored through periodic inspections by the FDA. The failure
to comply with applicable regulations may result in fines, delays or suspensions
of clearances, seizures or recalls of products, operating restrictions,
withdrawal of FDA approval and criminal prosecutions. The Company's operating
results and financial condition could be materially adversely affected in the
event of a withdrawal of approval from the FDA.
Liquidity
and Sources of Capital
Historically,
the Company has incurred cash operating losses relating to expenses to develop,
manufacture, and promote the female condom. In fiscal 2003 the Company
experienced a positive cash flow from operations of $0.3 million. Cash
used in continuing operations was $0.2 million for fiscal 2004. During
the second quarter of fiscal 2005 the Company experienced a positive cash
flow from operations of $0.2 million. For the first six months of fiscal
2005 cash used in continuing operations was $0.4 million.
In prior
years, the Company has funded operating losses and capital requirements, in
large part, through the sale of common stock or debt securities convertible into
common stock.
At March
31, 2005, the Company had working capital of $4.1 million and stockholder’s
equity of $3.5 million compared to working capital of $2.5 million and
stockholder’s equity of $1.8 million as of September 30, 2004.
The
Company currently has three revolving promissory notes with Heartland Bank that
allow the Company to borrow up to $2,500,000 and expire in July 2006. The
Company had a balance on one of the promissory notes of $500,000 at September
30, 2004 and this amount was paid off as part of the warrant exercise program
discussed below on November 23, 2004.
In an
effort to generate funds for operating needs and to retire outstanding debt,
between September 2004 and January 2005, the Company conducted a program to
induce the holders of the Company's outstanding common stock purchase warrants
to exercise their warrants. Pursuant to this program, the Company offered an
incentive to such holders providing for issuance of (1) shares of the Company's
common stock equal to 10% of the aggregate number of common stock purchase
warrants exercised or (2) new common stock purchase warrants equal to 20% of the
aggregate number of outstanding warrants exercised containing an exercise price
per share equal to the closing price of the Company's common stock as reported
on the OTC Bulletin Board on the date the holder committed to exercise the
outstanding warrants. Under the incentive program, five investors exercised a
total of 1,500,000 warrants and received 1,650,000 shares of the Company's
common stock, including 150,000 incentive shares, and two investors exercised a
total of 1,200,000 warrants and received 1,200,000 shares of the Company's
common stock and 240,000 incentive warrants with an exercise price in each case
of $1.50 per share and an expiration date of November 23, 2007. Among the six
persons participating in this program include three of the Company's directors
(Stephen M. Dearholt, Richard E. Wenninger and O.B. Parrish). The Company
received aggregate proceeds of $2.5 million from the exercise of the outstanding
warrants. With the proceeds, the Company paid off the remaining outstanding
balance of its long-term debt.
The Company believes it’s current cash position and available
borrowings are adequate to fund the operations of the Company for the year ended
September 30, 2005; however, no assurances can be made.
If the
Company is unable to raise adequate financing when needed, the Company may be
required to sharply curtail the Company's efforts to promote the female condom,
to attempt to sell certain of its assets and rights or to curtail certain of its
operations and may ultimately be forced to cease operations. Currently, the
Company is focused on growing its business and, therefore, the Company has made
no plans to sell any assets nor has it identified any assets to be sold or
potential buyers.
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.
CONTROLS
AND PROCEDURES
As of the
end of the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Company's management,
including the Company's Chief Executive Officer and the Company's Principal
Accounting Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on
this evaluation, the Company's Chief Executive Officer and Principal Accounting
Officer concluded that the Company's disclosure controls and procedures were
effective. It should be noted that in designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. The Company has designed its disclosure
controls and procedures to reach a level of reasonable assurance of achieving
desired control objectives and, based on the evaluation described above, the
Company's Chief Executive Officer and Principal Accounting Officer concluded
that the Company's disclosure controls and procedures were effective at reaching
that level of reasonable assurance.
During
the evaluation of the Company's disclosure controls and procedures as of the end
of the period covered by this report, the Company's management determined
that two material weaknesses within its internal control framework, which
had been identified earlier, were still present.
The first
weakness relates to the timeliness of accounting for certain transactions.
Equity transactions pertaining to outside consultants and new employees were not
communicated in a timely manner to the Principal Accounting Officer by senior
management. In the final stages of preparation of the Company's Form 10-KSB, as
part of a reconciliation process, the Principal Accounting Officer discovered
the excluded transactions and informed the Company’s external auditors of the
proposed adjustments and their potential financial impact. Such issues were
discovered at the end of both fiscal 2003 and fiscal 2004 and related to fourth
quarter activity only. During the quarter following the discovery of each issue,
the Company discussed setting up a procedure to eliminate the possibility of
future exceptions. No new weaknesses relating to the specific equity
transactions have subsequently occurred.
The
second weakness relates to the adequacy of supervisory reviews. The lack of
reviews resulted in adjustments being proposed during the year-end field work by
the Company’s external auditors following the end of fiscal 2004. To remediate
this weakness, beginning with the first quarter of the current fiscal year, the
Principal Accounting Officer began reviewing all of the components of the U.K.
balance sheet and income statement including material financial transactions. No
new adjustments have been proposed by the Company’s external auditors during the
first two quarters of the current fiscal year related to the U.K. financials. In
the U.S., the Company has begun the process of hiring a consultant to function
as an accounting manager and allow the Principal Accounting Officer to serve in
a supervisory review function. The Company believes the supervisory review
function will begin in earnest during the third quarter of the current fiscal
year.
The
Company is in the process of implementing Section 404 of the Sarbanes-Oxley Act.
In doing so the above material weaknesses will be addressed and
remediated. In completing the evaluation of disclosure controls and
procedures as of the end of the period covered by this report, the Company's
management concluded that the Company's disclosure controls and procedures
were effective despite these two material weaknesses because the material
weaknesses involved isolated matters affecting relatively discreet, immaterial
items and management believes that the issues were promptly brought to its
attention.
There was
no change in the Company's internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934,
as amended) during the Company's most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART
II - OTHER INFORMATION
ITEMS
1-5
Item
4
The
Company held an Annual Meeting of its shareholders on March 18, 2005. At the
meeting, shareholders were asked to elect O.B. Parrish, Mary Ann Leeper, Ph.D.,
William R. Gargiulo, Jr., Stephen M. Dearholt, David R. Bethune, Michael R.
Walton, James R. Kerber, Richard E. Wenninger and Mary Margaret Frank, Ph.D. to
the Board of Directors to serve until the 2006 Annual Meeting, and to ratify the
appointment of McGladery & Pullen LLP as the Company’s independent auditors
for the fiscal year ending September 30, 2005. The results of the shareholder
voting are listed below:
|
Matter
Voted On:
|
For |
Against |
Withheld |
|
O.B.
Parrish |
18,748,667 |
- |
99,413 |
|
Mary
Ann Leeper Ph.D. |
|
- |
99,098 |
|
William
R. Gargiulo, Jr. |
18,748,667 |
- |
99,413 |
|
Stephen
M. Dearholt |
18,746,617 |
- |
101,483 |
|
David
R. Bethune |
18,746,523 |
- |
101,557 |
|
Michael
R. Walton |
18,748,917 |
- |
99,163 |
|
James
R. Kerber |
18,745,958 |
- |
102,122 |
|
Richard
E. Wenninger |
18,746,682 |
- |
101,396 |
|
Mary
Margaret Frank, Ph.D. |
18,743,257 |
- |
104,823 |
|
Ratification
of Independent Auditors |
18,763,755 |
87,050 |
7,275 |
Exhibit
Number Description
|
3.1
|
Amended
and Restated Articles of Incorporation. (1) |
|
|
|
|
3.2
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation of the
Company increasing the number of authorized shares of common stock to
27,000,000 shares. (2) |
|
|
|
|
3.3
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation of the
Company increasing the number of authorized shares of common stock to
35,500,000 shares. (3) |
|
|
|
|
3.4
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation of the
Company increasing the number of authorized shares of common stock to
38,500,000 shares. (4) |
|
|
|
|
3.5
|
Amended
and Restated By-Laws. (5) |
|
|
|
|
4.1
|
Amended
and Restated Articles of Incorporation (same as Exhibit 3.1).
|
|
|
|
|
4.2
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation of the
Company (same as Exhibit 3.2). |
|
|
|
|
4.3
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation of the
Company increasing the number of authorized shares of common stock to
35,500,000 shares (same as Exhibit 3.3). |
|
|
|
|
4.4
|
Articles
of Amendment to the Amended and Restated Articles of Incorporation of the
Company increasing the number of authorized shares of common stock to
38,500,000 shares (same as Exhibit 3.4). |
|
|
|
|
4.5
|
Articles
II, VII and XI of the Amended and Restated By-Laws (included in
Exhibit 3.5). |
|
31.1
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
|
|
|
|
31.2
|
Certification
of Principal Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. |
|
|
|
|
32.1
|
Certification
of Chief Executive Officer and Principal Financial Officer pursuant to 18
U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002) (6)
|
_____________________________
|
(1)
|
Incorporated
herein by reference to the Company's Registration Statement on
Form SB-2, filed with the Securities and Exchange Commission on
October 19, 1999. |
|
|
|
|
(2)
|
Incorporated
by reference to the Company's Registration Statement on Form SB-2,
filed with the Securities and Exchange Commission on September 21, 2000.
|
|
|
|
|
(3)
|
Incorporated
by reference to the Company's Registration Statement on Form SB-2,
filed with the Securities and Exchange Commission on September 6,
2002. |
|
|
|
|
(4)
|
Incorporated
by reference to the Company's Quarterly Report on Form 10-QSB for the
quarter ended March 31, 2003. |
|
|
|
|
(5)
|
Incorporated
herein by reference to the Company's Registration Statement on
Form S-18, as filed with the securities and Exchange Commission on
May 25, 1990. |
|
|
|
|
(6)
|
This
certification is not "filed" for purposes of Section 18 of the Securities
Exchange Act of 1934, as amended, or incorporated by reference into any
filing under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended. |
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
16, 2005
/s/
O.B.
Parrish
O.B.
Parrish, Chairman and
Chief
Executive Officer
DATE: May
16, 2005
/s/
Robert R.
Zic
Robert R.
Zic, Principal
Accounting
Officer (Principal
Financial
Officer)